Inside Ownership — Family Business
In the usual corporate setup, the board is elected by the shareholders in a general meeting. Then, the board appoints the management who runs the day-to-day operations of the company on their behalf. In some cases, the management also has inside ownership.
What is inside ownership?
Inside ownership arises when the management of a company has a significant stake in the company. In that case, they run the company as owners, not just employees, because their financial interests and the company’s interest align.
Generally, the management has the best information about the company: order intake, suppliers, customers, the nature of the industry, and the competitors. So, they are expected to know the best time to buy shares in their company. When they buy or sell shares of the company, the market takes note.
What is good about inside ownership
Good management makes decisions that are in the company’s long-term interest to ensure a good return for the owners. When the management has significant ownership in the company, there won’t be a conflict of interest, as both parties are in the same boat.
With the management operating as owners, they are more likely to always seek the best interest of the company. In effect, inside ownership reduces agent cost — the loss of value due to conflicts between the owners and the management.
Since the management obviously knows the situation of the company more than anyone else, tracking the buy and sale of shares by such insiders has been seen as a good trading approach. Some have tried out the strategy in the past.
For example, in 1996, the Norwegian financial daily called Finansavisen created its own inside portfolio, which consists of five stocks with significant insider purchases. The portfolio is assessed once a week, and a new stock may be added depending on whether it meets the requirement.
Qualitative analysis shows that the inside portfolio does much better than the market, without the risk being particularly higher.
Here is the annual return since 1996:
| %-Growth | The Market Index | The Inside Portfolio |
| 1996 | 32 | 80 |
| 1997 | 32 | 44 |
| 1998 | -28 | -14 |
| 1999 | 46 | 116 |
| 2000 | -2 | 7 |
| 2001 | -15 | -14 |
| 2002 | -30 | -26 |
| 2003 | 48 | 92 |
| 2004 | 38 | 65 |
| 2005 | 40 | 115 |
| 2006 | 33 | 55 |
| 2007 | 15.3 | 26 |
| 2008 | -56.8 | -55.2 |
| 2009 | 76.2 | 221.3 |
| 2010 | 18 | 34 |
| 2011 | -12.9 | -24.7 |
| 2012 | 16.2 | 21.9 |
| 2013 | 23.1 | 53.2 |
| 2014 | 5.66 | 16.67 |
| 2015 | 5.4 | -7,5 |
| 2016 | 12.1 | 13.1 |
From the table, you can see that the market index made better returns than the Inside Portfolio only on two occasions — 2011 and 2015. The average annual return for the market index is 14.1%, while that of the Inside Index was 39%.
Inside Portfolio vs. the rest of the market
Most times, retail traders get to know about insider purchases after they have been made, and the market has already reacted to the news. As such, retail investors can hardly achieve the returns of the Inside Portfolio. In a master’s thesis written by Martin Flemsæter Hamre and Andreas Sande in 2014, the buys and sales of Finansavisen’s Inside Portfolio were analyzed. The result is shown in the graph below:
Source: https://brage.bibsys.no/xmlui/bitstream/handle/11250/278443/Hamre_Sande2014.PDF?sequence=1&isAllowed=y page 35
From the graph, you can see that it is not easy to achieve as good a return as the insiders.
Family-controlled businesses
Similar to inside ownership are family-controlled businesses. But in this case, a family or person holds a significant ownership position.
Such a person can have an undue influence on the way the company is run. Interestingly, Warren Buffet, one of the greatest investors in the world likes such companies. According to him, family-controlled companies are more patient and less concerned with short-term fluctuations.
In the US, statistics show that such companies on average have less debt, and they tend to operate conservatively and cautiously.
Also, several academic studies confirm that family ownership has positive effects on the share price. But this is not the case in Asia: family ownership tends to have lower returns than companies with no dominant owners.
The reason for this could be cultural, less transparency, and weak legislation to protect minority shareholders.