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Governance relationships between shareholders: Learnings from private equity investments in family firms
by Professor Jeroen Neckebrouck
A firm’s shareholders are diverse and rarely have fully homogenous objectives. An outcome is that conflicts among shareholders constitute a topic of high practical relevance and broad academic interest. Research in this area has paid particular attention to the conflicts that arise when ownership is shared between a dominant, controlling shareholder and minority shareholders. In such a scenario, majority shareholders have incentives to pursue personal goals through the business (since they appropriate the benefits but do not fully bear the economic costs), and can misuse their power to expropriate minority shareholders. That is, the majority shareholder may push management and the board to pursue objectives that align with their own priorities but that are detrimental for the minority shareholder. Studies have shown that such conflicts have a detrimental effect on firm performance, firm valuation and innovation. In listed companies, market regulators try to avoid this abuse of power, but in private equity markets there is no regulator to prevent this conflict.
Surprisingly, however, far less research has examined whether and how different types of shareholders can complement each other so that mutual benefits arise. In a recent study, to examine shareholder relationships in privately held firms more deeply, we analyzed the outcomes of private equity investments in privately held family businesses. This setting provides a valuable “case”, as the objectives of professional investors and family owners should markedly differ. PE investors focus on maximizing financial returns through a medium-term exit and generally have lower levels of risk aversion. Family shareholders, in contrast, generally have most of their wealth concentrated in a single firm, hold longer time horizons, and are often particularly concerned about non-economic benefits the firm brings to the family (e.g., reputation in the community). So can we expect successful collaborations to arise?
Our research suggests that private equity investors can make strong contributions to family businesses. A general insight that emerged from our study is that the time horizons, risk preferences and objectives of shareholders may vary over time. A family business owner who may previously have been critical of the private equity industry, may at one point find out that the next generation is not interested in taking over the business. In such a scenario, private equity investors may offer a great pathway to give the company a push, in terms of professionalization and growth, before a joint exit. In another scenario, a family business owner may find that the next generation is willing to take over the business but is not yet ready. In such a scenario, selling a part of the shareholdings to an external investor can offer a valuable way for an owner to buy time, while already monetizing part of its shareholdings.
Just like boards of directors and management need to stay aligned with shareholders’ objectives of that specific moment, shareholders should also regularly review the extent to which they are still aligned in terms of time horizons, risk preferences, need for cash and the prioritization of financial goals versus goals that are more societal and environmental in nature. Ultimately, wise shareholders should incorporate the varying goals of other shareholders in their decisions about what to own, when to own, and how to own.
Jeroen Neckebrouck
Professor of Entrepreneurship
IESE Business School
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