Managing Family Businesses: Theory and Practice (2017) PDF

Managing the Family Business THEORY AND PRACTICE Thomas Zellweger Professor of Management, University of St. Gallen, Switzerland © Thomas Zellweger 2017 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any...

Managing the Family Business THEORY AND PRACTICE Thomas Zellweger Professor of Management, University of St. Gallen, Switzerland © Thomas Zellweger 2017 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA A catalogue record for this book is available from the British Library Library of Congress Control Number: 2016959910 ISBN 978 1 78347 071 6 Contents in brief Preface 1 Introduction 2 Defining the family business 3 Prevalence and economic contribution of family firms 4 Strengths and weaknesses of family firms 5 Governance in the family business 6 Strategic management in the family business 7 Succession in the family business 8 Change and transgenerational value creation 9 Financial management in the family business 10 Relationships and conflict in the family business References Index Full contents Preface 1 Introduction 1.1 Thematic focus 1.2 Intended audience 1.3 Structure and pedagogical tools 2 Defining the family business 2.1 The distinction between family and nonfamily firms 2.2 Defining family business by type of family involvement 2.2.1 Amount of family control 2.2.2 Complexity of family control 2.2.3 Business setup 2.2.4 Philosophy of family control 2.2.5 Stage of control 2.3 Circle models of family influence 2.3.1 Advantages of circle models 2.3.2 Disadvantages of circle models 2.4 Family firm identity 2.5 Family business definition used in this book 3 Prevalence and economic contribution of family firms 3.1 Prevalence of family firms worldwide 3.1.1 United States 3.1.2 Europe 3.1.3 Asia and Pacific Rim 3.1.4 Middle East/Gulf countries 3.1.5 Latin America 3.1.6 Africa 3.1.7 Summary 3.2 Economic contribution of family firms 3.2.1 Size of family firms 3.2.2 Contribution to employment  3.2.3 Contribution to GDP 3.2.4 Summary 3.3 Institutional setting and the prevalence of family firms 3.3.1 Industry affiliation of family firms 3.3.2 Stock market listing of family firms 4 Strengths and weaknesses of family firms 4.1 Typical strengths of family firms 4.2 Typical weaknesses of family firms 4.3 Bivalent attributes of family firm characteristics 4.4 Case study 5 Governance in the family business 5.1 Why do family firms need governance? 5.1.1 Motivation of family owners 5.1.2 Functionality of traditional governance mechanisms in family firms 5.1.3 Specific governance problems in family firms 5.2 Typical governance constellations in family firms 5.3 Performance implications of governance constellations 5.4 Untangling corporate, ownership, family and wealth governance 5.5 Corporate governance 5.5.1 Picking the right people for the board of directors 5.5.2 The role and involvement of the board of directors 5.5.3 The board’s involvement in strategy formulation 5.6 Ownership governance 5.7 Family governance 5.7.1 Goal and topics of family governance 5.7.2 Family values and goals 5.7.3 Family involvement in management 5.7.4 Family involvement in ownership 5.7.5 Family involvement in new entrepreneurial activity 5.7.6 Family involvement in philanthropy 5.8 Wealth governance 5.8.1 The uncoordinated family 5.8.2 Embedded family office 5.8.3 Single-family office 5.8.4 Family trust/foundation  5.8.5 Which wealth governance constellation is best? 5.9 Governance documents: code of conduct and family charter 5.9.1 Family charter 5.10 Governance bodies: family assembly and family council 5.11 Integrated governance in family firms 5.12 Case studies 6 Strategic management in the family business 6.1 Strategic decision making in family firms 6.1.1 Socioemotional wealth (SEW) 6.1.2 Distinctiveness of financial and socioemotional viewpoints 6.1.3 How SEW impacts strategic decision making: a framework 6.1.4 Some evidence of SEW in family firm behavior 6.1.5 Preference reversal under vulnerability 6.2 Conceptualizing the competitive advantage of family firms 6.3 The agency perspective 6.3.1 Aligned interests of family owners and family managers 6.3.2 Misaligned interests of family owners and family managers 6.3.3 Family owners harming nonfamily managers 6.3.4 Family owners monitoring nonfamily managers 6.3.5 Family owners expropriating nonfamily minority owners 6.3.6 Family owners in conflict with each other 6.3.7 Summary and case study: family firm competitiveness from an agency perspective 6.4 The resource-based perspective 6.4.1 Familiness 6.4.2 Family as resource provider 6.4.2.1 Financial capital 6.4.2.2 Human capital 6.4.2.3 Social capital 6.4.2.4 Physical capital 6.4.2.5 Reputation 6.4.3 Family as resource manager 6.4.4 Turning familiness into business strategies 6.4.5 Summary and case study: family firm competitiveness from a resource-based perspective 6.5 The organizational identity perspective 6.5.1 Intertwined identities of family and firm  6.5.1.1 The particular relevance of identity and identification in family firms 6.5.1.2 Linking family firm identity to corporate reputation 6.5.2 Corporate social responsibility in family firms 6.5.3 Branding in family firms 6.5.3.1 Family firm image: the particular role of relational qualities 6.5.3.2 Family firms as brand builders 6.5.4 How a family firm image drives financial performance 6.5.5 The dark side of family firm identity 6.5.6 Some empirical findings on the family firm image– performance link 6.5.7 Summary and case study: family firm competitiveness from an identity perspective 6.6 The institutional perspective 6.6.1 The micro view: strategic conformity of family firms 6.6.2 The macro view: family firms under various institutional regimes 6.6.3 Family business groups: an institutional perspective 6.6.4 Some international comparisons 6.6.5 Summary and case study: family firm competitiveness from an institutional perspective 6.7 The paradox perspective 6.7.1 What are paradoxes? 6.7.2 Tensions and paradoxes in the family firm context 6.7.3 The promise of a paradox perspective for family firm management 6.7.4 Management approaches to dealing with tensions 6.7.5 How the management of paradoxes drives firm performance 6.7.6 Paradoxes at play: innovation in family firms 6.7.7 What it takes to manage paradoxes: collective mindfulness 6.7.8 Summary and case study: family firm competitiveness from a paradox perspective 6.8 Generic strategies for family firms 6.9 Tools for strategic management in family firms 7 Succession in the family business 7.1 Succession options 7.2 Opportunities and challenges of succession options 7.3 Significance of succession options 7.4 Declining relevance of intra-family succession 7.5 Sources of complexity in family business succession 7.6 Structuring the succession process: succession framework 7.7 Clarifying goals and priorities 7.7.1 Which succession option to choose? 7.7.2 Goals of incumbent and successor 7.7.3 How incumbent and successor determine acceptable transfer prices 7.7.4 What motivates and discourages family successors from joining? 