What determines the level of premiums paid by family firms in M&A transactions?

Lennert van der Heijden and Roman Rudman, EDHEC graduates in Msc Corporate Finance and Banking, received the EDHEC Family Business Center award of the Best thesis on Family Business. The subject of the dissertation was “The influence of family ownership on premiums in mergers and acquisitions.”

Lennert shared with us the motivations for the study and the most significant findings that allowed him and his partner to win the award. He also provided two interesting lessons for family businesses considering M&A decisions. 

What motivated you to study the influence of the family ownership on M&A transactions?

Initially, I wanted to study the effects of corporate governance on financial performance, while my co-author Roman was more interested in M&A transactions. Therefore, we suggested combining our proposed topics to investigate how corporate governance plays a role in the frequency or price of M&A transactions. We narrowed it down by using the ownership structures as part of corporate governance and comparing family firms versus non-family firms. After reading several existing papers on family firms, we believed this could be a very interesting topic to study, as it combines several fields of existing literatures.

What makes your study different from existing ones on the topic?

There have been studies into the effect of family ownership on firm performance, as family firms often have a larger potential for agency problems than non-family firms, since the ownership and management are not both held by the family. Existing literature has shown that firms in which ownership and control are united in the same family face lower agency conflicts, which leads to higher performance.
Other research has studied the factors that influence the premiums paid in takeovers, such as the size of the target and the buyer, the growth rate of the acquirer and the return on assets. These studies generally find that firms with higher financial performance tend to pay higher premiums for the targets they acquire.
Our study combines these two fields of research, in a way that has not been done earlier. 

What are the most significant findings of your work? To what extent did you expect them?

First, we tested whether or not family firms pay higher premiums than non-family firms. Based on the existing literature, which shows that family firms outperform non-family firms and that firms with higher performance generally pay higher premiums, we expected family firms to pay more for their acquisitions. This was exactly what we found in our regressions, looking at S&P 400 Mid-Cap firms.

However, this does not explain why. One of the reasons could be related to agency costs, meaning that the family takes advantage of minority shareholders. On the other hand, it could also be explained by the stewardship theory, which views the family as having a long-term view and wanting to ensure a profitable business for the future generations. Therefore, we limited our sample to family firms and added different stock ownership levels. We found that higher stock ownership by the family is negatively related to the premium paid. We also tested the effect of voting power enhancing mechanisms, such as dual class shares or family members as CEO or board members. These mechanisms were by themselves negatively correlated to the size of the premiums, although statistically insignificant. The results became significant when we combined multiple mechanisms. This tells us that the families use their influence to pay lower premiums, even if they do not own stocks.

Our final tests combined the governance mechanisms with stock ownership, in which we found that a higher stock ownership strengthens the negative relationship between premiums and family voting power.
The finding that family firms with voting power enhancing mechanisms pay lower premiums than family firms without those mechanisms is an indication that agency costs are not the driver of the higher premiums paid by family firms.

As a result of your work, do you now see family firms in a different way?

• Certainly, I found it very interesting to read about the two opposing views on family firms, with agency problems on the one hand and the stewardship theory on the other hand. Seeing that families are generally outperforming non-family firms makes you look at them as examples for good management.

With regards to acquisitions, family firms seem to make decisions more aimed at the long-term performance of the firm, rather than taking advantage of minority shareholders to grow their business quickly.
Based on the existing literature used as our starting point and our own findings, I have started to look at family firms as a more stable factor in our economies and societies.

Family owners do not look at their own personal gains only, rather they seem to have in mind a broader picture and a sustainability outlook in the long-term. This is definitely something that I believe can improve our societies if this becomes the norm.

Could you share a few lessons based on your dissertation to help family business managers or shareholders in their decision-making regarding M&A?

Do not feel pressured to grow quickly or keep growing through acquisitions when your organic growth slows down. This does not mean that acquisitions are always negative, on the contrary. However, only do it when you find the right target. 

First assess if that company is a perfect fit in your corporate strategy and culture, before committing to it.

An acquisition of a bad target can do a lot of harm to your company.

• We have found that family firms pay relatively more for their targets than non-family firms. This does not have to be a bad sign, as family firms also generally outperform non-family firms. With a stronger business profitability, you are able to expect higher returns from the target company as well.

Once you have find a target that you believe will contribute to that long-term view and profitability you have in mind for your company, it is okay to pay for it.