Monitoring and Collusion in the Family Firm Part 3

5. Applied Analysis 5.1 The New York Times Company As an example of the relationship between board composition and ownership, consider the cases of the New York Times Company and its owners, the Sulzberger family. The company was founded in 1851 and went public in 1967. It decided to go public after a struggle with labor unions; strikes and increasing labor costs had cut into the company’s profits. The company needed to diversify, and to do this, it needed money. It first created Class A common stock in 1957, but these were not given voting rights, so the American Stock Exchange would not list them. The company then changed their policy so that Class A shareholders could elect 30% of the board. Some secretly hoped that going public would force the owning family to cede some of its control and “save the Sulzbergers from themselves.” (Tifft & Jones, 1999, p. 469) They feared that, unless the company changed drastically, it could never make a profit and would perhaps be taken over. The New York Times Company went public on January 14, 1969 at $42 per share. The price quickly dropped as shareholders realized that the company had a haphazard, family-controlled management with no formal planning process (p. 469). One and a half years later, New York Times common stock was selling at only $20 a share. The company was obliged to cut costs and reduce the size of the staff (p. 471). They were temporarily saved by the purchase of Cowles Communications, which had fortuitously gotten into trouble right at the moment. However, the takeover opportunity was only good luck, strengthened by a friendly personal relationship between the Sulzbergers and the Cowleses. The management of the Times did not have a clear strategy and remained vulnerable. 27 The family’s control had already prevented several profitable investment opportunities. In particular, Arthur Hays Sulzberger, the newspaper’s second publisher, refused to buy television stations or other newspapers on the grounds that “they are not grocery stores or outlets for merchandise.” (Tifft & Jones, 1999, p. 329) The company was devoted to publishing the news, and one newspaper was as much as they could handle. They did, however, retain The Chattanooga Times, the original newspaper owned by the founder of the dynasty, Adolph Ochs, even though it had been floundering ever since the 1950s, when it lost readers by advocating desegregation. It also insisted on keeping the same political tone as The New York Times, regardless of its location in Tennessee and far different readership. Orvil Dryfoos, who succeeded his retired fatherin-law as president and publisher, conceded to Sulzberger’s requests and found other, probably less profitable, ways to diversify, such as investing in a newsprint producer. A desire to maintain family harmony also complicated the company’s governance. In the mid-1990s, when Arthur Ochs Sulzberger was picking his successor, some members of the board thought that it was time for a professional CEO and possibly a nonfamily chairman. However, Mr. Sulzburger was slow to make a decision. An outsider on the board, the chairman and CEO of IBM, asked for Sulzberger for a written succession plan for the board to consider. The choice was difficult, as there were five younger family members working within the company, and it would not be fair to give one all of the power. This was especially true of board membership: they had all been observing the board for years, but had never discussed openly who would eventually join the board. In fact, there was a family taboo on open confrontation and discussion of succession issues. The younger generation was supposed to wait for their elders to decide (p. 721). In 1992, 28 the five younger descendents working for the company, who were tired of waiting for their parents’ decision, arranged a series of family meetings, with a paid consultant to mediate (p. 722). On the board, too, there were problems with nepotism. For instance, one of the Sulzberger daughters, Judy, had her ex-husband removed from the board and took his place, feeling that it was her prerogative, since her sisters and brother were on the board (476). However, unlike them, she took little interest in the company and was mostly silent at meetings (640). One valuable board seat was thus taken by someone who had very little to offer the firm. The company is still controlled primarily by the Sulzberger family, which owns only about 19% of the stock. However, it controls 90% of the Class B stock, which allows it to elect 9 out of the 13 board seats. In the past, they often had de facto control over the other seats as well. The company has defended this disproportionate power because the dual structure helps limit outside forces from interfering with the quality of the publications. In recent years, the newspaper industry in general has been losing revenue as the Internet becomes more widespread. Last year Morgan Stanley, which owned 7.2% of the shares, criticized the board of The New York Times and recommended changing the dual class structure. However, in the end Morgan Stanley sold its shares. Earlier this year, two hedge funds, Harbinger Capital Partners and Firebrand Partners, bought about 19% of the common stock and threatened a proxy fight, in order to get two seats on the board. They disapproved of the company’s investment decisions, believing that the company should sell many