Family businesses and ESG, champions or pariahs ?
By Clémence de Rothiacob, manager of the Richelieu Family fund
As a preamble, we feel it is appropriate to point out that it would be difficult to highlight one or another ESG ranking of family businesses, as the extra-financial rating of a company depends on the criteria used and their weightings, which differ from one rating agency to another and would therefore be a source of confusion. Indeed, since there is sometimes only a weak correlation between the ESG ratings of the different rating agencies, it seems to us to be of little relevance to favor one or the other This is also why, for our fund invested in family businesses, Richelieu Family, we have opted for our own methodology, developed by us with the help of experts, to adapt to the specificities of family businesses.
In addition, the ratings of family businesses should also be differentiated according to their size of capitalization. Indeed, due to a lack of data (most often due to a lack of resources) and not to a lack of compliance, small and medium-sized companies are sometimes poorly rated, and family businesses are no exception to the rule. A poor rating should not be attributed to their family nature but sometimes to their status, knowing that the majority of listed family businesses are SMEs.
On the other hand, in terms of stock market performance, studies, based on factual elements, converge, demonstrating the long-term outperformance of family businesses(cf Credit Suisse, Sept 2020). We who are convinced of the causal link between strong ESG ratings/ absence of serious controversies and long-term performanceTherefore, in the long-term stock market outperformance of family businesses, we see a possible as a result of their solid treatment of ESG issuesFamily-owned companies are already champions in the rankings when it comes to fundamental criteria such as balance sheet strength, sustainable growth, profitability and investment in innovation.
Family businesses have, by nature, a strong environmental and social orientation
Let’s not forget that the notion of sustainability is at the heart of the economic model of family businesses and their mission, since the transmission of the business to future generations is their primary vocation. They take a long-term perspective in most of their decisions and feel responsible for their commitments to their stakeholders.
Favoring long-term value creation over short-term profits, companies are naturally and pro-actively organizing themselves to best meet ESG and sustainability requirements. Contrary to certain preconceived ideas that family-owned companies are ” lagging behind ” and less inclined to change, academic studies show that they have been working harder than their non-family-owned competitors for more than 8 years to improve their ESG criteria(see Credit Suisse, Sept 2020).
- The social issue at the heart of their mission :
When we talk about family businesses, theaffectio societatis that they generate is rightly highlighted. There is often a positive feeling of belonging to the family company on the part of its employees, the awareness that having an embodied shareholding is beneficial, the image of a more human capitalism is often evoked… The family shareholder often believes that it has an important social responsibility.
The evidence is that family-owned businesses often have lower employee turnover than other businesses(see Havard Business Review, March 2019 ” the turnover rate for a non-family business is 11% compared to 9% for family-owned “). These companies are also at the top of the ” best workplaces ” rankings drawn up by business schools, which give priority to the quality of life at work (every year, Michelin, Wavestone, Décathlon, Dassault Systèmes, Hermès and L’Oréal, among others, are cited). It also appears that during the health crisis, family businesses were more supportive of their employees.
- The environmental issue at the heart of their agenda :
Family businesses are often aware of their need to set an example, if only to avoid any reputational risk that would taint the family, which often participates in a whole local ecosystem.
They take environmental issues very seriously, which are crucial to their survival, and this in the highest places At LVMH, for example, it was Antoine Arnault who very early on took charge of the company’s Corporate Social Responsibility (CSR) policy, ensuring that the group’s roadmap and its environmental commitments were communicated and applied.
We believe it is crucial that these emblematic family businesses are pioneers in these issues, that they lead the way and show smaller family businesses the importance of putting Sustainable Development at the heart of their long-term perspectives.
The great challenge of family business governance
It is on the criterion of governance that family businesses are regularly attacked by the rating agencies. Governance would thus be their Achilles heel, where the problem lies.
They are often perceived as having weak governance structures : rating agencies criticize the lack of independence within their Boards of Directors and therefore the absence of countervailing power to defend the interests of minority shareholders, and the fact that the functions of Chairman and Chief Executive Officer are often the prerogative of family-owned companies. Added to this is the fear of exaggerated remuneration of family managers.
Nevertheless, we question the relevance of these criteria. Are they so decisive in assessing governance ? Since solid corporate governance is undoubtedly necessary to create long-term value, how can we explain that family businesses outperform over the long term if their governance is deemed to be far from good practice ? If we go into more detail, we can also observe that returns on capital employed (ROCE) are better in family-owned companies(cf. Credit Suisse) : aren’t they the consequence of good governance ?
Isn’t the judge of peace that, creating value and being sustainable ? Shouldn’t the rating agencies revise their criteria when it comes to a family business which has specificities intrinsic to its status?