7.7.5 Successor willingness and ability 7.7.5.1 Successor willingness: it is the type of commitment that matters 7.7.5.2 Successor ability: it is the job profile that matters 7.7.5.3 The willingness and ability diagram 7.8 Reviewing the firm’s strategy 7.8.1 Stagnating performance 7.8.2 Leadership vacuum 7.8.3 Diversified product/market portfolio 7.8.4 Intertwined operating and non-operating assets 7.8.5 Firm as incumbent’s retirement fund 7.9 Planning the transition of responsibilities 7.9.1 The succession road map 7.9.2 Entry paths for the successor 7.9.3 Adapting roles for incumbent and successor 7.9.4 Grooming the successor 7.10 Valuing the firm 7.10.1 Net asset value 7.10.2 EBIT or EBITDA multiple valuation 7.10.3 Discounted free cash flow (DCF) valuation 7.10.4 Combining different valuations to get a fuller perspective 7.10.5 From valuation to price 7.11 Financing the succession 7.11.1 Financing with equity 7.11.2 Financing with vendor loan  7.11.3 Financing with bank loan 7.11.4 Financing with subordinated debt and mezzanine capital 7.11.5 Combining multiple financing options 7.12 Defining the legal and tax setup 7.12.1 Transfer to family members 7.12.1.1 Giving shares to family members 7.12.1.2 Trusts 7.12.1.3 Selling shares to family members 7.12.2 Transfer to co-owners 7.12.3 Transfer to employees 7.12.3.1 Employee stock ownership plans (ESOPs) 7.12.3.2 Management buyouts (MBOs) 7.12.4 Private equity, recapitalizations and leveraged buyouts 7.12.4.1 Private equity recapitalizations 7.12.4.2 Leveraged buyouts (LBOs) 7.12.5 Complete sale to financial or strategic buyer 7.13 Case study 8 Change and transgenerational value creation 8.1 Change and adaptation in family firms 8.1.1 The sensemaking of family firms in changing environments 8.1.2 Recognition—the ambiguous role of the family firm’s network 8.1.3 Interpretation—long-term orientation versus socioemotional wealth 8.1.4 Decision making—the key advantage of family firms 8.1.5 Implementation—the double-edged sword of experience and loyalty 8.1.6 Summary: family firms and change 8.2 Longevity of family firms 8.3 Transgenerational value creation in family firms 8.3.1 Value creation versus longevity 8.3.2 Some evidence on transgenerational value creation 8.3.3 Transgenerational value creation defined 8.3.4 Transgenerational value creation: a model 8.3.4.1 Upholding change and entrepreneurship 8.3.4.2 Parallel control of several businesses and limited diversification  8.3.4.3 Sequential control of businesses: buy, build and selectively quit 8.3.4.4 From business management to investment management expertise 8.3.4.5 Maintaining control despite looser forms of family involvement 8.3.4.6 Multiple and changing roles for family members 8.3.4.7 Focus on the overall performance of family wealth 8.3.4.8 Renewed identification: we are a ‘family in business’ 8.3.5 Transgenerational value creation from a dynamic point of view 8.3.5.1 Evolution of business management 8.3.5.2 Evolution of investment management 8.3.6 Integrated business and investment management for large fortunes 8.3.7 Case studies 9 Financial management in the family business 9.1 Why finance is different for family firms 9.1.1 Concentrated and active majority owners 9.1.2 Owners with a long-term view 9.1.3 Owners who value economic and socioemotional utility 9.1.4 Owners with privileged access to information 9.1.5 Illiquid market for shares 9.2 Family equity as a distinct asset class 9.3 Performance of family firms: a short review of the evidence 9.4 Risk taking in family firms 9.4.1 High wealth concentration 9.4.2 Low leverage 9.4.3 Low investment risk 9.5 Debt financing 9.5.1 Advantages of debt financing 9.5.2 Disadvantages of debt financing 9.5.3 Cost of debt capital 9.6 Equity financing 9.6.1 Advantages of equity financing 9.6.2 Disadvantages of equity financing  9.6.3 Cost of equity capital 9.7 Leverage 9.7.1 Leverage effect 9.7.2 Leverage, risk and firm value 9.7.3 Practical advice on the appropriate leverage level of family firms 9.7.4 Leverage and strategic challenges 9.8 Value management 9.9 Key financial indicators 9.10 Dilemmas in the financial management of family firms 9.10.1 The growth versus liquidity dilemma: the role of dividends 9.10.2 The profitability versus security dilemma: the role of leverage 9.10.3 The liquidity versus security dilemma: the role of portfolio management 9.11 Principles for the sustainable financial management of family firms 9.12 The role of the CFO in family firms 9.13 Management compensation in family firms 9.13.1 Some findings and reflections on compensation practices in family firms 9.13.2 Base salary 9.13.3 Bonus plan and supplemental benefits 9.13.4 Common stock 9.13.5 Phantom stock and stock appreciation rights (SARs) 9.13.6 Psychological ownership 9.14 The responsible shareholder in the family firm 9.14.1 Clarify values for the family and firm 9.14.2 Translate values into strategic goals 9.14.3 Hold management accountable to the goals 9.14.4 Establish family, ownership and corporate governance rules—and stick to them 9.14.5 Understand the key financials and value drivers of the firm 9.14.6 Be mindful 9.15 Case study 10 Relationships and conflict in the family business 10.1 The social structure of the family  10.1.1 The spousal team in business 10.1.2 The sibling team in business 10.1.3 The extended family in business 10.1.4 Family embeddedness 10.2 Trends in the social structure of the family 10.3 International variance in family values 10.4 Understanding interpersonal dynamics in the family firm: a systemic view 10.4.1 Systems in conflict and ambiguous context markers 10.4.2 Who is speaking? The challenge of skewed communications 10.5 Justice perceptions 10.5.1 Distributive justice 10.5.2 Procedural justice 10.5.3 Interactional justice 10.5.4 The importance of procedural and interactional justice in the family 10.5.5 Injustice perceptions and their consequences 10.6 Why family firms are fertile contexts for conflict 10.7 Types of conflict 10.7.1 Relationship conflict 10.7.2 Task conflict 10.7.3 Connection between task and relationship conflict 10.8 Conflict dynamics 10.8.1 The role of time in conflicts 10.8.2 Conflict and the lifecycle of the firm 10.8.3 Conflict escalation 10.9 Conflict-management styles 10.9.1 Domination 10.9.2 Accommodation 10.9.3 Avoidance 10.9.4 Compromise 10.9.5 Integration 10.9.6 Which conflict-management style is best in the family business context? 10.10 Communication strategies 10.10.1 Moving across time using conflict rooms  10.10.2 Principles of constructive and destructive communication 10.10.3 Why governance is not always the best solution 10.11 How to behave in the face of conflict 10.12 Case study References Index Preface This textbook is the result of two observations from being a teacher and researcher in the field of family businesses. First, when I began looking for a comprehensive textbook to support my teaching, I could not find one that satisfied me. While there were numerous textbooks on entrepreneurship, human resource management, marketing and strategy, these books only covered selected aspects of the challenges and managerial practices observed in family firms. Meanwhile, there seemed to be a dearth of supporting materials for the sort of family business class that covers the full breadth of relevant topics. My aim in writing this book was not to replace the many important books, case studies and research papers already in existence on specific topics. Rather, I tried to provide an overview of what makes the family firm a unique type of organization, to integrate knowledge from practitioners and scholars, and to help readers navigate the large array of available materials. This book thus intends to guide students and practitioners through the rich insights that those involved in managing and studying family firms have accumulated in recent years. In this attempt, the book will most likely leave some readers unsatisfied. Family firms are highly heterogeneous organizations, and their heterogeneity arises not only from the particular goals of family owners or family constellations but also from the varying institutional contexts in which the firms are embedded. The present compilation of topics, conceptual models and case studies is the result of an attempt to discuss the core topics that these firms share, and hence to explore what is essential about family firms despite their heterogeneity. It is inevitable that some aspects may have been overlooked or inadequately represented. This partial limitation, I think, must be weighed against the opportunity to offer insights on many of the central aspects of managing family businesses in a single book. The second observation that led to this book relates to my work with family business practitioners. Over the years, the individuals and families I have