of its smaller newspapers and the Boston Red Sox and invest more in Internet companies. They successfully reached an 29 agreement with the company in which the company agreed to add two board seats, one more chosen by Class A stock and one chosen by Class B stock. It was the first time the company accepted directors nominated by outsiders (Pérez-Peña, 2008). In reply to the dissident shareholders, New York Times CEO Janet Robinson defended the investment, saying that the Red Sox and regional newspapers have been profitable investments. However, she did not rule out the possibility of selling some of the company’s assets, as suggested (Ovide, 2008). The company was not in debt at the time of the proxy fight, although its profits had been declining over time. The family’s response to the suggestion was unclear. Unlike other notable publishing companies, the family is relatively close and involved in the company. In June 1986, the Sulzberger family—four grandchildren of the founder and their thirteen children--signed an agreement that they would never sell their Class B shares to outsiders without first converting them into Class A stocks, and that this could not be changed until twenty-one years after the last person who signed this agreement had died. The agreement not only ensures that the family retains control for many years to come; it also restrains any of them from making a huge amount of money by selling their valuable voting power (Tifft & Jones, 1999, p. 585). The Sulzberger clan has come under pressure before for certain business decisions. When it merged with The Boston Globe in June 1993, shares of Times stocks fell farther than they had for several years. Many people believed that the Times had paid far too much, considering that the newspaper was neither new nor situated in a fast-growing area. One Times correspondent described that move as “great for the Sulzbergers, terrible for 30 the other stockholders. It expanded the family’s empire hugely without giving up one jot of control.” (Tifft & Jones, 1999, p. 680) Other decisions, however, show the benefits of having the family in control. Interference from people who did not know the newspaper’s goal and traditions could be disastrous, as in the fiasco of 1992, when The New York Times added an edgy section called “Styles of the Times”2. The company’s president, Lance Primis, had wanted to add a trendy section to attract advertising from small New York shops, and the project was mostly designed by a young outside consultant. However, the section alienated many regular readers, and the Times had a hard time finding advertisers. The company had made a similar gamble when they started a Weekend section in 1976, but that decision was made by a managing editor who had been in the company for many years and knew its readers well (p. 509). The New York Times is a well-established, solid company whose controlling family still exerts considerable control and considers keeping its reputation for good journalism part of their responsibility. The hedge funds that mounted the proxy fight thus carefully took aim at the company’s policies rather than at its structure, knowing that the family would likely withstand any effort to change its structure, as it did with the Morgan Stanley disagreement last year. As in my model, the company has made some decisions, such as its early refusal to invest in television stations, that probably made it less profitable than it would have been under non-family ownership. However, there has been no sign of the family expropriating profits, even though the family remains strong enough to credibly commit 2 “Styles of the Times” should not be confused with the far less controversial “Sunday Styles” section that it currently runs on the weekend. 31 to fighting an attempt to completely change its structure and displace the family. A shareholder initiative centered only on increasing firm value could succeed without resorting to a proxy fight because, as in Proposition 1, the family had low private benefits to protect and, as in Proposition 2, the potential increase in firm profits from putting outsiders on the board outweighed the non-family shareholder’s cost of requesting board seats. 6.2 Dillard’s Another recent proxy battle occurred in the department store company Dillard’s. In the late 1980s and early 1990s, the Southern retail chain Dillard Department Stores was growing quickly. It grew much faster than similar stores due to its acquisition of several other department store chains and its expansion into malls. It also featured an excellent tracking system, which allowed executives to track how fast each item was selling and to restock quickly when they were running out of the item. As in many family firms, the founder, William Dillard, played a huge role in the character and governance of the firm until his death in 2002. He insisted that the store keep prices fairly low instead of having sales, a standby of most department stores. He was also notably attentive to the small details of his chain, looking at which products were selling well and how stores were arranged (Ortega, 1994). Like the New York Times Company, Dillard’s has a dual class share structure, where the family has two-thirds of the voting power. William Dillard clearly wanted his children to keep the company in their power: all five of them were given authority positions within the firm, and he put his sons on the board within two