For example, one of the things we like about a family business is the long-term vision of the family members Why then judge it on the number of independents on the board of directors (the rating agencies recommend 50% independents), independents who might be less inclined to deploy a long-term vision ? In addition, noting the independence of the board seems justified by its link to better financial discipline Yet this is a quality that is specific to family businesses, despite the fact that the board of directors is mostly family-owned ! It is precisely because they take a long-term view that family businesses are more orthodox than others in terms of balance sheet strength*, which is key to capital preservation. What we value when we analyze the composition of a Board of Directors or Supervisory Board is above all the real added value that a particular member will bring to the Board and not whether or not he or she belongs to the family.
*SeeCredit Suisse study comparing 10 years of Net Debt/EBITDA ratios of family-owned versus non-family-owned companies
In our opinion, the independence of the Board is not an essential qualitative criterion ; on the other hand, the independence of the other committees (nomination, audit and remuneration) seems to us to be much more relevant, and the practices of family-owned companies in this area do not differ much from those of non-family-owned companies. Moreover, we, who systematically vote at the AGMs of the companies in our portfolios, pay particular attention to the remuneration of managers and have no reason to report excessive remuneration in family-owned companies : they follow, at least for those listed on the stock exchange, the market standards. In any event, the independence of the compensation committee is an element to be monitored
For a listed family company, there is an alignment of interests between the family managers and the minority shareholders towards a sustainable increase in the share price. Moreover, aren’t public companies inspired by this to motivate their managers in the long term, since they multiply stock option plans that make their managers shareholders ?
- More work to be done in some areas
There are, however, a few caveats to be made, areas in which family businesses still have some way to go to be exemplary. Asymmetric treatment of shareholders is one such issue. Families may tend to set up special legal structures to maintain control. The dual class of shares (ordinary and preference) is widely used by more than 20% of the listed family businesses and is notably the specialty of Swiss and German family companies. Non-financial rating agencies value, and rightly so in our opinion, a pari passu treatment of minority shareholders, the overriding principle being “one share one vote”. To ensure that the interests of the company do not take precedence over those of the family, an in-depth analysis of the corporate culture and of any controversies that may arise is essential.
Another special legal structure, the status of limited partnership with shares, is also a prerogative of family businesses in Germany (Merck, Fresenius or Henkel) and in France (notably Michelin, Hermès International, Bonduelle or Lagardère in its time). The managers have broad powers to govern the company, in exchange for liability on their personal assets. Hermès International justifies its legal form (SCA since 1990) by the need “to preserve its identity and culture and thus ensure the long-term survival of the company, in the interests of the group and all its shareholders The stability of family businesses, necessary for a long-term strategy, is at stake. It is an anti-hostile takeover shield that will allow the company to avoid dispersing itself by defending itself against predators.
The influence of long-term shareholders is often perceived as an asset that should be favored in voting policies (as opposed to the decisions of short-term shareholders, notably pure financial speculators), and many Think Tanks are pushing for an acceleration of regulations in this sense. Among the recommendations of the PRI (Principles for Responsible Investment), in the Practical Guide to Active Shareholding, it is indicated that ” the new version of the European Union directive on shareholders’ rights (…) also recognizes that shareholders can exert short-term pressure on the companies in which they invest, at the expense of long-term value creation and ESG issues “. They also state that it is interesting ” to strengthen the loyalty of long-term investors “, which are the family shareholders !
Nevertheless, opinions differ, with some believing that short-term objectives, which are so important in the stock market since results are published quarterly, may be sacrificed by family businesses in favor of the long term, and thus minority shareholders who cannot afford the patience of a founding family may be harmed, particularly if they hold shares without dividends or voting rights to make their voices heard.
In addition, there are also issues specific to family businesses, such as the question of harmony within the family which must be the object of constant attention and a clear formalization of the roles of each one at the risk of an imbalance of the motivations of the members of the family (around the questions of the employment of certain members and the policy of distribution of the dividends in particular…), of dissidence at the time of the successions, of risk of dynastic temptation…
Family businesses thus have specific characteristics that invite us not to be dogmatic when assessing their extra-financial characteristics. Even if, as we indicated in the preamble, it is not easy to generalize ESG ratings, it is interesting to note that some statistics (notably via historical data from Refinitiv analyzed by Credit Suisse) indicate that multigenerational family businesses have better ESG scores than newer family businesses One of the explanations could be that they benefit from more seasoned business models, but also that they have a greater number of young members involved in the company, who are certainly more sensitive to ESG issues. Let’s bet that the generation that takes up the torch is certainly the one that will move the lines forward, that will reshuffle the cards, while keeping the strengths and values inherent to family businesses, towards more pro-active initiatives towards sustainability, in order to transform the intention and ambition, clearly identified, into concrete actions.
And the stakes are high because family businesses contribute significantly to the creation of jobs in the world, so they have a leading role to play in Sustainable Development !
Richelieu Gestion | Focus – April 2023
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