KNOWLEDGE LINK
Founder knows best in the eyes of investors

Companies that are still run by the men and women who started them tend to perform better in the stock market than do other firms, a new study suggests.

Firms with founder-CEOs outperformed other companies in the stock market by 8.3 percent from 1993 to 2002, said Rüdiger Fahlenbrach, author of the study and assistant professor of finance.

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

“They approach their company differently than any successor could, and that is reflected in how the company is valued,” he said.
Rudiger Fahlenbrach
Fahlenbrach studied 2,327 large U.S. firms from 1993 to 2002. He compared those companies still run by their founders – 11 percent of the total – to all the remaining firms. The founder-CEO firms contain some of the largest and most successful firms of the 1990s, including Berkshire Hathaway, Comcast, Dell, Home Depot, Microsoft and Toys "R" Us.

The results showed a clear advantage for those companies led by their founders, even after Fahlenbrach took into account a wide variety of other factors that may have affected the results. For example, he took into account the industries the firms were in, to ensure that the success did not occur only in, say, technology companies. He also examined the size and age of the firms, and many other factors.

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

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 percent more on research and development than non-founder firms, results showed.

“Founder-CEOs have a different investment behavior, a different perspective,” Fahlenbrach said. “They are very centered on innovation which helps their company grow on its strengths.”

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. Many CEOs are interested in diversifying their firm's interests, to protect themselves in case their core business suffers a downturn. But that often means the company loses its focus and cannot run its various businesses effectively.

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

“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.”

The study is available as a working paper at the Social Science Research Network at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=606527 .