Tightly controlled companies are the unloved children of the public markets, because they concentrate decision-making in the hands of the few to the exclusion of a firm’s wider shareholder base. But when those power brokers happen to be a family or founder, retail investors tend to shrug and invest anyway—for good reason, it turns out.
A 2013 study by the Clarkson Centre for Business Ethics and Board Effectiveness (CCBE) at the University of Toronto found that Canadian family-controlled issuers outperformed their TSX peers. The study compared the compound annual growth rate of a Family Index of 23 companies—in which at least 30% of voting control belonged to a family with multi-generational involvement in the ownership or management—against 412 widely held firms over a 15-year period (1998 to 2012). The Family Index posted an annualized return of 7.7%, compared with just 6.1% for non-family firms.
This is not just an anomalous finding in a small market where families happen to control many blue-chip stocks, either. A 2012 Credit Suisse report and a 2014 study from Spain’s Banca March found similar outperformance for family firms compared with widely held issuers in Germany and Europe, respectively.
Anyone whose portfolio contains Canadian stocks knows it’s hard not to have exposure to family-controlled firms. A significant portion of the S&P/TSX 60 Index consists of such companies, including the Desmarais-controlled Power Corporation of Canada (TSX: POW), the McCain-controlled Maple Leaf Foods (TSX: MFI) and the eponymously controlled Saputo Inc. (TSX: SAP), to name three that have outperformed their sectors so far in 2015.
Insiders at family-controlled firms attribute their superior performance to a difference in priorities, says Matt Fullbrook, manager of the CCBE and co-author of the study. Effective voting control allows a family (or its appointed managers) to ignore the pressure to deliver short-term financial results. Rather than cater to retail investors demanding growth every quarter, these companies plan and invest for the long term, since the founding family’s wealth is tied up in the business.
Fullbrook acknowledges that the CCBE, among other organizations, has long viewed controlled companies as “somehow inferior when it comes to corporate governance.” Dual-class share structures, which give controlling shareholders more than one vote per share or designate some shares as non-voting, are particularly unpopular among governance wonks and institutional investors. The likes of the Ontario Teachers’ Pension Plan, Canada Pension Plan Investment Board and British Columbia Investment Management Corp. have policies favouring the principle of one share, one vote.
Still, the CCBE study indicates dual-class structures may actually contribute to the outperformance of family-controlled firms. Companies with a voting imbalance posted an annualized return of 8.8%, whereas Family Index firms with balanced voting structures underperformed the market, returning 5.1% a year on average. Companies led by a family member were particularly good bets, producing better returns than both widely held firms and those that were family controlled but managed by someone outside the clan.
Dual-class structures can be a good thing for investors if they’re set up properly, says Som Seif, founder and CEO of Purpose Investments Inc., a fund manager with more than $1 billion in assets under management. Allowing a founder or family to retain control gives private companies an incentive to enter public markets, he points out. “These are still high-growth businesses that have many of the same attributes of a private company,” he says. “Shareholders are basically being offered the opportunity to participate.”
Scandals aided by preferential stock structures at companies such as Hollinger International in the early 2000s turned institutional investors against these systems. A more recent cautionary tale involved the costly unwinding of the Stronach family’s control of Magna International Inc. (TSX: MG). “The moment it becomes economic—like it did in the case of Magna—where that large shareholder was using it as a way to facilitate greater payments and economic value to themselves, that’s when I think it’s disgustingly wrong,” Seif says. He emphasizes that family-controlled companies should have policies in place to allow for the unravelling of preferential share structures.
Regardless, common shareholders continue to show themselves willing to trade their voices in company oversight for the prospect of attractive returns. Consider the April initial public offering of the Phelan family–controlled Cara Operations Ltd. (TSX: CAO). The dual-share offering jumped 43% on its debut.
Fullbrook suspects the outperformance of family-controlled firms may not persist in future, because institutional investors have begun to pressure companies to adopt the same longer-term perspective that sets controlled firms apart. “To the benefit of Canada’s markets, we may see that gap close between controlled companies and widely held companies, not because the family firms are getting worse, but because the rest of the market is getting better,” he says.
However, Seif sees little evidence to suggest these pressure campaigns are having any effect. “Look at the way management is thinking—it’s all share buybacks and short-term incentive thinking,” he says. He points to activist investors as a particular thorn in the side of management, forcing it to focus on quarter-to-quarter earnings and giving up board seats instead of investing in research and development. If that trend continues, investors with a longer-term perspective might be better off keeping their investments in family businesses.
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