The Governance of Foundation-Owned Firms

Henry Hansmann is Oscar M. Ruebhausen Professor of Law at Yale Law School, and Steen Thomsen is Professor of International Economics and Management and Chairman of the Center for Corporate Governance at Copenhagen Business School. This post is based on their recent paper.

A number of highly successful companies around the world are owned by foundations. Examples include world-class companies such as Bertelsmann, Heineken, Ikea, Robert Bosch, Rolex, the Tata Group, and Carlsberg. The so-called “industrial foundations” that own them are nonprofit institutions which typically combine business ownership and philanthropy, but give priority to the business goal. Contrary to the predictions of agency theory, foundation-owned companies are, on average roughly as profitable as investor- or family-owned companies. But how is it done?

In a recently updated working paper, The Governance of Foundation-Owned Firms, we explore the range of governance structures exhibited by industrial foundations and the relationship between those structures and the performance of the companies that the foundations control. We use data from Denmark, where industrial foundations are particularly numerous. We limit our study to foundations that own a majority of a company’s voting rights and thus have complete control of the company.

We propose that a key factor is the appropriate “managerial distance” between the foundations and their companies. Managerial distance, as we define it, is a measure of the extent to which the foundation and the company are managed as separate entities. For example, complete overlap between the foundation and the company boards is low managerial distance, while complete separation is high distance.

To test this proposition, we employ panel data on a sample of more than 100 of the largest foundation-owned firms in Denmark. We construct a foundation governance index comprised of structural factors that plausibly reflect or complement managerial distance, including board separation, public listing of minority shares, private minority ownership, physical distance, multiple businesses owned by the same foundation, and the foundation’s commitment to charitable objectives. We find a strong and robust positive correlation between firm profitability and our foundation governance index, although (as one would expect) there is evidence that the relationship turns negative at extremely high levels of distance.

Our proffered explanation for this relationship is that, at one extreme—low managerial distance—the foundation and its controlled company are essentially a single organization. The board of directors of the foundation is comprised of precisely the same individuals who serve on the company’s board of directors, and the foundation has no officers or staff of its own, much less its own office space. The only distinction between the operating company and the industrial foundation that controls it is that sometimes the individuals comprising the board(s) of directors declare themselves to be acting in the name of the operating company, and sometimes in the name of the foundation. In substance, the arrangement would be no different if there were no separate foundation and the operating company itself were simply formed as a nonprofit corporation.

At the other extreme—high managerial distance—both the foundation and the operating company have their own distinct board of directors, with no overlap in membership between them. The foundation has its own staff, and occupies offices of its own that are well removed from the operating company’s facilities. The stock in the operating company is only partially held by the foundation, with the remaining (minority) shares listed and traded on the stock exchange. And the foundation, in turn, also controls one or more other operating companies. In short, the foundation is effectively a nonprofit holding company that is quite distinct from any of the operating companies in which it holds a controlling share.

The problem with low managerial distance is that the foundation-owned company essentially loses the checks and balances of outside ownership. In contrast, very high managerial distance may involve a loss of effective control, since the foundations is insufficiently informed to be an active owner. For example, complete board separation means that the foundation board is not automatically informed about discussions in the company board. Moreover, the board of a listed entity must answer to minority shareholders as well as to the foundation (the majority owner). Theoretically, optimal foundation governance will balance the costs and benefits of managerial distance.

Managerial distance may be particularly important for industrial foundations because of the absence of personal pecuniary incentives. But we believe that the concept is sufficiently general to inform governance under other kinds of majority ownership. For example, state-owned enterprises, private equity-owned companies, or family businesses may also benefit from managerial distance through outside board membership and public listing.

The complete paper is available for download here.

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