Incestuous Companies

Previously, stocks have been discussed on this site where it appeared that the founder's descendant was destroying the value of the company's remarkable collection of assets. Unfortunately, this type of occurrence is all too common among firms where management succession is chosen based on blood rather than merit.

It's not just anecdotal data, as empirical research has been done on the subject as well. For example, this paper found that professional, non-family CEOs generate better returns on assets than descendants of the founder. Therefore, when a family controls a business (either through majority ownership or through share classes with special rights), be aware of this issue.

But families no longer dominate corporate America as they once did, so this issue only affects a handful of American companies. However, one developed country in particular where families continue to play a large role in the management of companies is Japan. Due to the fall of equity prices in that region as a result of the recent disaster, many value investors are currently exploring securities in Japan, making this a front-burner issue.

But surprisingly, Japanese family firms are actually rather well-run as compared to their peers. While this might make the investor complacent to this issue when considering Japanese stocks, they should still be wary. A recent paper argues that the strong performance of Japanese family-run companies is due to adoption!

But not the adoption of just anybody! Many Japanese families that run firms actually adopt adults that are fit to run the company! From the paper:

"These findings are consistent with adult adoptees displacing blood heirs in the left tail of the talent distribution, with the “adopted son” job motivating star managers, and with the threat of displacement inducing blood heirs to invest in human capital, mitigating the so­ called “Carnegie conjecture” that inherited wealth deadens talent"

So investors in family firms (even in Japan) beware! Look for signs that the company has indeed looked outside the founding family for management talent, even if they ended up adopting such talent!

This article was written by Saj Karsan of Barel Karsan. If you enjoyed this article, please consider subscribing to the feed.