years of their 32 joining the company. He had his son Bill meet with the chief executive of Macy’s in 1994, when Macy’s was faring poorly and it looked like Dillard’s could buy some of its stores. When Dillard Department Stores3 was doing well, employees commented favorably on the family ownership and, in particular, the way that the entrenched management kept the company’s mission consistent over time. The family refused to talk to the press but was easily reached by firm employees. They also often hired relatives of employees, as well as Dillard family members (Hymowitz & O'Boyle, 1991). Dillard’s exhibits many of the problems that family firms are known for. The management does not have routine meetings with stockholders and avoids speaking to the press. It is also known for its private benefits—the company owns five corporate jets, which is more than Macy’s, a larger chain, which has three. In 2002, Business Week singled Dillard’s out as a company with one of the worst boards because two-thirds of the board were elected by those with class B shares, and there was no nominating committee within the board. Dillard’s disagreed with the rating, arguing that the six insiders or affiliates on the board were people who understood the company well and brought good insights to the board. In my model, this corresponds to the family in period one whose superior monitoring abilities allows them to better direct the manager. Dillard’s once mushrooming stock has been falling since William Dillard II, the son of the former CEO, took over in 1998. It slowed its rate of acquiring other firms from 1992-1997, instead focusing on building new stores and expanding the old (Dillard's, 2008). In 1998 it purchased Mercantile, a large Midwestern chain. Mercantile’s clients 3 Dillard Department Stores, Inc. changed its name to Dillard’s, Inc. in 1997. 33 were used to its frequent sales, which Dillard’s put an end to after it took over. As a result, the stores were overstocked and sold less than expected. Over the course of the two years following the deal, the company’s earnings fell by an average of 10% per year. As one analyst put it, with heavy sarcasm, “In a 10-year period, they spent $5 billion in capital expenses and expansion costs and their earnings slipped 80%. That’s a remarkable achievement.”(Zimmerman, 2002) The hedge fund Barington Capital, which owns a 5.6% share in the company, tried this March to nominate four candidates to the board, after trying and failing to meet with the CEO. With the news of Barington’s letter, Dillard’s shares jumped 68 cents. On April 1, Dillard’s agreed to nominate four new people to the board, including at least one suggested by Barington ("Dillard's agrees to 4 new directors to avoid proxy fight," 2008). Dillard’s represents a company whose high potential loss µ2 from actions that reduced firm value spurred its large shareholders to action. Its sudden and drastic decline and the fact that it is being led by the founder’s son both indicate that it is probably taking measures that do not best serve the shareholders. Since the probability of outsiders winning a proxy fight has also increased in recent years, the company’s situation resembles Proposition 1: the board conceded when threatened because it had a high chance of losing a proxy fight and because it had been doing very badly under William Dillard II’s management. 5.3 Dow Jones & Co. Dow Jones, the owner of The Wall Street Journal, was sold to News Corp. in 2007. In an attempt to prevent the sale, a family member from the controlling Bancroft 34 family attempted to buy enough shares to control 51% of all votes. He did this mostly by buying shares from other family members. The Bancrofts’ shares had extra voting rights: ten votes per share, though these voting rights are lost if the shares are sold outside the family (Warren, Ellison, & Berman, 2007). A former senior vice president and board member of Dow Jones bemoaned the sale, saying that it would hurt the quality of The Wall Street Journal, whose quality was maintained by family protection of the newspaper’s independence. The acquiring company, owned by Rupert Murdoch, is instead known for biased news coverage that attacks Murdoch’s personal enemies (Ottaway Jr., 2007). Many analysts blame the Bancrofts’ ultimate failure to prevent a takeover on internal divisions that kept the family from working together. Christopher Bancroft, one of three family members on the board, attempted to coordinate their actions by buying up their shares, but he was hindered by a cousin, Leslie Hill, also a board member, who also opposed the deal but did not agree with Mr. Bancroft. Other family members did not agree with either (Warren et al., 2007). The family’s inability to organize as a team led to problems after the sale was complete, as well. News Corp. gave the Bancrofts thirty days to nominate their own candidate for the board of News Corp., but the family could not agree on one candidate and missed the deadline. Instead, News Corp. picked their family representative, 27 year old Natalie Bancroft, who had had little to do with the company before her nomination (Karnitschnig & Ellison, 2007). The Bancrofts represent one of the families in my model with a very high cost of resisting a proxy fight or takeover attempt. Because they could not decide on one policy, 35 they were taken over even though the company was not in grave financial distress or suspected of mismanagement. 