January 24, 2023

Governance At Controlled Public Companies

Controlled companies, those with strong single investor or family ownership, would seem low on the list of prospects for any board candidate that wants to be an active, dynamic director. In truth, the authors find public, controlled company boards are often at the cutting edge of good governance.

The New York Stock Exchange defines controlled companies as those in which “more than 50 percent of the voting power is held by an individual, group [often a family], or another company” and “which is therefore exempt from the director independence requirements for the board, nominating/corporate governance committee and compensation com­mittee.” Disclosure in the proxy or 10-K is still required.

Contrary to popular belief, controlled public com­pany directorships are not the governance equivalent of a surgeon general’s warning. While controlled companies do raise some unique governance issues, most often these boards are progressive models of good governance, offering exceptional professional growth opportunities.

Yet many board candidates initially dismiss this type of directorship, before learning about the spe­cific opportunity. To the vast majority of potential directors, the word “controlled” is off-putting, even the antithesis of good governance. They embrace the view that conflict of interest is inherent in a public controlled company board. The controlling party will act in its own interest, not that of minority shareholders.

An independent outside director serving on a con­ trolled company board disputes this point of view. He had served as a senior executive for two different controlled companies. When approached with the directorship invitation, he accepted the opportunity to serve, in part because of his career experience.

“While there is the perceived potential for a conflict of interest, in principle, the [controlled company] board structure doesn’t determine this.”

“A controlled company may require more rigor in governance, a more disciplined path to the process, but maybe that also makes boards work a little harder on this. In some ways, there is a greater burden on the controlling entity not to act against the interests of the minority shareholders.”

“Particularly in today’s regulatory environment, you had better take extra care lest you wind up in a legal wringer. If you zealously guard against the potential conflicts and related party transactions in a focused and disciplined way, I think that the extra care to adhere to both the letter and the spirit of the law pays off.”

Controlled public company boards are actively recruiting the specific talents needed to strengthen their governance capabilities.

Many candidates for board seats hold fast to the flawed belief that being a director on a controlled public company board is likely to be a superfluous role, akin to Alfred Sloan’s view of outside directors as “parsley on the fish.” An outside director on such a board forever remains “outside.”

In reality, “outsiders” are “in.” In addition, they had better be prepared to contribute and work. Controlled public company boards are actively recruiting specific talent to strengthen the boards’ governance capabilities. They are conducting more rigorous self-assessments, identifying gaps in skills and experiences.

Consider the heretofore unthinkable action of a public-controlled consumer products company with a global brand. They wiped the slate clean and built from scratch a new energized board of active, independent directors. The controlling shareholder group and the senior management team agreed “the best board experience we ever had was when we didn’t know any of the people prior and chose them solely on their ability to contribute specific skills to the business.”

Another common fallacy is that controlled firms will not perform as well as other companies because the controlling interest inhibits management action.

American University Professor Ronald Anderson and Temple University Professor David Reeb have found that “all in the family” should be a green light for investors and for potential board members. Their study, conducted from 1992 through 2001, confirms the influence of family members and sheds light on the effects. During this period, 141 of 403 S&P 500 companies included in the study were family-controlled. These firms made up 35 percent of the S&P’s $10.5 trillion market value.

On financial results, family-controlled public companies seem to do better. A survey found they average a 30 percent premium on return on assets over most public firms.

When it comes to financial results, family-con­ trolled public companies seem to do better. Anderson and Reeb found that these companies averaged a higher return on assets than their “ordinary” public counterparts, 6.1 percent compared to 4.7 percent, a 30 percent premium.

Some are hard pressed to accept the facts and test them independently. The CFO of a $10 billion plus controlled company has conducted illuminating research that paired controlled and non-controlled public companies in related industries. The con­ trolled companies outperformed the non-controlled. “The results proved counter-intuitive to us and ran directly against our hypothesis,” he told Christian & Timbers.

A 1999 study from the World Bank pointed to academic evidence that found a 20 percent discount on closely held stocks. However, the controlled companies did not experience a discount because of their majority shareholder status. Total market float was the higher correlative factor in determining valu­ations. One conclusion is that if companies’ stocks are both closely held and widely traded, the share prices are at least as good as their non-controlled counterparts.

Some director candidates are openly skeptical about the accuracy of controlled company financials, pointing to the controlling interest’s influence. They also allude to regulatory exemptions. Like all pub­lic companies, though, boards of controlled public companies must have audit committees comprised of independent directors. They are not exempt, since this is a federally mandated requirement, enacted by Congress as part of Sarbanes-Oxley.

