In November 2012, Amit gave a talk to a group of entrepreneurs in Shanghai on the costs and benefits associated with a range of mechanisms used by families to maintain voting control of their firms… During the lecture, Amit highlighted a range of alternatives to finance the growth of family firms, including, among others:
- retained earnings
- bank debts
- internal capital of family groups
- joint venture partners
- strategic partners
- private equity
- public equity
- public debt.
Arguing against going public
Although each method has its pros and cons, he said, the deeper issue “is that a family
business owner is very reluctant to share the control or even give up control in some
cases to any external capital provider.” For example, he said, an argument against going public might be that by using public sources of financing, one has to disclose valuable business information to competitors and be subject to the short-term orientation of public capital markets.
But there are also advantages, he noted:
“By being public, you have a lot of flexibility. You have the currency – your stock – to use for acquisitions; it provides the potential for liquidity to family members and other shareholders, and it provides transparency for consumers and investors. Public companies can also use stocks as incentives for professional managers, as one of the biggest problems that family businesses have is to try to attract and retain professional managers.”
But families don’t like to relinquish control, Amit said, and often put in place potentially “costly” mechanisms like dual-class shares with different voting power, pyramidal ownership, and disproportional board representation…
“By far the most prevalent control mechanism used by families is dual-class stock. The
reason is that it gives the largest wedge between their ownership (i.e., their economic
interest) and their voting control. But it’s also the most costly in the sense that dual-class shares have the most negative impact on the value of the firm’s stock.
In general, my joint research with Professor Villalonga of Harvard Business School on
large family businesses has validated empirically that dual-class shares and disproportional
board representation negatively affect the value of the firm. However, voting agreements have
a positive impact on value. So, while the downside of a voting agreement is that it doesn’t provide
as large a wedge as dual-class shares, you don’t suffer in firm value.”
The cost of control
What mechanisms has your family put in place to maintain voting control of the business?
Raffi Amit is the Robert B. Goergen Professor of Entrepreneurship and a Professor of Management at the Wharton School. Dr. Amit is the Academic Director of the Goergen Entrepreneurial Management Programs which encompasses all of Wharton’s entrepreneurial programs.
As well, he co-founded and leads the Wharton Global Family Alliance (WGFA), a unique academic-family business partnership established to enhance the marketplace advantage and the social wealth creation contributions of global families through thought leadership, knowledge transfer and the sharing of ideas and best practices among influential global families.
Dr Amit has published extensively his empirical and field research on a broad range of issues that relate to Families and their businesses and is frequently quoted in the press. For the full story, read The Cost of Control: Managing the Growth of Family Businesses.