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Understanding the Differences

EOY firms grow faster, use more debt financing and utilize their invested capital more efficiently than publicly-held firms from the same industry. In the paragraphs that follow we summarize evidence from the NCER survey pertaining to corporate governance which may help explain these results. At this point our observations are more descriptive in nature, since we do not have corresponding information for the publicly-held firms. Nevertheless, there are several observations that we can offer from the survey data.

Observation #1: Boards of directors include significant representation by individuals who are not part of the management team, nor do they hold any particular allegiance to management, and thus can more faithfully represent shareholder interests.
Consider the following:

Observation #2: Founding families continue to hold substantial equity investments in the firm.

The founders and/or family members of the founders continue to hold 72 percent of the voting control on average, with mostly outsiders and non-family members holding the rest of the shares. Moreover, 48 percent of the founders or their families still own 100 percent of the voting control. Eighty-three percent of the firms have long-term ownership plans for the business, mostly consisting of continued family management and ownership (26%), being acquired by third parties, management, and/or employees (31%), or other plans (24%).

It is also of interest that 43 percent of the employees have some ownership in their firm, with 33 percent being minority shareholders and 10 percent owning more than 50 percent of the firm's voting control.

Observation #3: Entrepreneurial firms make effective use of their boards of directors in monitoring management activities.

Table 4 offers insight as to the board member's role within the EOY firms. From the table, we see that over one-half of the boards are always involved in reviewing plans, monitoring results, and reviewing CEO performance. Forty-five percent of the boards always set compensation benchmarks. However, only about one-third of the boards are always involved in the planning and/or approval process of future investments, which is probably best since board members who are not part of the management team are at a competitive disadvantage to the firm's managers in questioning proposed plans. Instead, these individuals are far more effective at monitoring performance, rather than assessing future plans.

TABLE 4
Board Member Involvement

    Extent of Involvement  
  Always Sometimes Never
Reviews and approves business plan 53 (62%) 22 (26%) 11 (13%)
Evaluates planned vs. actual performance 50 (62%) 22 (27%) 9 (11%)
Reviews CEO’s performance 47 (57%) 14 (17%) 21 (26%)
Sets compensation benchmarks 38 (45%) 28 (33%) 18 (21%)
Assists in developing business plans 29 (35%) 34 (41%) 20 (24%)
Approves capital expenditures 28 (33%) 47 (56%) 9 (11%)

Observation #4: The managers of the EOY companies are held accountable for their performance and compensation is linked to performance.

A significant 89 percent of the respondents compare plans against actual performance, with 87 percent sharing actual-versus-planned performance with the firm's employees. Seventy-two percent of the responding entrepreneurs indicate they specifically link management compensation to performance. Also, in making comparisons, 83 percent of the firms use external information in assessing the firm's performance. The frequency of the frame of reference used in these external comparisons used are as follows:

Industry norms 35%
Industry leader 30%
Primary competitor 30%
Similar world-class firms 18%
Other 6%
Not compare against others 13%
No response 3%

Of interest, 78 percent of the firms compared their own performance against industry leaders, primary competitors and similar world-class firms, suggesting their tendency to hold themselves to standards of excellence.
The foregoing survey results give some suggestion that entrepreneurial firms are more effective in generating higher rates of return on invested capital because of their efforts to reduce agency problems and by linking compensation to performance.

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