Are family firms superior performers?

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The share of family firms’ contribution to global GDP is estimated to be in the range of 70%-90%. 73% of firms in the Bombay Stock Exchange 500 index are family run. That is, a large fraction of economic activity takes place inside family owned businesses where the founder or the descendants play a key role in managing the firm’s affairs.

Does ownership by a family improve firm performance? An advantage of sustained, concentrated ownership is that it gives the owners better incentives to monitor the firm and make necessary changes in management. If stable concentrated ownership leads to better corporate decisions by owner-managers, we would expect a positive relation between ownership concentration and firm performance (return on assets or shareholder returns). However, a high concentration of equity holdings also has the potential to give undue power to family members, and lead to extraction of private benefits, which can adversely affect firm performance and shareholders’ wealth.

Research in the U.S. measure family firm performance using an accounting measure of profitability such as the return on assets (ROA) and conclude that family firms perform better than non-family firms. Further, it suggests that family firms outperform their non-family peers when a widely used market value of firms is used as an alternative measure of performance. Authors in the US also find that when family members serve as the CEO, performance is better than when outsiders serve as CEOs. Similar results to those in the U.S have been reported for European countries and Japan. Now does this superior accounting return on assets translate into relatively higher returns to you, the stockholder? We investigated this question using Indian data. We measure abnormal returns as stock returns over and above that to the market index.

A unique feature of Indian family business is the unusually high average equity ownership level and management participation by the family at 51% (of the total shares), compared to about 38% in Europe, 18% in the U.S., and 6% in Japan. Further, unlike the more developed markets, India offers relatively higher growth opportunities combined with less competitive product markets. A large majority of Indian family and non-family firms enjoy relatively high growth opportunities and low product market competition. Without controlling for differences in firm characteristics, family firms, on average, earn abnormal returns of 22.4%, while non-family firms earn 20.7%.  After controlling for risk, however, family and non-family firms earn positive abnormal returns of 0.24% and 0.59%, respectively, per month. The difference in performance is insignificant. A strategy of going long on the high insider ownership portfolios and short on the non-family firms produces an insignificant, negative alpha of 1.014% after controlling for market risk, size and value factors.

Using Indian data for ten years from 2001 to 2010 we find that in the vast majority of industries characterized by high growth rates and low product market competition, family firms do not generate positive market-adjusted abnormal stock returns when their ownership stakes are low, but they display positive performance when their ownership level is high. However, the superior performance of family dominance gets dissipated in the case of a smaller fraction of firms facing high product market competition in high growth environments. Overall, family dominance in India tends to enhance firm performance in a broad swath of economic landscape marked by less competitive and high growth market environments, but the superior financial performance of high family holdings evaporates in more competitive environments.

[Authored by Rama Seth, Professor of Finance, IIM-Calcutta; This article is based on a paper forthcoming in the Pacific Basin Finance Journal by S. Hegde, R. Seth and S.R. Vishwanatha]