Founder-led firms do better on the stock market

2006

Public companies such as Berkshire Hathaway, Comcast and Dell that are still run by their original founders tend to perform better on the stock markets than do other firms, new research has suggested.

Firms with founder-CEOs outperformed other companies in the stock market by 8.3 percent from 1993 to 2002, according to the study by Rudiger Fahlenbrach, assistant professor of finance at Ohio State University's Fisher College of Business.

Fahlenbrach studied 2,327 large U.S. firms from 1993 to 2002. He compared those companies still run by their founders – 11 per cent of the total – to all the remaining firms.

These firms include some of the largest and most successful firms of the 1990s, including Berkshire Hathaway, Comcast, Dell, Home Depot, Microsoft and Toys 'R' Us.

"Entrepreneurs who started a company and developed it through years of hard work often consider that their life's achievement," Fahlenbrach said.

"They approach their company differently than any successor could, and that is reflected in how the company is valued."

Companies led by their founders showed a clear performance advantage even after taking into account a wide variety of other factors that may have affected the results such as the sector, size and age of the business.

Even after controlling for these other variables, founder-CEO firms still outperformed other companies by 4.4 per cent.

The findings revealed several key differences between firms led by their founders and other firms that may help explain why founder-CEOs seem to be more successful, at least in terms of Wall Street.

One key difference is that founder-led firms tended to spend more on capital expenditures and research and development. For example, firms with founder-CEOs spent up to 8.8 per cent more on research and development than non-founder firms.

"Founder-CEOs have a different investment behaviour, a different perspective," Fahlenbrach said. "They are very centred on innovation which helps their company grow on its strengths."

Companies led by their founders have avoided the empire building and growth-at-any-cost attitude

Companies led by their founders also avoided the empire building and growth-at-any-cost attitude that many other firms had during the 1990s, Fahlenbrach said.

In contrast, CEOs keen on diversifying their firm's interests often preside over a loss of focus and end up with an organisation that cannot be run effectively.

While founder-CEO firms did participate in the merger frenzy of the 1990s, Fahlenbrach argues that they did this in a more focused way, tending to buy companies that were smaller in size and that were in the same industry.

"The founder-CEOs were more strategic, buying targets that enhanced the value of their core business," he said. "They were less concerned with diversifying outside their industry or building an empire."

Founder-CEOs can take more risks than other corporate leaders because they feel less vulnerable, and are obviously less likely to be fired, Fahlenbrach explained. The result is they take risks that often end up strengthening their company in the long run.

"Many successor CEOs have to be concerned with the short-term, how their company looks to investors right now. They often can't focus as much attention on investing for the future," he said.

Fahlenbrach said some of the reasons for the success of firms led by their founders probably can't be captured by data that are used in a study like this.

"Some of it may have to do with pride and motivation. A founder walks into his company's headquarters, and it may be his name that is above the door.

"Not only is that motivating for the founder, but it may be motivating for employees as well – they may be very happy to be working for a visionary in their industry, and that makes them work a little harder."