Fox’s Reeb: It pays to be a ‘good guy’

Family-run companies fare differently depending on the makeup of their boards, his analysis says

Photo Credit: Shelly Roseman

Reeb

When people think about family-run corporations, some picture the Rigas family’s Adelphia, said Fox professor of finance David Reeb, who was quoted in a New York Times article in April about family entrepreneurship. However, Reeb said that the case of Adelphia, a poorly run and corrupt family company, is the exception.

According to Reeb’s appearance on CNN’s “In The Money,” on Aug. 6, a better model for a family business would be Rupert Murdoch’s News Corp., because its success is based on its strong desire to see the family do well.

Reeb points out that the majority of family-run corporations are honest and well-run. After researching the board makeup of American family-run corporations, he found that family-run corporations fit into one of two categories.

“Type one are the good guys,” Reeb said, adding that they make up about three-fourths of family-run corporations. “Type two are the bad guys.”

According to Reeb, the “type ones” and “types twos” can be determined by looking at the makeup of a company’s board of directors. If independent directors hold more of the board’s seats than family members, then that company usually fits into the “type one” category. In these corporations, “the family monitors the managers, and the managers monitor the family to make sure no shenanigans are going on.”

The trouble with the type two companies is that “if the family holds the majority of the seats, they can do whatever they want. … If no one is looking, they tend to stick their hands in the cookie jar,” Reeb said.

The “good guys” do better than the “bad guys” in the long run. Reeb’s research shows that profit margins of family-operated corporations are directly related to the proportion of family members to independent directors sitting on the boards. Case in point: The now-bankrupt Adelphia would have fit into the “bad guys” category, as more family members held seats on the board than did independent directors.

A nearly decade-long analysis of 132 family-run companies in the Standard & Poor’s 500, conducted by Reeb and a colleague, concluded that a firm’s performance is highest when family members hold about 12 percent of the firm’s seats. Beyond that point, his research shows, “the benefits begin to decline.”

Reeb’s most recently published research appeared in the Journal of Accounting and Economics in January 2004. This research showed that the makeup of a corporation’s board of directors also helps determine its cost of borrowing. Reeb discovered that corporations whose boards are made up of more independent directors than family members, on average, borrow money at a better interest rate than corporations that have more family members on the board than independent directors. The benefit averages out to about the same as the difference that a one-tier-better credit rating makes when a person is taking out a loan.

Reeb attributed the difference to the accounting process. “Creditors care a lot about the accounting process, and the board is responsible for providing that information,” he said. It only makes sense that creditors loan money to the “good guys” at a better rate, since they do better in the long run.

One of the reasons Reeb’s research has concentrated on family-run corporations is that while many people don’t realize it, there are a lot of family-run corporations in America. Reeb noted that Wal-Mart, Ford, DuPont and Motorola are a few of the most notable ones.

Of the 3,000 largest publicly traded corporations in America, more than half are family-run, and these businesses usually do well.

In fact, on average, he said, these corporations tend to be more profitable than their peers. This may be because family-run corporations tend to be highly focused. “Take Ford — they make cars. Take Wal-Mart — they sell stuff. They are a retail chain, and that’s it,” Reeb said.

The average family-run corporations “are not the GEs of the world. … GE makes everything.”

- By Lisa Litzinger