worked with have entrusted me with their stories, challenges and questions, including: How should we approach the succession process? Who should become the successor? How do we achieve long-term success? Should I enter my parent’s company? What competitive advantages do we have as a family firm? What is an adequate return on the capital the family has invested in the firm? How do we structure decision making in our family with regard to the business? When I was first confronted with these questions, I was unable to answer them satisfactorily. However, over time, and with the help of many excellent family business researchers and family business practitioners, I have arrived at some possible answers. I am indebted to the many individuals who helped me compile this book. First and foremost to Miriam Bird, Urs Frey, Michael Gaska, Marlies Graemiger, Maximilian Groh, Frank Halter, Sonja Kissling Streuli and Melanie Richards from the Center for Family Business at University of St. Gallen. Many thanks go to Urs Fueglistaller, my co-director at the Swiss Research Institute of Small Business and Entrepreneurship at the University of St. Gallen, for creating a very collaborative, fun and entrepreneurial atmosphere. I am grateful to Joe Astrachan, Michael Carney, Jim Chrisman, Alfredo De Massis, Kim Eddleston, Marc van Essen, Luis Gomez-Mejia, Nadine Kammerlander, Franz Kellermanns, Tim Habbershon, Robert Nason, Mattias Nordqvist, Pankaj Patel, Peter Rosa, Bill Schulze, Pramodita Sharma, Philipp Sieger, Alex Stewart, Wim Voordeckers, Arist von Schlippe and John Ward from whom I have learned a tremendous amount about family firms and who have contributed to the book in one way or another. Thank you also to Heinrich Christen, Peter Englisch, Carrie Hall, Patrick Ohle, Santiago Perry, Johannes Rettig, Yuelin Yang, and Marnix van Rij. Your input and support has been invaluable. Finally, my deepest gratitude and love to Nathalie, Nikolaus and Leo, my closest family. This book is dedicated to the many individuals who share a common goal: to understand what makes family firms unique and successful organizations. April 2017, St. Gallen & Singapore Thomas Zellweger 1 Introduction Writing a textbook about the management of family firms poses a particular challenge. On the one hand, family firms undoubtedly represent the largest fraction of all firms across the globe. On the other hand, there are relatively few family business classes being taught in business schools and universities today, suggesting that the market for such a book may be limited. If you are reading this book, then you are likely a manager, scholar or student who believes—as I do—that the mainstream management literature does not sufficiently describe family firms or address their managerial challenges. There are dozens of textbooks on topics such as entrepreneurship, human resource management, marketing, financial management or strategy, but hardly any about family firms. Admittedly, the above topics are relevant to all types of firms, independent of their family or nonfamily status. But family businesses face challenges that may be more pronounced than they would be in nonfamily firms, or that may need to be addressed differently. For instance, while governance in nonfamily firms is mainly concerned with the effective structuring of the cooperation between a dispersed group of owners and a limited number of managers, governance in family firms also includes topics such as the effective collaboration of a group of family blockholders or the efficient oversight of family managers (such as children) by family owners (such as parents). Similarly, while a firm leader’s exit is an increasingly relevant topic in entrepreneurship, succession has been and remains a central preoccupation in family firms. When we look at other broad topics such as strategy, financial management or even human resources, we again find that family and nonfamily firms face similar questions but that family firms address them in different ways. The goal of the present textbook is to look at these managerial topics through the family business lens and to come up with actionable strategies to promote family firm success. 1.1 Thematic focus Although this book aims to provide guidance to practitioners in various domains, its content necessarily mirrors my training as a management scholar. This precondition brings with it some preferences that guide my approach to family firm challenges. In the best cases, the thematic focus I use in this book leads to greater conceptual clarity and simplicity. But the management scholarship approach also comes at a certain cost, which is the potential oversight of other rationales and theoretical backgrounds through which family firm behavior could be explained. Thus, although I aim to embrace different points of view throughout the book, I mainly focus on the organizational processes in family firms and the way they can be managed to ultimately achieve firm-level success. In consequence, the main level of analysis—although I relax this assumption in the last two chapters of the book—is the firm, and to a lesser extent the family itself. The frameworks put forth in the book stem primarily from management theory and economics, with a secondary emphasis on family sociology. Because this is a book that focuses on the management of family businesses, it explores managerial challenges that are decisively influenced by the family. This choice is a matter of my perspective. But it is a deliberate choice that strives to avoid a common pitfall in much of the current family business writing and thinking: the idea that any given aspect or behavior of family-controlled firms is decisively impacted by the family. I try to single out the specific managerial practices in family firms where the family aspect matters to a degree that is decisive for the effectiveness or ineffectiveness of the firm. 1.2 Intended audience I wrote this book for family business students and practitioners. It is not the classical ‘how-to’ or ‘do-it-yourself’ book, filled with checklists of ‘success factors’ derived from looking at a few successful family firms. Rather, this book is written for people who seek guidance in dealing with the most pressing challenges faced by family firms. In trying to deal with these challenges, the book attempts to combine frameworks that have been proven in practice with the latest research findings. This book will be most useful to you if you are: looking for an inclusive discussion of topics generally faced by family firms, a family business student trying to immerse yourself in the family business world, a family business owner/manager looking for actionable and at the same time tested advice about how to tackle managerial challenges, and/or an advisor looking for an overview of research findings relevant for your practice. The book may not be a satisfactory resource if you: are looking for easy answers and one-size-fits-all solutions to complex problems, do not have the time to explore the foundations of practical questions, and/or are not interested in exploring research findings. 1.3 Structure and pedagogical tools The book is structured along the following sections: defining the family firm, family firms’ significance and economic contributions, and the typical strengths and weaknesses, governance, strategic management, succession, change and transgenerational value creation, financial management, and interpersonal relationships in family firms. Each chapter makes use of multiple pedagogical tools: conceptual frameworks, presentation and summary of research findings, case studies, reflection questions both for students and practitioners, and suggestions for background reading. The use of literature is limited to the most relevant and up-to-date studies needed to support an argument. Thus, the studies cited do not encompass all the relevant literature, but they do represent some particularly foundational and intriguing studies and books. In addition, at the end of every chapter, you will find a list of bibliographical references suggested as background reading for a more in-depth view of the subject. 