Some candidates cannot see how they will be able to execute their fiduciary responsibilities as a member of these boards. Some interpret exemptions from the standard rules as fostering an environment that enables controlling shareholders to manipulate the board. Without wholly independent directors on the compensation and governance committees, director candidates openly voice concerns about impartial review of performance and board composition.

After all, how does one calmly discuss with a parent, if founder or chairman, that a child, if CEO, just is not delivering the leadership needed? Most executives believe it too difficult a task.

In truth, expectations of family members active in the business are often higher. So is the level of intolerance for non-performance, a fact not lost on the next generations.

In an interview with the New York Times earlier this year, Shari Redstone, daughter of Viacom’s legendary founder, stated that she tells her own children that “doors open fast, but they close even faster.”

Family members are often subjected to more intense scrutiny and stringent standards than other executives, whether or not the mantle is to be passed. Witness the exits of not one, but two, scions of the Greenberg insurance clan from AIG’s top ranks, well in advance of the company’s current struggles.

Clearly, the involvement of numerous family members may heighten tensions, as in AIG’s case. After evaluating other family companies, Comcast founder Ralph Roberts concluded that having too many family members involved in the board created problems. He decided that one family member should have full voting authority. He walked the talk-son Brian was given voting control at age 35.

A survey of Comcast shareholders would be likely to earn applause for the decision. The company has posted a five-year compound annual growth rate of over 25 percent and now boasts a market capitalization of nearly $70 billion.

Passion and dedication to a company can play out in a variety of ways. In many cases, the tough deci­sion is made. After a difficult seven-year tenure at the helm, Christopher Galvin, the grandson of Motorola’s founder, resigned. The company had lost 80 percent of its market value in his last three and a half years as CEO. Under the leadership of a non-family CEO, Motorola is regaining ground.

Rather than restricting or demeaning directors’ roles, actively involved ownership often gives di­ rectors the freedom to truly act as fiduciaries. They also experience a progressive business environment unlike that of most corporations.

Controlled public company boards more often live by Andrew Carnegie’s dictum to “put all your eggs in one basket and then watch that basket very carefully.” Of course, fiduciaries are entrusted with protecting shareholder interests, regardless of how many “eggs” an individual may own. It is clearly enlightened self-interest to protect and nourish the company’s long-term value if it more closely corre­sponds to one’s own and one’s family’s net worth.

Academic research on agency theory points to an almost “by the book” business orientation at many controlled companies.

As with private equity investors’ portfolio compa­nies, family-controlled companies are more likely to act in an economically rational fashion than those entirely directed by agents and managers with less at stake. “Agency theory” supports the premise that managerial actions in non-controlled companies routinely diverge from shareholder value.

Academic research on agency theory points to the almost “by the book” business orientation of many controlled companies.

As with private equity investors’ portfolio companies, family-controlled companies are more likely to act in an economically rational fashion than those entirely directed by agents and managers with less at stake. “Agency theory” supports the premise that managerial actions in non-controlled companies routinely diverge from shareholder value.

Academic research on agency theory points to the almost “by the book” business orientation of many controlled companies. They show a long-term horizon and willingness to reinvest profits into the company rather than appease short-term sharehold­ ers. They are less likely to inflate earnings reports to exercise options at a favorable time. It also strongly suggests that controlled companies act with greater speed and efficiency in making critical decisions.

The COO of a $1.5 billion consumer products company performed a detailed financial analysis for a major capital investment overseas that pointed to a longer than usual payback period. He recom­ mended against building the factory. The CEO, the son of the founder, thanked him. He then built the factory. Today it is a cornerstone of the firm’s very successful business in the region.

Outside directors who serve on controlled public boards have the opportunity to practice what they preach in their day-to-day careers. These include a strategic business focused on the long-term and forward moving productivity.

The presence of actively involved controlling interests provides this business “luxury.” In most instances, family members wear several hats simultaneously, that of management, director, and/or shareholder. Some controlling interests believe that being able to look at issues from different perspec­tives helps them make the very difficult decisions needed to build a business rather than provide instant, quarter-by-quarter gratification.

Active involvement means controlling interests are more likely to safeguard the financial health of the company. One is more likely to mind the store when the name on the door is your own. Many controlled companies are household names worldwide, protected for generations. Controlling shareholders are loath to undermine brand loyalty, trust, and tarnish their own name and image or that of their legacy. They value the relationships created over the years as a result of the name, and work diligently to maintain the integrity of the brand. They refuse to let their brand or legacy be reduced to a commodity.

