Section 2 Chapter and Lecture Notes 15
Chapter 3 The Ownership Challenge
Learning Objectives
1. To promote a better understanding of the owner-manager-family member
relationship.
2. To develop a fuller appreciation for the importance of ownership and the leadership
of shareholders in a family-owned or family-controlled company.
Chapter 3 Essence
While family-controlled firms have been shown to outperform management
controlled-firms in terms of return on equity and shareholder value creation, governing
the relationship between family owners and the firm continues to be a unique challenge to
family-owned and family-controlled firms. A vicious cycle appears to easily take hold in
family firms beyond their first generation, when owners are not always owner-managers.
The cycle is precipitated by family members who are only shareholders and receive
dividends are often minuscule to nonexistent.
Shareholders not active as employees in the business then harbor concerns about
excessive executive compensation and benefits the new BMW company car and the
country club membership. Over time, these same shareholders become less willing to
invest in business expansion, preferring profit distributions through a dividend, bonus,
and/or board fee. When these shareholders become frustrated enough, they may consider
16 Section 2 Chapter and Lecture Notes
companies. This is not just a family dynamic issue, but an ownership issue, with
precedents in finance, business management, and corporate and criminal law.
If a family business is going to preserve one of its intangible yet well-documented
competitive advantages its propensity to manage with a long-term horizon
investments in the ownership subsystem are essential. That means investing in:
1. The design and execution of an appropriate ownership and control structure.
As pointed out in Chapter 1, one recent study showed that during the past decade, the
35 percent of the S&P 500 firms that were family-controlled outperformed management–
controlled firms by 6.65 percent in return on invested assets. Similar results were found
in terms of return on equity. Family-controlled firms were also responsible for creating an
Notwithstanding the established influence of ownership on firm performance, it is not
unusual to listen to CEOs, particularly of first- and second-generation entrepreneurial and
family firms, comment, if not outright brag, about the fact that they held their last
shareholder meeting on the way to their favorite vacation spot. Understanding and
successfully leading the ownership of the family firm, its shareholders, is an essential part
management of the company. Without it, the desirable alignment of management and
shareholders is at risk. Without it, family-business shareholders can easily become just as
indifferent or impatient, fickle, and greedy as investors on Wall Street. As part of their
financial literacy, owners should also be able to understand the capital structure of the
to gauge their
Section 2 Chapter and Lecture Notes 17
Holding these numbers close to the vest (whether the vest of the founding CEO or of
family members who hold key jobs in management or of nonfamily CEOs or key
managers who prefer not to be held accountable by the other shareholders) undermines
the fundamental advantage that so many family firms enjoy a long-term horizon on
their investment decisions.
Governance of the shareholder firm relationship is essential. The tools for governing
that relationship are the board, shareholder meetings, and family meetings.
Discussion Questions
1. What leadership actions are the responsibility of the chairman and CEO with
regards to effectively governing the relations between majority-minority
shareholders and between shareholders and the firm?
Understanding and successfully leading the ownership of the family firm, its
minute the firm stops being owned by the single, founding entrepreneur.
18 Section 2 Chapter and Lecture Notes
2. What are the three primary responsibilities of shareholders towards the
corporation they own?
1. Define and Then Demand What are Reasonable Returns on Shareholder Equity or
Invested Assets.
Past success has led the management of many companies to be less demanding of
2. Provide the Values and Principles of Doing Business and Ensure They Remain
Instilled in the Company.
Tim Timken, sixth-generation chairman of the board of The Timken Company,
revealed in the research on centennial family companies discussed in Chapter 5
that he believes he has a special role as an owner and Timken family member
values and the legacy is clearly an ownership responsibility.
3.
Priorities.
Owner values influence family priorities, and vice versa. In the Timken case, the
Section 2 Chapter and Lecture Notes 19
In order to successfully carry out their responsibilities, owners need to know what
those responsibilities are and how to exercise them. The ability to read and
understand a financial statement with a high degree of comprehension is a must for
shareholders. Of course, those statements first need to be provided on a frequent and
timely basis. Financial statements that aim to educate and inform, without the
presumption of an advanced degree in management, are essential to family-firm
As part of their financial literacy, owners should also be able to understand the capital
able gauge their ability to operate independently or risk influence by banks and other
sources of capital i
20 Section 2 Chapter and Lecture Notes
3. Why do ownership structures that worked well in one generation often prove
ineffective in later generations?
As businesses pass to succeeding generations, it naturally becomes more difficult for
family members active in the business to manage efficiently because of the ever–
expanding number of owners. This is an unavoidable consequence of successfully
Buy sell agreements are also typically used by family business owners to facilitate an
orderly exchange of stock in the corporation for cash. The most obvious benefit of a
buy sell agreement is that it allows some family members to remain patient
shareholders while providing liquidity to family members with other interests or
goals. In this way, families can prune the corporate family tree across generations. A
buy sell agreement is often the primary vehicle through which family shareholders
can realize value from their highly illiquid and unmarketable wealth company
stock. The ability to sell their stock and achieve liquidity, even if unexercised, often
leads previously dissatisfied shareholders to a happier place.
Relevant Case Resources
The Ferré Media Group case highlights, at the end, the relevance of restructuring
ownership with an eye to corporate control. It is a centennial family company and a great
family business. The Vega Food Company case can be used to highlight the strengths and
special vulnerabilities of family firms that result from their unique ownership structure;
Section 2 Chapter and Lecture Notes 21
case; so is the impact that dividends or shareholder returns has on the concept of patient
capital. The Reliance Industries: From Conflict to Continuity case is a captivating