2 Defining the family business One of the most serious challenges in many social sciences relates to the definition of the phenomenon under study. In the case of family businesses, this challenge is particularly important given that what distinguishes family firms from other types of organizations is the influence of the family on the firm.1 Note that the distinction between family and nonfamily firm is not a matter of the size of the business, nor whether it is privately or publicly held. Rather, what qualifies a family firm as such is the degree to which— and the ways through which—a family controls its firm. Family firms deserve an approach to management that takes into consideration what makes them unique: the fact that they are influenced by a particular type of dominant coalition, a family, that has particular goals, preferences, abilities and biases. 2.1 The distinction between family and nonfamily firms Students, practitioners and researchers alike often look for an easy answer to the question of what distinguishes family from nonfamily firms. In search of such a demarcation line, many have tried to assign some cutoff level for family involvement in a firm, for instance in the dimensions of ownership or management. The underlying assumption behind such an attempt is that a minimum level of family involvement is required above which a firm is defined as family firm and below which the firm is nonfamily. In the case of ownership control, some argue that a majority stake is required for a family to exert a decisive influence on a firm. Others suggest that control is possible even without a majority ownership stake. For instance, in publicly listed companies, and in the many cases where ownership outside the family is diluted and widely held, a significant minority ownership may be enough to control important strategic decisions in a firm (such as, for instance, the appointment of board members and top managers, acquisitions, divestments, restructuring and the like). In consequence, and in the case of large and publicly quoted family firms, there is an increasing consensus that an ownership stake of 20 to 25% may be sufficient for a shareholder to have a decisive influence on strategic decisions (Anderson and Reeb 2003b; Villalonga and Amit 2006). As such, and for the case of large and publicly listed family firms, the 20 to 25% cutoff in ownership is often used as the criterion to distinguish family from nonfamily firms. For instance, the European Commission suggests that a public firm is a family firm if a family controls 25% of voting rights. Most importantly, in countries where dual-class share ownership structures are allowed by law, an even smaller ownership stake may entitle a family to exercise control over a company. For example, in 2010, the Ford family collectively owned less than 2% of Ford Motor Company in terms of rights to its cash flows, but it remained firmly in control of the company with 40% of the voting power through a special class of stock. Accordingly, it seems reasonable that the minimum threshold of ownership rights should be applied to voting rights and not to the cash flow rights of owners (see the case study about the Ford family and Ford Motor Corporation in Chapter 6 on strategy in family firms). Others would argue that a firm only qualifies as a family business if it is family managed as well as family owned. The underlying rationale here is that influence takes place not only through formal ownership, but also through leadership, and hence through the values and leadership styles that permeate a company. Family management is often understood as the family’s involvement in the firm’s top management, in many cases even in the CEO position. The use of family involvement in management as a criterion for family firm demarcation is especially common in the case of smaller firms. For large firms, and especially for publicly listed firms, family management is less often seen as a distinguishing factor between family and nonfamily firms. At the same time, there is a good deal of literature suggesting that what makes a family firm unique is its transgenerational focus (e.g., Chua, Chrisman and Sharma 1999). That is, the wish to pass the firm on to future family generations separates family firms from nonfamily firms. The transgenerational outlook is indeed important, as it represents the critical feature distinguishing family firms from other types of closely held companies. Some argue that, regardless of the ownership or management structure, a business can only qualify as a family firm if it has remained under family control beyond the founding generation. In fact, many empirical studies find significant differences between founder-controlled companies and those controlled by later generations. For instance, there is mounting empirical evidence that later-generation firms underperform founder-controlled firms on the stock market. Table 2.1 Family business definitions Influence Cutoff criterion Rationale dimension distinguishing family from nonfamily firms Ownership For small firms: at least Ownership rights, and in particular voting 50% of voting rights in rights, equip actors with a decisive power to family hands alter the strategic direction of the firm For large and public firms: at least 20% of voting rights in family hands Management Small firms: family Management involvement is what allows a involvement in top dominant coalition (the family) to imbue a management team firm with particular values and to directly Large and public firms: influence decision making involvement often not required Transgenerational Firm is controlled by a It is the desire for transgenerational control outlook family with the intent of that distinguishes a family from a nonfamily passing it on to the next firm family generation Later-generation First-generation firms: Control that spans generations—and hence is control founder-controlled firms not limited to a founding generation—is Later-generation firms: what constitutes a family firm family firms However, the argument that firms held by the founding generation are not family firms is not universally accepted. Many would argue that firms founded with the involvement of family members (e.g., those founded by siblings or a spousal team) or firms held by the founding generation with the intent of passing control on to some future family generation should qualify as family firms as well. These various arguments about the seemingly clear-cut distinction between family and nonfamily firms are summarized in Table 2.1. The arguments summarized in Table 2.1 show that there is no such thing as a clear demarcation between family and nonfamily firms (for further reflection on this topic, see Astrachan, Klein and Smyrnios 2002). In their understandable attempts to come up with a decisive definition of the family business, practitioners and researchers alike have created an artificial dichotomy between family and nonfamily businesses, thereby falling prey to some serious simplifications about what family firms are and what they are not. Three such simplifications may be particularly problematic: 1. Overlooking the heterogeneity of family firms: Many studies that suggest a clear-cut distinction between family and nonfamily firms overlook the heterogeneity within the group of family firms. As we will see later on in this chapter, family firms are numerous among the smallest firms, but they are also found among the largest ones, and they exist in a wide variety of industries. At the same time, family firms do not share a single mode of governance structure. Some families exercise control solely through ownership and board involvement, while other families are also active in management. Similarly, some families control a single firm, while others control large conglomerates. 