Chinese family businesses, which represent 67% of the Shanghai and Shenzhen stock exchanges, are more profitable than non-family businesses, says report by March A.M. and IE University 17 April 2024 Category: Grupo Banca March The compound annual growth rate (CAGR) of family-owned companies listed on Chinese Stock Exchange for the 2005-2020 period was significantly higher than the CAGR registered by non-family businesses, at 41% compared to 23% (both weighted by market capitalisation), according to a report by March Asset Management (AM), the asset management business of Banca March, and the IE University's Center for Families in Business. The average ROA for the period was 3.92% for family businesses, and 2.89% for non-family businesses. This higher profitability was accompanied by higher volatility, evidencing the need for greater understanding of the specific characteristics of these companies to help identify profitable investment opportunities and effectively minimise risks. Chinese family businesses, which represent 67% of the Shanghai and Shenzhen stock exchanges, are more profitable than non-family businesses. A study by March Asset Management (AM), Banca March's asset management business, and IE University's Center for Families in Business has provided the first rigorous evidence on the profitability of family businesses in the Chinese markets of Shanghai and Shenzhen. These markets have been gradually opening up to foreign capital since 2003, offering attractive investment opportunities in companies which are focused on meeting growing domestic demand in a market of more than 1.4 billion consumers. IE University’s Cristina Cruz, who headed up the report, said: "The extraordinary growth of the Chinese stock markets has been driven largely by the development of private equity firms, many of which are controlled by their founders or family members." This is reflected in the explosive growth of family businesses on these markets, which rose from 27% to 67% in just fifteen years, and in the significant increase in the number of family businesses founded by their owners or immediate family members, as opposed to companies created via state privatisation. According to the report, in 2005, only 40% of family businesses on the stock exchange had been founded by their owners. By 2020, this percentage had risen to 80%. Despite the growing importance of family businesses in China, Dr Cruz highlights the differences between these family businesses and those listed in other markets: "With an average lifespan of only 20 years, these companies lack an established corporate culture and are facing their first generational change. They compete in an environment marked by high volatility and significant government intervention, which raises questions about their ability to balance long-term growth visions with the immediate demands of the market that justify the existence of the family premium we have found in other markets such as Europe and the US." Javier Pérez, manager of March International The Family Businesses Fund by March A.M., said: “The Chinese market offers huge potential, and is shifting towards a more consumer-focused economy. At March A.M., we want to harness this strong growth to offer our clients investment opportunities in family businesses, which we consider to be a key market segment. Through March International The Family Businesses Fund we are looking for companies with profitable businesses, with reference shareholders involved in the development of the business." Family businesses: Stronger gains and lower risk of insolvency Despite contextual differences, the report confirms that there is a family premium in the Chinese stock market, i.e. higher profitability in both accounting and market terms of family businesses compared to non-family businesses. The compound annual growth rate (CAGR) for the period for the portfolio of family companies was 41% compared to 23% for non-family companies (weighted by market capitalisation) and the average ROA was 3.92% for family companies and 2.89% for non-family companies. All this implies that family businesses created more value during the study period: the economic value added (EVA) of family businesses stood at 39.42, versus 18.5 for non-family businesses. The report also shows that this stronger performance was accompanied by higher average volatility (30% for the family business versus 25% for the non-family business), although family businesses also have a lower risk of insolvency. The family premium is mainly determined by the 100 family businesses with the strongest stock market gains; over the period from 2016 to 2020, these companies generated average gains of 50.49%, compared to 3.90% for the other family firms. These companies are also more profitable in accounting terms (ROA of 5.59% versus 3.96% for the other family businesses) and generated far greater economic value added (EVA of 275.22 versus 39.71 for the remainder of the family businesses). These Top100 companies have unique characteristics: they are significantly larger companies (average market capitalisation of USD 3.49 billion compared to USD 657 million for the other family-owned companies), and they compete mainly in industries that are leading the transformation of the Chinese economy (renewable energy, electric car manufacturing, etc.). These Top 100 companies include: Sungrow Power Supply, the world's largest manufacturer of solar inverters and energy storage systems for photovoltaic projects. Its founder, Cao Renxian, is currently the company's CEO and Chairman. ByD, the world's largest electric vehicle manufacturer with more than 200,000 employees. Its founder, Wang Chuanfu, is CEO and Chairman. Midea Group, the world's largest home appliance manufacturer, founded in 1968 with more than 150,000 employees. Its founder, He Xiangjian, has retired from management, and Fang Hongbo, a non-family executive, is currently CEO and Chairman of the company. Family businesses recover better in post-crisis periods The report also studies the performance of these companies during the COVID-19 crisis. According to Cristina Cruz: "The analysis shows the vulnerability of family businesses in this context, but also their commitment to the long term, in line with the findings in other markets." The number of listed family businesses fell by approximately 25% from 2020 to 2021, and the profitability of those that survived registered a steeper relative drop compared to non-family businesses. These family firms did not reduce their workforces and continued to invest in fixed assets, in contrast with non-family firms, which cut their workforces by an average of 33% and their investments in fixed assets by 56%. In the post-crisis period, family businesses recovered better that non-family firms, posting stronger compound annual gains (24% vs. 14%). However, this stronger performance was accompanied by higher volatility (19% versus 15% for non-family businesses). Future challenges include the generational transition, which many of these companies are facing for the first time. Only 23% of listed family businesses are in the hands of the second generation, with a clear preference for appointing a family successor: 60% of second-generation companies are led by a family CEO. Sustainability and corporate governance In terms of sustainability and corporate governance, although they underperform non-family firms, family businesses have improved significantly in both areas over the last 15 years. For example, the incorporation of independent board members has increased from 35.34% in 2005 to 38.73% in 2020. In 2020, 16% of CEOs at the head of family businesses were women, up 11 percentage points versus 2005. One such example is New Hope Liuhe, a leading agricultural industrialisation company which, in 2018, ranked 126th among the top 500 Chinese companies on the Fortune list. The daughter of the group's founder, Liu Chang, is the company's president. However, the proportion of companies at which the same person holds the position of CEO and Chairman has risen, from 10% in 2005 to 45% in 2020, while this percentage remains stable at around 10% for non-family companies. Commenting on these results, Cristina Cruz concludes: "The report shows that family businesses are key pillars of the Chinese economy, but their ability to adapt to rapid change and address generational transitions will be crucial to their success in an increasingly complex business environment. It is essential that these companies continue to innovate and adapt to market demands, while keeping their focus on the long term."