Guests at the table? Independent directors in family-influenced public companies

Journal of Corporation Law, The, Summer, 2008 by Deborah A. DeMott

Another dimension of the relative performance of family firms is the market's valuation of companies with dual-class shares, which typify a subset of family firms. (57) The recent and comprehensive study of firms with dual-class shares by Gompers et al. used a sample from the United States from 1995 to 2002. (58) The study found a positive association between firm value and insiders' cash-flow rights and a negative association between firm value and insiders' voting rights. (59) Firm value was negatively associated with a "wedge" between cash-flow and voting rights. (60) That is, firm value declines the greater the disproportion between insiders' economic interest in the firm and their degree of voting control. The authors suggest that a controlling shareholder could rationally decide to sacrifice some portion of firm value to maintain private benefits of control, such as "[t]he ability to control editorial policy at a newspaper, corporate strategy at a software company, or brand identity at a consumer company" and suggest that the willingness to trade off financial loss for ongoing control is especially likely when "insiders are already very wealthy." (61)

A final question on which recent empirical work provides illumination is whether corporate governance choices within family firms are associated with differences in firm performance. Anderson and Reeb's 2004 study examined the performance of family firms within the S&P 500, using as variables different choices about the composition of each firm's board of directors. (62) Their study differentiated directors who were neither present or past employees nor immediate family members into two categories: (1) "affiliate" directors, who had present or potential business relationships with the firm; and (2) "independent" directors whose directorship constituted the director's sole relationship to the firm. In nonfamily firms, independent directors held 61.2% of seats on boards, as opposed to 43.9% in family firms. (63) Family members held almost 20% of seats in family firms. (64) Greater family presence on the board's nominating committee was associated with a smaller fraction of independent directors on the board. (65) Consistent with some (but not all) prior research, (66) Anderson and Reeb observed no significant relationship across the entire S&P 500 between firm performance and board independence. (67) But for family firms, a higher proportion of independent directors on the board was associated with significantly better firm performance. (68) Allocating a greater proportion of board seats to affiliate directors was associated with worse performance. (69) Anderson and Reeb suggest that the negative association between relative board independence and family representation on the board's nominating committee implies that family firms select independent directors in response to outside shareholders' demands that the founding family be monitored and not the demand of family members for the expert advice that independent directors may provide. (70)