2. Simplifying the definition of family: One traditional line of thinking sees the family as a social unit whose operation is fundamentally distinct from the market. For example, in his famous work on the role of family in society, Bourdieu (1996, p. 20) argued that a family is ‘a world in which the ordinary law of the economy is suspended, a place of trusting and giving—as opposed to the market and its exchange of equivalent values’. However, this view of the family neglects the particular situation of families in business, including the ways in which they have to deal with family and business issues in parallel. More generally, families are not social systems that are incapable of dealing with  financial issues—think, for example, about the task of allocating income and wealth among family members. Furthermore, the definition of what a family is and who belongs in it may differ widely across cultures. For example, Arab families tend to be relatively inclusive in determining family membership. In China, despite the relevance of the family as a social actor, the one-child policy severely limits family sizes, with important consequences for decisions such as family succession and the intergenerational transfer of family wealth. Family structures also change over time because of changing social norms, as evidenced by the increasing number of divorces and non-marital births in Europe and the United States. 3. Underestimating the value of studying family involvement along various dimensions: Finally, the view that there is a clear-cut criterion that can distinguish family firms from nonfamily firms overlooks the value of examining different types of family influence. Resisting the temptation to lump various means of family involvement into one category can lead to valuable insights. For example, we may come to better understand the sources of heterogeneity among family firms as well as the managerial levers needed to alter a firm’s circumstances. Taken together, whether we like it or not, there is little to be gained from creating a family/nonfamily firm dichotomy. If we want to achieve a more refined understanding of what makes family firms unique organizations, we need to move beyond such simplistic divisions. Instead, we should ask ourselves: what are the specific ways in which families influence their firms? 2.2 Defining family business by type of family involvement To answer the question posed above, we can start by examining the dimensions along which families may be involved in their firms. A particularly prominent example of a model that seeks to capture the essential dimensions of family influence is the F-PEC model (Astrachan, Klein and Smyrnios 2002). This model suggests that family influence stems from three dimensions. First, the power dimension captures the degree of ownership control in family hands, the extent of management control in family hands and the degree to which a governance body (i.e., the board) is controlled by the family. Second, the experience dimension is represented mainly by the number of generations for which the firm has been under family control. Third, the cultural dimension accommodates the degree of cultural overlap between the family and business systems, that is, the degree of overlap between family and business values. Building on the F-PEC model and drawing from more recent research on the channels through which families influence their firms, we can identify five dimensions of family involvement: (1) the amount of family control, (2) the complexity of family control, (3) the setup of the business activities, (4) the family owner’s philosophy and goals, and (5) the stage of control in terms of the family’s history with the firm. Figure 2.1 provides a graphical overview of these reflections on family involvement using what we call the family business assessment tool. The family business assessment tool does not suggest an optimal positioning along the five dimensions. Rather, the benefit of assessing family involvement according to these dimensions should be twofold. First, the five dimensions are meant to shed light on the sources of family firm heterogeneity, and in particular the opportunities and challenges that come with various types and levels of family involvement. Second, the tool allows family business practitioners to open a discussion not only about the current state of family involvement, but also about the family’s future involvement, and the opportunities and challenges the firm will likely face when altering its positioning along the various dimensions of influence.  Figure 2.1 Family business assessment tool 2.2.1 Amount of family control The control dimension captures the current degree of family involvement in ownership, management and governance functions. The current level of family control determines the degree to which the family is (potentially) able to exercise power and influence important strategic decisions. There is mounting evidence suggesting that firm performance is impacted differently by family involvement in ownership, governance and management, depending on the complexity and, in particular, size of the business. For instance, in a small firm a family-dominated ownership and management team may help performance as it represents a very efficient and lean governance form. In a larger firm, however, it may be necessary to open up ownership to outsiders to finance growth and drive performance. Moreover, given the complexity of a large firm and the expertise required to manage it, opening up management to nonfamily talent may be essential. However, in such a case, it is critical for the family to be present on the governance board to control the nonfamily managers. Depending on the type and degree of family control, family firms face different opportunities and threats, as depicted in Table 2.2. Table 2.2 Amount of family control 2.2.2 Complexity of family control While the control dimension captures the amount of family control, the complexity dimension measures the complexity of family control. Complexity of family control rises with the number of family owners and managers. The classical owner-manager constellation represents a fairly simple governance form with one person serving as the sole owner and manager. The opportunities of this governance form are the speed and efficiency of decision making, as well as the absence of owner–manager agency problems; the challenges are the lack of access to external advice and external capital to fund growth and, most often, succession problems. With increasing numbers of family owners and managers, the need for coordination, communication and hence family governance rises while the potential for conflict grows in parallel. With each generation the number of family members grows and owners’ identification with and attachment to the firm may suffer. Table 2.3 summarizes these considerations. Table 2.3 Complexity of family control Note: For a detailed discussion of owner-manager, sibling partnership and cousin consortium stages refer to Chapter 5 on governance. 