All over the world, the results are the same – family businesses make for better stock market investments. That’s according to a detailed Credit Suisse report which shows family businesses tend to be safer, more profitable and more long-term in their thinking than non-family-owned public companies.
The report, co-authored by Michael O'Sullivan – Credit Suisse's chief investment officer for international wealth management and a member of Ireland's National Economic Social Council – examines the performance of 1,015 companies worth at least $250 million where founders or descendants own at least 20 per cent of the firm.
The results are striking: since 2006, family companies have handsomely outperformed the broader equity markets in all regions of the world. The gap is especially wide in Europe, where almost a quarter of the companies analysed are located. European family-owned companies have outperformed local peers by almost five percentage points per year since 2006. Outperformance is especially marked in Germany and Italy, although the results are not distorted by any one country – family-owned companies have outperformed their non-family-owned counterparts in every European country analysed. Family companies have long been a staple of the investment landscape in Asia, where more than half the companies are located. Again the results are unambiguous, with family-owned companies outperforming in every Asian country. Family companies also outperform in the US, even if the degree of outperformance is not as dramatic as that seen in Europe and Asia.
Importantly, the global results are not driven by any one industry; family-owned companies outperform in every sector, indicating the family factor is a very robust one.
Corporate performance
Why do family companies deliver better equity returns? Quite simply, their corporate performance is better, with family firms generating greater revenue growth and higher profit margins. The majority of family firms are what’s known as quality companies. In fact, family companies score better in terms of corporate quality in each of the 21 largest countries analysed by Credit Suisse. They also tend to be more risk averse, holding less debt than non-family-owned companies.
This prudence, allied to their strong corporate performance, is recognised by credit rating agencies like Standard & Poor’s. In the US, for example, nearly a quarter of family companies are rated A- or better, almost double the percentage for non-family firms. Almost half of US family-owned companies have a credit rating of BBB or higher, compared to just 35 per cent of non-family-owned firms. Unsurprisingly, this cocktail of superior profitability, a conservative financial structure and creditworthiness is typically rewarded by investors, with family firms tending to trade at a premium to rival companies. The results might surprise some. In the past business historians tended to regard family companies as relics of a less developed capitalist era, when it was more difficult to recruit outside talent and capital. That all changed with globalisation and the growth of capital markets. Classical economists and management theorists predicted powerful family companies would diminish over time, with business patriarchs and family insiders supplanted by more qualified managers and professionals.
The assumption was that established family empires were at greater risk of nepotism and inefficiency. As a 2015 Economist report noted, businesses that restrict their choice of heirs to immediate family members "can be left with dunces".
Moreover, future generations may not have the same drive as their forefathers who grew the business, preferring to enjoy their riches rather than to continue growing the business. Many cultures have phrases that echo the Japanese saying that "the third generation ruins the house", the Economist report noted.
Connections
And yet, family-owned companies have not withered – far from it. The French companies on the Credit Suisse list have a combined market capitalisation of $812 billion. Germany ($515 billion) and Switzerland ($422 billion) also stand out, the report notes.
Separate research by the Centre for European Economic Research shows the 500 largest family-owned companies in Germany employ 57 per cent of the country's workers. Walmart, Samsung, Ford, BMW, Fiat, Heineken, Anheuser-Busch, Pernod-Ricard, L'Oreal – many of the world's biggest companies continue to have deep family connections.
How have family businesses managed to defy the doubters? The secret, suggests iconic investor and Berkshire Hathaway chief executive Warren Buffett, is their "long-term orientation, belief in hard work, and a no-nonsense approach and respect for a strong corporate culture".
The Credit Suisse report suggests Buffett is right. Family- and founder-owned companies want to hand their businesses down to their children, forcing them to take a long-term view as opposed to fretting over quarterly earnings targets. As a result, says Credit Suisse, they spend more money on research and development and capital expenditure, while less cash is typically taken out of the business through dividends and share buybacks.
Globally 15.8 per cent of cash flows is spent on share buybacks by non-family-owned companies; in contrast, this share is only 6.8 per cent in the case of family-owned companies. Incidentally, Berkshire Hathaway is a good example of a long-termist family company, with the company never issuing a dividend and pledging only to buy back shares when they are selling for less than their “intrinsic value”. Buffett’s son, Howard, is expected to become Berkshire’s non-executive chairman after Warren (87), is no longer leading the company, with Howard’s role being to “further ensure continuation of our culture”.
Sceptics
Any caveats? Well, the report examines performance dating back to 2006, and sceptics might argue this is far too short a period to conclude that family-run businesses are better-run enterprises.
Additionally, whereas previous studies defined a family business as one where there has been a transition from one generation to the next, or plans for such a transition, the Credit Suisse report includes founder-led companies. That means companies like Google and Facebook make the list.
Still, separate research covering other periods have come to similar conclusions, with most studies indicating family-controlled companies tend to be better investments.
Indeed, one of the most striking aspects of the Credit Suisse report is that even family companies employing seemingly shoddy corporate governance practices usually make for good investment candidates.
Some families maintain a tight grip on control by awarding themselves shares with special voting rights. That’s long been regarded as a no-no by corporate governance experts, who see it as disenfranchising other shareholders.
However, such concerns appear “misplaced”, with US companies run by families with special voting rights significantly outperforming other family businesses. Shares with special voting rights tend to be less liquid, the report noted. This lack of liquidity draws owners closer to their companies and likely fosters “an even longer-term view toward wealth creation and preservation”. In other words, ordinary shareholders might be displeased by this undemocratic centralisation of executive power, but they are more than compensated by the long-termism that tends to accompany such arrangements.
Dominant
Looking forward, economic power is moving towards Asia, where family-led companies remain dominant. The rise of emerging markets means family-owned companies are likely to represent 40 per cent of the world’s largest enterprises by 2025, estimates management consultancy McKinsey, up from 15 per cent in 2010.
Instead of retreating in the face of globalisation, it seems family-owned companies will likely become increasingly prominent in the coming years.
