HKUST Business School Magazine

How can family firms be more credible in the capital markets? (1) Be more transparent: a company’s information consists of financial reports and information intermediaries such as auditors or financial analysts. As mentioned, family firms tend to have lower institutional ownership due to their own shareholdings. Thus, family firms are often perceived to be more opaque than non-family firms, which may lead to higher financing costs and reduce stock liquidity. While family firms may not worry about the short term stock performance of their firms, they nonetheless should increase transparency, which can help enhance investor confidence and in turn reduce their financing costs. For example, controlling families could provide more financial/non- financial information during conference calls with financial analysts or at the annual shareholder meeting. Furthermore, family firms could issue more earnings forecasts to alert investors about a better or worse than expected financial performance, and they could also offer more information on their company websites. These actions not only increase the transparency of a family firm but also change their credibility in the capital markets. Our research indeed finds that corporate transparency matters more for family firms relative to non-family firms. 1 (2) Become more externally governed: family firms, particularly those in Asia, tend to have descendants succeed the company not only as the chairman of the board but also as the CEO of the firm. While family succession has benefits such as ensuring company direction and philosophy, it unavoidably creates an image that the firm is family governed. Importantly, when founder descendants succeed to the chairman or CEO positions without competition, outsiders and shareholders may perceive the selection to be based on blood rather than merit. Indeed, both anecdotal evidence and academic research find that family firms’ superior performance disappears when founder descendants take over as management, which is consistent with the old Chinese saying that a family won’t sustain the wealth for more than three generations. One way to mitigate this downward spiral is to crown one family member as the chairman of the board and appoint a professional manager as CEO. One good example of this practice is Walmart, which is a world-renowned family firm controlled by the Walton family. When Walmart’s founder Sam Walton passed away, his elder son, Robert Walton, succeeded as the Board Chair, while a professional manager was appointed as the CEO. Under the Walton family, Walmart continued to grow to become one of the largest and most successful firms. (3) Embrace higher ethical standards: holding key management posts and having long-term involvement with their firm accords controlling family members access to confidential company information. It is therefore easy for them to unload their shares to reap profits on the basis of undisclosed inside information. Of course, sometimes controlling families do need to dispose of some shares for personal reasons, such as paying tax. However, based on my observations, stock sales by the CEO or the Chair of the board typically lead to stock downturns, as investors consider the sales to show a lack of confidence in the firm’s prospects, and the stock downturns are more pronounced when the sales are carried out by the controlling family. As such, if it is deemed necessary to sell their shares, I would recommend the controlling family to do it “routinely” annually, in a given year, and communicate the stock transaction in a transparent way to avoid any suspicion. Further, related party transactions are often observed between firms controlled by the same family, and these can arouse investors’ concerns over self-dealing or channel stuffing. Again, if related party transitions are unavoidable, the controlling family should at least appoint an independent committee and engage an independent outside third party to review and endorse the deal, and the process should be transparent. In short, greater ability comes with great responsibility, so if controlling families would like their firms to be long-lived, they ought to impose higher ethical standards on themselves whenever they are involved in their company business. References 1 A. Ali, T. Y. Chen, and S. Radhakrishnan, “Corporate disclosures by family firms” Journal of Accounting and Economics, Vol. 44, Issues 1-2, 2007, pp. 238 – 286. T. Y. Chen, S. Dasgupta and Y. Yu, “Transparency and financing choices of family firms” Journal of Financial and Quantitative Analysis, Vol. 49, No. 2, 2014, pp. 381-408. Insight Biz@HKUST 42