2.2.3 Business setup Family firms also vary in their approach to conducting business. In the first place, this variance implies that family owners have different modes of self- understanding. On the one hand, the prototypical owning family defines itself as an entrepreneurial actor that strives to nurture a firm. Most often, this means protecting and developing a single business entity, the family’s legacy firm, which is active in a certain industry. When this firm is continuously successful, the family often alters its self-understanding from a ‘family business’ to a ‘business family’ mindset. In the latter case, the family as the controlling actor no longer sees itself as a nurturer, and even less so as the protector of a single business. The business family’s identity is derived from an altering and parallel engagement in and development of businesses. Over time, the business family develops a significant portfolio of businesses (a family business group) that is typically controlled via a holding company or family office. In contrast to the entrepreneurial approach, which focuses on a single business (most often, the firm in which the family has historical roots), the business family resembles an investor who seeks to deploy his/her funds in multiple businesses. Such an investment approach is unique in that the business family tries to buy, build and eventually exit businesses over long cycles. While in the family business case the controlling family derives its identity partly from its involvement in a particular firm, the business family identifies more with entrepreneurial activities in general, and thus is less dependent on a particular type of firm or industry. The family’s self-understanding and its approach to doing business are both related to the number of firms the family controls. While many family firms are ‘single business operations’, over time the family may opt to invest in several businesses. The differences in required competences for different numbers of owned firms are significant. For example, when a family manages a single business, industry expertise is essential. In contrast, for a family managing multiple businesses, deep industry expertise may actually be a hindrance. Managing a portfolio of companies requires the ability to develop and eventually rearrange the business portfolio, to take significant financial risks, and to invest in, develop and eventually divest from various businesses. The third element that captures the variance in families’ approaches to doing business is the degree of business diversification. Family firms often exhibit a strong preference for a core activity, product and industry. Their specialization is evidence of in-depth market, product and production know-how. While this may provide significant efficiency and reputation advantages, and hence protect family owners’ socioemotional wealth,2 the owners also face a significant financial risk to their undiversified wealth (Table 2.4). Table 2.4 Business setup 2.2.4 Philosophy of family control A prominent feature of many family firms is that their owners pursue a particular set of goals that includes noneconomic along with economic elements. This feature is often reduced to the idea that family firms try to pursue family (noneconomic) and business (economic) motives. Even though there may be synergies between economic and noneconomic goals, many family firms struggle with a (perceived) tradeoff between them. Put more bluntly, family firms struggle with the question of whether they should prioritize family-related goals over business-related goals, and hence whether they should adhere to a family first or a business first philosophy. In the related literature, the noneconomic goals have been termed ‘socioemotional wealth’. This umbrella term comprises a set of noneconomic goals that are seen as valuable by families but at the same time tend to impact the business sphere (Gomez-Mejia et al. 2011; for a further discussion of socioemotional wealth and its impact on strategic decisions, refer to Chapter 6 on the strategy). A family first approach to managing the family firm would thus emphasize socioemotional wealth, which prioritizes emotional attachment to the firm, the nurturing of the firm, the firm’s public image, and benevolent social ties to stakeholders. A business first approach would prioritize innovation, change, growth and profit over such nonfinancial goals. A prominent element of socioemotional wealth is the level of identity overlap between the family and the business, epitomized, for instance, by a shared name. Family owners with a high identity overlap with their firms are particularly concerned with the firm’s public image and reputation. A bad firm reputation reflects poorly on the owners, while a positive firm reputation may cast the owners in a favorable light. Identity and ultimately reputation concerns among family owners often result in an emphasis on social actions at the firm level (e.g., pollution reduction or support for local social activity). Benevolent social ties are another essential noneconomic goal and element of socioemotional wealth in family firms. These ties represent a preference for binding relationships that emphasize support, trust and the interdependence of firm actors (such as managers, employees, suppliers and clients) with each other and with external stakeholders. The value placed on benevolent social ties affects many aspects of firm behavior. For instance, a firm that prioritizes benevolent ties may have more internal promotions than outside hires, place a particular emphasis on organization-to-person fit for new hires (eventually at the expense of job-to-person fit) and/or exhibit a general hesitation to downsize the workforce. Because benevolent ties are particularly prominent in families and tend to grow over time, their emphasis within a firm may also denote a preference for family and senior nonfamily members over nonfamily and, in particular, junior nonfamily members in staffing and promotion decisions. Benevolent ties to external stakeholders may lead a firm to do favors for business partners (e.g., by providing referrals), to reciprocate received favors, and to nurture long-term interdependent relationships rather than focusing purely on the firm’s short- term financial gain. Again, this emphasis comes with opportunities as well as challenges (see Table 2.5). 2.2.5 Stage of control The stage dimension in our taxonomy of family control assesses the temporal aspect of the family’s relationship to the firm. This dimension distinguishes family owners from other types of blockholders, such as private equity investors. Table 2.5 Philosophy of family control The time horizon of the stage of control extends in two directions: it reaches back into the past (duration) and projects forward into the future (vision). The duration of family ownership denotes the history of firm control by the family. Families with a long duration of ownership may show a heightened concern for their entrepreneurial legacy, a commitment to the historic roots of the business, and a high level of emotional attachment to the firm. In some cases, however, especially when the family is not involved in operations, the owners may experience less attachment to the firm with each passing generation. Nevertheless, for owners who are involved in operations, the passage of time only strengthens the bond with the firm. In these cases, the firm may become a veritable heirloom asset with a value that exceeds the pure financial value of the firm. The owners’ vision for the future relates to the current generation’s desire to extend family control to the next family generation. If the future of the firm looks grim, the family may seek to sell or even liquidate the firm even if it has a long history of successful business activity. In such a case, the family will be less likely to care for, develop and invest in the firm compared to a family that believes in the future of the firm and wishes to pass it on to the next generation. The stage of control, like the previous dimensions, comes with its own specific opportunities and challenges (see Table 2.6). Table 2.6 Stage of family control Taken together, the above framework seeks to capture the heterogeneity of family influence in a firm. Understanding the sources of this heterogeneity is important as the family-involvement dimensions give rise to particular opportunities and challenges for the firm and its owners. As such, the framework points to managerial tasks that are directly tied to the type and degree of family control. The family business assessment tool and the associated framework will be most useful to family business practitioners when each dimension is considered distinctly and when discussions deal with the levels of control, interdependencies and managerial challenges that come with certain positions in the framework. As mentioned above, the family business assessment tool is not intended to point to some optimal positioning (e.g., inner versus outer circle). Rather, it should be seen as a tool that brings to light the managerial opportunities and challenges that are tied to specific dimensions of family influence. 