Adelphia’s Family Fools

Adelphia Communications, the sixth-largest U.S. cable company, last week filed for Chapter 11, undone by the disclosures of unsavory insider deals. It turned out the firm run by John Rigas had more related-party transactions than Oedipus Rex.

Adelphia routinely commingled its cash with that of other businesses controlled by the Rigas family and guaranteed billions of dollars borrowed by John Rigas and his three sons—all corporate officers and directors—to buy stock. In 2001, it paid $14.9 million to companies controlled by the family for everything from snow removal to furniture. It lent money to a film production company controlled by John Rigas and his daughter, Ellen. For several years, Ellen and her husband, who also served on the board, lived rent-free in a company-owned Manhattan apartment. As far as the company’s chief financial officer and board were concerned, all these were appropriate uses of Adelphia’s cash. Of course, that CFO was Timothy J. Rigas. And five of the board’s nine seats were filled by Rigas relatives.

The looting of Adelphia bears superficial resemblance to the scandals at Enron and Tyco, but there’s a crucial difference. Unlike other recent corporate rogues, the Rigases weren’t hired guns. They were the founders and controlling shareholders of a company they had built from the ground up over several decades. Accordingly, this spectacular flameout should raise some questions about corporate governance that are rarely asked on Wall Street or in the financial press, whose leading players are compromised on this very issue.

Adelphia was a relatively rare hybrid: a publicly held company whose economic interest was owned by thousands of holders of its common stock, but whose management interest was controlled almost entirely by the founding family. Investors held the 153.9 million Class A common shares. The Rigas family held all 19.235 million Class B shares, each of which carried 10 votes. With an 11 percent economic stake in Adelphia, the Rigases controlled 56 percent of the votes.

While not common, similar family arrangements are in place at several prominent companies: Ford, Dow Jones, the Washington Post, Comcast, Cablevision, and the New York Times, among others.

Such aristocratic arrangements—the absence of essential rights for minority shareholders and dynastic inheritance of jobs by people who may not be qualified for them—stand on its head the American style of one-share, one-vote corporate organization. Even the language surrounding this topic—Class A and Class B shares, common holders vs. special holders—is fraught with a class consciousness not typically found in our bourses.

Families concoct these strategies for a few eminently understandable reasons. The dual-stock structure lets them maintain control of the company beyond the lifetime or active career of the founder—all while tapping the public for money and creating an easy means of cashing out. It allows parents to create secure, rewarding jobs for their children and grandchildren. And by (anachronistically) paying dividends, family-controlled companies can provide liquidity to heirs who may chose to spend their lives in pursuit of public service, or of the hounds.

Some corporate aristocrats try to cloak family self-interest in the broader public interest. The New York Times is a great champion of democracy—except when it comes to its own governance. Holders of the company’s 149.9 million Class A shares can vote for four members of the board of directors. But holders of the 847,020 Class B shareholders get to elect nine. Who owns 87 percent of the Class B shares? A Sulzberger family trust, whose primary objective is “to maintain the editorial independence of the New York Times and to continue it as an independent newspaper, entirely fearless, free of ulterior influence and unselfishly devoted to the public welfare.” In other words, those who control far less than 1 percent of the House of Sulzberger’s economic value override all the other investors for the public good.

There are some theoretically positive attributes of family control. Because top executives are secure, family-run companies tend to be more paternalistic toward their workers and more patient with their money. Corning, Inc., with its five generations of Houghton family CEOs and long track record of expensive, time-consuming innovation from Pyrex to fiber-optic cable, neatly illustrates this. (Full disclosure: I’m co-author of a company history, Generations of Corning, commissioned by the company and published by Oxford University Press.)

Secure CEOs can also take more risks. If a company stumbles and its share price falls, it becomes a ripe takeover candidate. But companies in which the holders of a few Class B shares maintain voting control are takeover-proof. The sainted Katharine Graham didn’t have to worry about her control of the Washington Post Co. during Watergate because it was unassailable. The company went public in 1971, but a special class of shares kept authority in the hands of the Graham family. Today, Donald Graham controls 87 percent of the class of stock that elects six of nine company directors.

Of course, there’s a price to be paid for a few good newspapers and a little noblesse oblige. Family control is designed to insulate management from market forces. And frequently it does just that. Family companies may miss growth opportunities, as Dow Jones did during the ‘90s boom.

Selecting bosses from the gene pool means that shareholders are sometimes fishing in shallow water. I, for one, have my doubts that William Clay Ford Jr. is the best man to resurrect Ford Motor Co. But the company’s bylaws stipulate that the family’s shares control 40 percent of the votes. And in a company where ownership is as widely diffused as Ford, that’s tantamount to majority control.

In accepting family control, shareholders trade control for immunity from rapacious options hogs like Enron’s Jeffrey Skilling and Tyco’s Dennis Kozlowski, who viewed their relationship with shareholders as a zero-sum game. Historically, the well-bred scions of family empires haven’t stooped to fudging the books for the sake of hitting quarterly numbers. After all, their wealth stems from shares created or acquired at the company’s birth. Most members of intergenerational management teams are merely inhabiting the family mansion for a few years, not looking for a way to cash out.

Which is why the actions of John Rigas and his three Ivy-League educated sons are all the more dumbfounding. Their shares—real shares, not options—were worth nearly $900 million as recently as a year ago. The massive value of the asset was destroyed by their continual efforts to swipe nickels and dimes out of the cash register. As big owners of stock, they had the most to gain from long-term growth. Instead, they treated their vein of gold like a strip mine.

Family control was meant to protect the Rigases from the barbarians at the gates. But as was the case in another Greek tragedy, the killers were inside the walls.