Scott Mcculloch is editor of Families in Business magazine.
Are family-controlled companies heavy handed in their treatment of outsiders? Or are outsiders unfairly contemptuous towards family businesses? Scott McCulloch reviews a few boardroom crackdowns
After the death of Fiat patriarch Umberto Agnelli last May, the Italian carmaking family wasted little time sacking non-family CEO Giuseppe Morchio in favour of long-time family friend Luca Cordero di Montezemolo. Motorola's share price jumped 9% on the departure of chief executive Christopher Galvin, a scion of the founding family. Viacom's CEO Mel Kazmarin quit after more than 20 years with the company, much of which he spent awaiting the retirement of CEO and controlling shareholder Sumner Redstone. The octogenarian promptly named two co-presidents and said he planned to remain until 2007, perhaps stalling for time while daughter Shari Redstone prepares to take over. Analysts say she is unprepared to run a company the size of Viacom.
Why are family businesses under so much scrutiny? In a word: Parmalat. The Italian food conglomerate's sour implosion deepened concerns about governance of family-dominated public companies and prompted calls in Europe and beyond for tighter rules on who can sit on corporate boards. But it was arguably the Rigas family who single-handedly destroyed the concept (and credibility) of family dominated boards as a functional form. After all the family, say US prosecutors, ripped off the public shareholders in Adelphia Communications. The bankrupt cable company was looted of hundreds of millions of dollars.
The bigger the scandal, the wider the contagion. Last January Schnitzer Steel Industries, a US scrap metal concern, fended off a would-be shareholder revolt led by Microsoft chairman Bill Gates, and voted to keep the company's board of directors in the hands of the venerable Portland, Oregon family that founded it nearly a century ago. The proposal brought by Cascade Investment, which is owned by Gates, was intended to make the majority of the board independent from the descendants of Sam Schnitzer, who founded the company in 1906. Seven of the 10 board members are blood relatives or married to members of the company's namesake family. Cascade believes the family's dominance puts Schnitzer Steel squarely out of step with corporate governance standards and open to the same corruption that unwound Adelphia Communications.
The common perception is that founding families are bad news for investors in public companies. But is this fair? True, Parmalat had an untrendy management structure. The Tanzi family controlled 51% of the company's equity. The founder, Calisto Tanzi, was chairman and CEO, while his son, Stefano, was a former CEO and a board member, and a clutch of other family members held sway over other parts of the corporate group. One or two outside directors, says Italian governance expert Francesco Giavazzi, would have prevented the mess. Really?
Not necessarily, says Finn Poschmann of the CD Howe Institute, a Canadian think-tank. He believes one of two outcomes could have emerged with a few outsiders. "If a capable and informed board member would have stood up to management, the drawn-out fraud that curdled Parmalat might have been stopped sooner." But maybe not, he counters. "Outside board members are not always as well-informed of a company's detailed investment prospects as are insiders, and may not be in a position to act."
So, damned if you do, damned if you don't. Businesses often turn to outsiders because no one wants to see the company go down the drain after working so hard to build it up, say experts familiar with corporate governance. The problem is that outsiders are often nimble at running the company but rather sclerotic in negotiating family politics. It's a paradox, says Joe Astrachan, director of the Cox Family Enterprise Centre in the US. The natural inclination of an outside CEO is to avoid the family dirt and concentrate on steering the ship.
Yet outsiders are acutely aware of their finite lifespan. When mature companies that have been built by a family but handed over to outside managers run into trouble, and the founding family has enough clout to get its way, seizing control is a natural reflex. Bill Ford, CEO of Ford Motor, used his family's 40% voting interest to supplant Jac Nasser in 2001. The move came amid the Firestone tyre crisis, (US regulators linked Firestone tyres and Ford Explorers to 271 deaths from roll-over accidents). Ford lost a staggering $5.5bn that year and Wall Street analysts promptly predicted bankruptcy for the carmaker. A lot can change in three years and Bill Ford has since been lauded as all but the Messiah in turning round the company founded by his great-grandfather Henry.
So what of outsiders? Poschmann says there are two things to know before firing the founder or handing control to outsiders. Firms with founder CEOs tend to outperform others, whereas firms with more independent directors tend to do worse. About one-third of firms on the S&P 500 have significant family equity holdings, and those families tend to have board representation far greater than their equity ownership would directly warrant. According to professors Ron Anderson and David Reeb, between 1992 and 1999 these family-controlled firms outperformed non-family firms by a wide margin. They had better return on assets and their market values as a multiple of asset replacement costs tended to be much higher than others.
So why did Walter Hewlett, Hewlett-Packard board member and founding family scion vote with HP's board in September 2001 to okay a bid to buy Compaq only to turn around in November that year and publicly oppose it? He and many other descendants of the two founding families, and associated foundations, vehemently opposed the ensuing merger with Compaq. They saw it as unwise and in conflict with the 'HP Way' – an internal set of values focused on mutual responsibility between management and employees. Unfortunately for Walter Hewlett, the Hewlett and Packard families only controlled 18% of HP and lost the shareholder vote on the merger, despite support from many other investors.
Three years on, after CEO Carly Fiorina pulled off a transforming merger, Hewlett-Packard looks huge, frail and confused. Shares in the computer and printer company tumbled by 17% in August after it reported disappointing third-quarter results and warned of further weakness.
Would it have been different had the families got their way? When she took on the role of CEO in July 1999, Fiorina knew that as the first outsider at the helm of HP, she would have to tread a careful path. But a consensus has emerged in the industry that the new HP, the tech industry's most sprawling conglomerate, is being squeezed by two formidable rivals with much clearer business models, Dell and IBM. Today, the 49% of HP shareholders who voted against the merger will feel vindicated, if not richer. The families lost power; shareholders lost money.
A more recent example was Roy Disney's decision to step down from the Walt Disney board after his attempt to oust CEO Michael Eisner failed. The founding family's control had been diluted over time. Roy didn't have the power to get his way. Yet the entertainment giant shrugged off the effects of a poor first quarter at the box office and raised expectations with a prediction that full-year profits would rise at least 50%. Eisner called it a sign of resurgence. Dissident ex-directors Roy Disney and Stanley Gold dismissed the 50% growth prediction, claiming growth was over for 2004. In fact, the company is likely to make good on its promise for the year ending 30 September. Meanwhile, Eisner will step down as chief executive in 2006. The decision signals the end of his 20-year stewardship, a reign marked by an expansion of Disney's empire, bruising corporate battles and a shareholder revolt that he narrowly survived earlier this year.
Watching the struggles of the Hewletts and Disneys to try to hold sway at eponymous firms, it is easy to see why dynastically minded founders favour multiple stock classes that separate voting control from ownership. But is this always wise?