2.3 Circle models of family influence Practitioners and scholars alike have found it useful to define family firms as organizations characterized by the interplay of several subsystems. Figure 2.2 presents one version of the systemic view of family firms. Circle models such as this one are helpful because they remind us that family firms are composed of two social systems—the family and the firm—which adhere to differing, if not opposing, logics.  Figure 2.2 Two-circle model of the family firm system The depiction of the family business as a combination of largely incompatible subsystems brings to the fore the tensions inherent in this form of organization. Further, it suggests that the management of family firms can be equated with the management of tensions among the business and family systems that compete for influence. The circle model thus helps us in making sense of the underlying reasons for the tensions we observe. These tensions become apparent at various levels of strategic decision making, such as alterations at the corporate level (e.g., diversification), risk taking, investments, and research and development, but they also arise in the firm’s structuring of its incentive and compensation systems. The two- circle model would suggest that the discussions around these topics are ultimately influenced by the largely competing logics of the two underlying social systems that come together in the family firm. A much-used alternative to the two-circle model outlined above is the three- circle model of family, ownership and management (Figure 2.3). Originally introduced by Hoy and Verser (1994), this model has received wide acceptance in practice. The three-circle model is appealing to many practitioners because it helps them to grasp the role-related complexities that individuals experience in a family firm. In total, it identifies seven types of roles that an individual can play in a family business system (see Table 2.7). Source: Tagiuri and Davis (1996). Figure 2.3 Three-circle model of family influence Table 2.7 Roles and motives in the three-circle model Number Role Typical motives and concerns 1 Family members who are Harmony, mutual support, long-term survival of the firm neither shareholders nor business managers 2 Shareholders who are Return on equity, dividends, value of the ownership neither family members stake nor managers 3 Employees or managers Job security, salary, stimulating work environment, who are neither family promotion opportunities, opportunity to become owner members nor shareholders 4 Family members who hold Return on equity, dividends, information access shares but are not involved in management 5 Nonfamily managers Opportunity to benefit from firm performance and holding shares increase in value, managerial discretion 6 Family members involved Get to know the firm, career path inside the firm, ways in operations without to eventually become owner shares 7 Family managers holding Trying to be ‘successful’ in all three systems: family shares (togetherness), business (commercial and entrepreneurial success), ownership (financial success) 2.3.1 Advantages of circle models The circle models outlined above rank among the most commonly used models to analyze family influence and governance in family firms. This is not surprising given their undisputed strengths: 1. Disentangling the underlying logic of the subsystem The key advantage of circle models is the way in which they make visible the underlying logics of family and business. They reveal the principles through which role identities, relationship modes, personal expectations and problem analysis are constructed and executed. As a result, they make us aware of the subtle contexts in which reasoning, communication and decision making take place. 2. Enabling discussion about roles and related interests The three-circle model furthers our understanding of the various roles that individuals can play in a family firm. Combined with an understanding of the expectations and motives that come with different roles, it can help us sort out and simplify the complexity inherent in the family business governance structure. Although this model provides a static assessment of the positions of individuals involved with the firm, it can also enable a discussion about how people might switch roles within the model over time. 3. Improving our understanding of role complexity The diagram makes us aware of the fact that people not only have differing interests associated with their roles, but also may wear several hats—that is, they may play different roles at the same time. This insight is important in helping us unearth the inherent complexities of family businesses as well as the sources of misunderstanding and conflict that plague many family business communications. 2.3.2 Disadvantages of circle models Despite their clear advantages, circle models necessarily reduce real-life phenomena to conceptual models. As such, they are fraught with several important shortcomings. 1. Flawed subsystem prototypes The attributes assigned to the family and business spheres are largely overstated. For instance, it does not seem plausible that decisions and relationships are purely emotional/irrational on the family side and purely rational on the business side. Board dynamics in nonfamily firms may be very emotional, and decision making in family firms is not irrational per se. Relationships among family members may be more complex than those among nonfamily members, but they are not necessarily less rational. In the family sphere, financial considerations may be an important matter (e.g., when distributing wealth and income within a family). Circle models thus attribute certain features solely to family or business that actually occur in the other subsystem as well. 2. Flawed functionality assumptions A particularly severe disadvantage of circle models is their implicit assumption that the family inhibits the success of the business. That is, the family logic presented in these diagrams injects disturbing emotions into rational business decisions, emphasizes tradition while limiting change and innovation, and hinders rational decision making and success. Ultimately, one may conclude that because the purpose of the business is to be logical and profitable, the emotional aspect of the family is an interference that is best excluded (Whiteside and Brown 1991). This view, however, has two major flaws. First, family involvement is a given in family firms; by definition, a complete separation of family  and business is impossible in these organizations. Second, many aspects of ‘family logic’ may be present and even desirable in the business sphere. For instance, support, commitment, cohesiveness and interdependence are particularly pronounced in the family context. But these features of interpersonal relationships are often much sought after in the business sphere as well. Similarly, certain attributes that are ascribed to the business sphere, such as the efficient use of resources, are a part of familial norms (e.g., think of the norm of parsimony and the family’s provision of economic goods such as shelter and education). Circle models are undermined by flawed functionality assumptions about the nature of family and business systems because each is defined as the opposite of the other. 