Hitting the goldilocks point is the key to outperformance


It’s a perennial debate at private firms once they reach a certain point: should you float or not?

The usual reasons to go public include the firm needing money to grow further, and whether it has a clear enough plan about how to do so; the founder retiring and having no successor in the family; a desire to become more professional, at least in the eyes of employees, customers and other stakeholders.

There are downsides, of course: the family loses its privacy, for a start, and potentially loses control of the company in bad times, when it is easy for managers to blame the family’s interference for their problems. Family Capital has looked at this previously here.

But there is another, simpler, reason that going public can be a good idea: if you do it right, it boosts the performance of the company. At least, that is what the academic literature suggests.

The conventional wisdom is that founding-family share ownership is “inefficient”: families might prefer stability and capital preservation over profit maximisation, of they might prefer to employ family members rather than better, non-family employees. These are among the reasons that firms in which a family owns a large proportion of the equity could perform worse than companies where no founding family is involved.

But it is not necessarily the case, as two studies argue.

One showed that the relationship between family ownership and profitability has an inverted U shape. In other words, profitability increases as family ownership increases, until it reaches a certain point, and then it drops off. According to the paper: “It reaches a peak when 40% of shares belong to a family but then falls as family share continues to rise.” The study also found that having a family CEO, and high levels of family voting rights, increased financial performance.

The problem? That the study was based on Polish firms in the 1990s and 2000s. Not only was this an emerging market, but almost all of the firms were in their first generation of family ownership, because they had started only after the fall of communism.

However, the results are backed up by another study, which was carried out in the US and looked at S&P 500 firms. This found that in terms of both profitability and market performance, family ownership was a boon, and again this was most pronounced if there was a family CEO. “ One interpretation [of this fact] is that the family understands the business and that involved family members view themselves as the stewards of the firm,” write the authors. They also found with the inverted U-shape, that there is what you might call a Goldilocks point for family share-ownership – not too hot, and not too cold.

There are problems with this study too, of course. For a start it only studied large American firms, which you might argue are hardly representative of all businesses. And secondly, the sample might be skewed towards success, because families might only stay in firms which are doing well, becasue they know when things are going wrong and sell out. Thirdly, it was based on data over a decade old.

But that both had two of the same conclusions – about the U shape and the family CEO – is compelling. However, it raises question: do we still see the same pattern today? What about in other economies? Does the dynamic change as businesses get older? How powerful is the CEO effect?

Come back for future instalments of Family Capital’s series on financing the family business for answers.