Shareholder capitalism to stakeholder capitalism: Are Indian family firms prepared?

This article was first published in moneycontrol.com, April 18, 2022, Co-authors: Sougata Ray & Navneet Bhatnagar; https://www.moneycontrol.com/news/business/shareholder-capitalism-to-stakeholder-capitalism-are-indian-family-firms-prepared-8371801.html

The debate whether companies should be governed with the sole objective of maximising shareholder value (shareholder capitalism as reflected in the shareholder primacy model advocated by Prof. Milton Friedman) or balancing the interests of multiple stakeholders (stakeholder capitalism as reflected in stakeholder primacy model advocated by Prof. R. Edward Freeman), including shareholders, has been raging for several decades.

Climate disasters, rapidly rising inequalities and COVID-19 have perhaps put to rest the shareholder vs. stakeholder primacy debate and tilted the balance firmly in favour of the latter. Modern corporations, irrespective of ownership, have an obligation to act in the interests of multiple constituents -- viz., ecology, environment, society, and shareholders.

It has been argued in literature, with some empirical validation across country contexts, that family firms are generally more influenced by the ideals of stakeholder capitalism and less by the idea of shareholder capitalism.

Anecdotal evidence in India suggests so. Many times in the past, when there has been the need, family firms in India have risen to the occasion and swiftly aided government and people, be it during the Independence movement, wars, floods, famine or pandemics.

How family firms fare

To measure how family firms fare with various stakeholders, we analysed them on various parameters and found interesting results.

Using a sample of over 6,000 firms, over the last 30 years, we found that family firms underperformed non-family firms in terms of return on assets. This indicates that family firms are, in fact, not very focused on returns. This is congruent with the socio-emotional wealth theory of family firms which suggests that they, at times, compromise on economic gains for non-economic goals of the family. This may not be something non-family shareholders want.

Pledging of shares by family owners is an example. Here, the goals of the family and non-family shareholders may deviate. Pledging of shares enables the family to raise funds against shares as collateral. The funds can be used for the same firm whose shares are pledged or for personal use. This results in a limited downside risk for family shareholders as they have already got the funds, but the minority shareholders risk losing a significant amount of their investments, if margin calls are not met.

Such situations are detrimental to minority shareholders. The behaviour of the dominant shareholders may lead to loss of wealth for other shareholders, and ultimately loss of wealth and control of the firm for dominant shareholders, too.

In the recent past, there has been a significant loss of wealth for all shareholders due to the misguided ambitions and decisions, clubbed with the pledging of shares, by promoters of family firms.

Low scores on social, environment fronts

It is, therefore, not surprising that the governance scores of family firms in the ESG (Environment, Social and Governance) rating, as per Reuters and Sustainalytics data, were found to be lower than those of other firms.

Family firms were also found to have relatively low scores on environment and social categories as well as consolidated ESG parameters. The low social score is somewhat puzzling as family firms in India are known to care for the community in which they operate.

In fact, among a larger sample of firms from a different database, we observed that the CSR spends of family firms are higher than those of non-family firms, suggesting that family firms are more compliant to CSR regulations.

It is important to note that the debate around primacy to shareholders vs stakeholders is not about the reaction of corporations to exigencies or CSR spends. It is not the primacy of other stakeholders over shareholders, but about achieving balance on sustainability principles.

It is not about one heroic act catching media attention, but their every action, every day. It is also not about one bottom line – profit. It is about the triple bottom line – people, planet, profit -- and generating and sharing value for all constituents in a fair and equitable manner.

It is about being purposive without losing focus on profit in day-to-day activities. Therefore, to be a multi-stakeholder-friendly and sustainable organisation, family firms need to adopt the principles of triple bottom line and make ESG their strategic ally. It is no longer an option. It is needed for the long-term sustainability of the firms as well as the business families in order to create and pass on the wealth to the next generation and build and sustain the family legacy.

The authors are from the Thomas Schmidheiny Centre for Family Enterprise, Indian School of Business.

Family Firms in India: Performance and Relevance

This article was first published in moneycontrol.com, April 05, 2022, Co-authors: Sougata Ray & Navneet Bhatnagar; https://www.moneycontrol.com/news/business/family-firms-in-india-performance-and-relevance-8320491.html/amp?ajaxcall=yes

Concentrated ownership of a firm in the hands of a family presents unique opportunities and challenges that impact its performance.

In India, family firms are a dominant force in the economy, contributing significantly to nation-building, the exchequer, creation of jobs and asset creation. Their footprints on the Indian economy are indelible. It is imperative for family firms to perform well, grow profitably, create value and contribute to economic progress if India has to realise its full potential.

Researchers have argued that family firms have better monitoring and lower agency costs than non-family firms, have incentives to take long-term views of maximising firm value, and are value-driven organisations. Yet, many of them are found to be plagued by rent-seeking behaviour, succession issues, lack of transparency and governance, lack of professionalisation, and family conflicts. Understandably, therefore, there is mixed evidence globally on whether family firms perform better than non-family firms.

Using a unique proprietary database of scientifically classified listed family and non-family firms, the team at the Thomas Schmidheiny Centre for Family Enterprise conducted a study on all listed firms in India over the past three decades. The analyses overwhelmingly reveal that on an average, family firms underperform non-family firms.

What are the reasons? Lapses in overall strategic planning by family firms, conflicting intrinsic motivations of family members, lack of professionalisation and governance, and opposing utility functions of management (non-family professionals) and the promoting family could be responsible. Many a time, maintaining control and influence over the firm also pushes the family to take decisions independent of financial considerations. These idiosyncratic strategies and irrational choices, mainly due to the emotional ties that the family has with the firm, may overpower the advantages of being a family firm. The analysis also reveals a negative impact of family leadership on performance among family firms.

While the average trend is negative, there are family firms across industries that have performed exceedingly well. They have withstood the licence raj as well as the winds of change that swept the nation during the economic liberalisation in 1991. There had been widespread apprehensions about the capabilities of family businesses to withstand the pressure of the newly created “freedom” that made them vulnerable to competition for resources, markets and capital. However, many family businesses transformed themselves by taking stock, restructuring their operations, taking advantage of new opportunities, putting the right governance systems in place, and professionalising.

There is much to learn from these businesses.

90% of the listed world 

Despite the underperformance of family firms on an average, their dominance in India continues. Ninety-one percent of all listed firms in India are family firms. Large family firms and business groups have consolidated their positions even more in recent years. As these business families and the firms owned by them are firmly embedded in the society and institutional context and develop patterns of trust and confidence among stakeholders, they have better access to social and financial capital and are willing to embark on enterprises involving considerable risk with a reasonable chance of success. This reinforces the continued cultural, political and social importance of family firms in India, which is not going to diminish any time soon.

However, a vast majority of family firms in India does not possess these constructive characteristics exhibited by the more successful ones. These underperforming family firms must be open to learning from the select others who have been performing well, put in place family as well as business governance systems, professionalise as they grow, delegate management and operating responsibilities to the right persons outside the family, and change with time to adapt and modernise. They need to be made aware of the enormous opportunities and be nudged to overcome their challenges building on their inherent strengths.

Policymakers must be open to framing targeted interventions that are required to create favourable conditions for improving the performance of family firms. Given the importance and significance of family firms in an economy like India, more family firms across industries have to undergo a transformation and start pulling their punches to make India Aatmanirbhar.