5.4 Ford Motor Company Ford Motor Company was a public company early on its history, but in 1919 Henry Ford bought out the non-family shareholders. He created a dual-class structure in 1936 and created the tax-exempt Ford Foundation to which the family left their class A shares, in order to avoid the estate tax. The company’s by-laws give 40% of votes to the family’s Class B shares, though they own only 4% of the stock (Guerrera, Reed, & Simon, 2007; Lippert & Koenig, 2007). The Fords retain a great deal of control because they act as a block, careful to appear unified in public. They have private family meetings every six months and have a secret website. They take their secrecy seriously—at meetings they even check for hidden recorders. They have a fund to buy any B shares that any individual wants to sell, and they vote all of the B shares in unison. As a result, even though there are only two Fords on the board, they can efficiently get their views across (Lippert & Koenig, 2007). The Fords have, however, been in trouble because the company has not been doing well. In the 1980s, Ford flourished under the leadership of chairman and CEO Alexander Trotman, who controlled the company, though with the family’s agreement. However, Nasser, Trotman’s preferred successor, had to share power with Bill Ford as chairman ("The prince and the pauper," 1998). Trotman tried to prevent Bill Ford from becoming chairman, though other outside directors and the family supported him. Bill Ford resented Nasser’s unwillingness to share information with him (Bradsher, 2001). 36 From 2001-2006 the company was run by William Clay Ford Sr., a great-grandson of Henry Ford. Bill Ford was put into office as chairman and chief executive after the family led an effort to remove the previous CEO, Jacques Nasser. Choosing one of their own was actually might be seen in this case as a sign of commitment to the company’s share value rather than an expression of nepotism: Bill Ford was the largest individual shareholder, with 6.3 million shares, indicating that he was as invested as anyone in Ford’s profitability. He also went without a salary since 2005, vowing to do so until the company was doing better (Maynard, 2006). However, he stepped down in 2006, claiming that he could not convince shareholders or workers that he could revive the company (Doran & Buckley, 2006). Despite Bill Ford’s very public sacrifice, Ford was in the news again in 2007 for paying new CEO Alan Mulally a total of $28 million despite the company’s continuing poor performance (Doran, 2007). In the April 2007 Ford family meeting they invited a Wall Street analyst to their family meeting to help them consider selling their shares. Ford was in a dangerous situation because it was heavily leveraged—it had mortgaged most of its assets, including its logo (Guerrera et al., 2007). However, even in dire straits, the company refused an alliance proposed by the CEO of Nissan and Renault, which would have required giving up the company’s dual-share structure. They were accused of not reacting enough to global changes because “They have this sense of entitlement—that the company always has been and always will be Ford” (Lippert & Koenig, 2007). Ford has an unusually low cost of resisting pressure from outsiders—the χ in my model—since they are organized to act as one unit. Despite having a family CEO, they 37 tried to convey to shareholders that they were not acting in their own selfish interests. They did this by not paying Bill Ford’s salary for three years. His high personal ownership stake in the firm also reduced his incentive to take private benefits at the expense of firm value. Nevertheless, the company has come under pressure both for bad performance and for suspiciously high compensation for the new CEO, and it is not at all certain that the family can avoid losing control if the company continues to perform poorly. 6. Conclusion I have shown under which circumstances a family firm is most likely to face a proxy fight or a takeover. These occur when the outside shareholders suspect that the family has been directing the firm in a way that benefits themselves at the expense of the other shareholders. As the cost of fighting a proxy battle or takeover decrease, they become more likely. The cases illustrate these: the nature of the family and its relationship to the company make a difference in their chances of being taken over. Wellorganized families that act as a unit can be powerful forces in firms, as in Ford and The New York Times Company, while divided families cannot easily fight takeovers, as in Dow Jones. The board of directors helps maintain a balance between shareholder and family interests. Its ability to monitor the CEO’s actions allows outsiders to offset the family’s destructive tendencies to stick to outdated plans or to retain incompetent management, if these benefit the firm. In cases where proxy fights are being waged to put more outsiders 38 on the board, the value of the company is expected to rise, expressing an expectation that the family has been making decisions that are not in the interests of the firm as a whole. It would be interesting to develop the family side of the model more. In my model, I assumed that monitoring a family member was costless, which made hiring a family member more desirable. However, this was a rather crude approximation of the situation. 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