Perhaps only a controlling interest can fully com­ prehend the strategic edge active ownership brings. The family members of John Pitcairn, a founder of PPG, decided to capitalize on the perceived advantage of family businesses. They created the Family Heritage Strategy, a mutual fund that was open to public investment in 2000. It invests in companies with minimum family ownership of 10 to 15 percent. Thus far, the only fund pursuing this strategy, it has edged out S&P 500 returns by 2.4 percent through the first quarter of this year.

Controlled company leadership tends to value and recognize the contributions of others, including their outside directors.

For every Adelphia, there are numerous count­erweights such as Berkshire Hathaway, Brown-Forman, Cox Communications, Estee Lauder, Ford, McGraw-Hill, Nordstrom, Timberland, Wal-Mart, and the Washington Post Company–examples of family-dominated or controlled businesses with good corporate governance and high performance for shareholders.

Controlled company leadership also tends to value and recognize the contributions of others. That ex­ tends to outside directors.

One family-controlled company, approaching $3 billion in sales and $6 billion market cap, was headed for a governance collision. The family was entering a new generation, comprised of more than 25 members. The CEO intended to retire in three years. However, there was no family successor. Many family members were concerned about personal in­ vestment diversification. Few were close enough to the business to understand or trust how it was being run. Four of twelve directors were independent, all hand picked by the CEO.

To deal with these issues, the CEO chose to in­ crease the independent membership of the board. A successful search resulted in the appointment of a seasoned independent director.

A young non-family executive in the company was named COO and earmarked for CEO succession. The family then turned to Christian & Timbers to assist in the selection of the next family member to serve on the board. The changes sustained the track record of a highly profitable and growing company. The contributions of the independent directors were key.

The difference between a potential train wreck and success was the leadership of a CEO who un­derstood how to facilitate decisions that preserved the welfare of all shareholders. He chose to take the long view.

Serving on a controlled public company board can be an experience unlike any other and provide professional growth opportunities most executives can only imagine. Such directorships can offer meaningful engagement in building a company more quickly, with an eye toward to the long-term benefit of all shareholders and a legacy for the controlling party. Active outside directors become part of the legacy.


Who Controls This Board?

Some Questions To Ask

Prospective directors should approach controlled public company directorships with an open mind ready to evaluate the facts and assess compatibility in relation to the individual’s skills, personality, and goals.

Examine the following areas:

  • Financial accountability. Are there robust financial controls and procedures in place? Is the company fully compliant with new regulations, including sections 404
    and 302 of Sarbanes-Oxley?
  • Compliance. What is the level of compliance with regulation and the requirements set forth by the federal government and the major exchanges? Independence requirements for the board or some committees may be waived, but not all controlled companies actually do so. Some operate as if they were comprised of completely independent directors.
  • Personal financial liability. Check on the limits and exceptions of the board’s D&O coverage.
  • Time commitment. Expect to devote at least 15 hours a month. Add more time for audit committee work. Senior executives should obtain approval from their own boards.
  • Legal liability. Is there any outstanding litigation against the company or any lurking contingent liabilities?
  • Structural conflict. Are there board factions or cliques at work? What role has the board played in leadership transitions and major decisions? What exactly is the view of the controlling interest on outside directors? Do the outside directors have ready access to the controlling shareholders and to the company’s management, at various levels?

How the board has handled major issues, and the out­ comes, can provide indications of the approach, involvement, and influence of family members. Seek out former directors to find another perspective.

  • Interpersonal dynamics. Compatibility is a crucial factor in determining a director’s overall effectiveness. Research board culture to assess fit.
    Most families keep personalities out of the boardroom, resolving issues prior to meeting and preserving board time for business rather than personal agendas. The shared interests of a controlling group (to maintain unity and to preserve and enhance wealth) actually tend to bind them together. Prospective directors should not interpret this as undermining the independence of the board. In most instances, it serves to focus the board on business and can actually promote more effective governance.
  • What gets measured, gets done. Look closely at employee performance metrics and senior management com­pensation plans. Learn whether full board and individual director performance evaluations are conducted and how. Is a formal process in place for new member assimilation or are new members integrated through informal mentoring?
  • Try to predict surprises. What are the non-obvious risks, the potential “bear traps”? Consider some possible worst-case scenarios and run them by the present board members to anticipate how they would deal with crisis and conflict.

If possible, potential directors should also seek people who have served on other controlled public company boards. These veterans can provide a balanced perspective about “unexpected” issues.

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Controlled company boards are often at the cutting edge of good governance.
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