3. Overlooked synergies between family and business The polarization of family and business attributes neglects the synergies between family and business systems. The ways in which a controlling family can contribute to a business’s success deserve particular attention. As mentioned above, certain social rules and norms, such as support, commitment, cohesiveness and interdependence, are particularly pronounced in the family context. However, these relationship qualities are often depicted as highly desirable in the business context as well—in particular, ironically enough, when it comes to embracing change. Stabilityproviding systems, which are also associated with families, have been found to be essential grounds for organizational change (see, e.g., Martha Feldman’s work on routines, Feldman and Pentland 2003). Similarly, families often favor a long-term investment horizon, patient financial capital, and networks that may be highly valuable for a firm. The negative and inertial role that the diagram tends to assign to families disregards the synergies between family and business and the ways in which family attributes contribute to firm success. 4. Simplified view of roles and communication Circle models tend to obscure the challenges for actors who ‘wear several hats’ in the organization (in particular, see roles 4, 5, 6 and 7 in the three-circle model). For instance, a dispute between a junior (daughter) or senior (mother) family member involved in the business can be better understood and potentially solved if both sides acknowledge that the two protagonists may each speak as ‘two types of people’. When the daughter criticizes a business decision by the mother,  the mother may interpret the critique as inappropriate behavior by her subordinate. The daughter, however, is used to open communication with her mother in the family sphere. Moreover, she wants to position herself as a determined entrepreneur and successor who is able to successfully continue the mother’s business. Similarly, a family business owner and manager whose son also owns shares and is involved in management may ask himself: when I talk to my son about the business, am I speaking to him as a father, boss or co-owner? In nonfamily business settings, we have familiar ‘markers’ to indicate our roles (at home as a family member, at work as a professional). These contextual markers are often missing or hidden in the family business context. In consequence, and particularly in cases where actors simultaneously occupy multiple roles, circle models tend to underestimate the complexity of communication and decision making.3 2.4 Family firm identity Interestingly, not every family firm that qualifies as a family business under the criteria suggested above defines itself as such. For instance, in a study of private family firms in the United Kingdom, Westhead and Cowling (1998) found that 17% of firm leaders in the sample did not perceive themselves to be part of a family firm despite the fact that the firm was majority controlled by a family. Conversely, 15% of the firm leaders in the sample perceived their firm to be a family firm despite a low level of family control. These findings point to the relevance of the firm’s self-perception. Some firms may want to conceal family influence due to legitimacy concerns for instance on the stock market, as the financial community and minority shareholders may fear nepotism and expropriation by the controlling family. However, other firms may openly portray themselves as family firms in order to project an image of tradition, relationship quality and reliability. Therefore, some argue that the classification of a family firm depends not only on objective governance criteria, but also on the degree to which the controlling family projects a family firm image to its internal and external stakeholders. 2.5 Family business definition used in this book The discussion above is evidence of the lively debate about the essential aspects of family firms. We have seen that there is significant value in separating the dimensions of family influence to unearth the distinct opportunities and challenges tied to family control. Still, as a reader you may well ask about the common denominator this book uses for family firms and the type of family firm for which the concepts discussed in the book are particularly suitable. With these concerns in mind, we suggest the following working definition: Family business definition used in the book: A family firm is a firm dominantly controlled by a family with the vision to potentially sustain family control across generations. This definition of family business is aligned with the prominent definition of Chua, Chrisman and Sharma (1999) and emphasizes two central features: Dominant control in the hands of family: The channels through which this control is exercised may vary significantly depending on the complexity, size and age of the firm and on the particular value system and goals of the family, as shown above. Transgenerational outlook: This aspect is critical when distinguishing between any closely held company and a family firm. It points to the particular relevance of succession and long-term value creation, aspects that are either absent or less relevant in nonfamily firms. We will emphasize different parts of the definition above when discussing different topics in this book. For instance, in the discussion on governance, we will explore the element of ‘dominant control’ in more detail. When discussing succession, we will emphasize and explore the ‘transgenerational outlook’. And when exploring the strategic management of family firms, we will explore how both elements in conjunction impact the strategic choices of family firms. Of course, how one chooses to define a family firm has implications for the prevalence of the family business phenomenon around the world. This will be the topic of the next chapter.  REFLECTION QUESTIONS 1. What are the particular advantages and disadvantages of using the two-circle model to describe family firms? 2. What modes of family influence may be overlooked when one determines family control only in terms of ownership, board and management involvement? 3. What are the potential sources of conflict between family owners involved in management and those not involved in management? 4. Why are there so many communication problems among family members who work together in the family business? 5. For a family firm you know: what is its position in the family business assessment tool? And what are related challenges and opportunities? 6. For a family firm you know: position the family members, shareholders, board members and managers in the three-circle model. What are their goals and concerns? NOTES 1 The terms ‘family firm’ and ‘family business’ are used interchangeably throughout this book. 2 Socioemotional wealth is defined as the total stock of affect tied to the firm by the family, such as benevolent ties, familial control, identity and reputation, just as emotional benefits. For further details refer to the related literature by Luis Gomez-Mejia and colleagues, which is further explored in Chapter 6 on strategy. 3 To remedy this confusion in family business communications it can be helpful to clarify the boundaries between roles and indicate the role from which one is speaking at a particular moment. BACKGROUND READING Anderson, R. C., and D. M. Reeb (2003b). Founding-family ownership and firm performance: Evidence from the S&P 500. Journal of Finance, 58 (3): 1301–1328. Astrachan, J. H., S. B. Klein and K. X. Smyrnios (2002). The F-PEC scale of family influence: A proposal for solving the family business definition problem. Family Business Review, 15 (1): 45– 58. Bourdieu, P. (1996). On the family as a realized category. Theory, Culture and Society, 13 (3): 19–26. Chua, J. H., J. J. Chrisman and P. Sharma (1999). Defining the family business by behavior. Entrepreneurship Theory and Practice, 23 (4): 19–39. Gomez-Mejia, L. R., C. Cruz, P. Berrone and J. De Castro (2011). The bind that ties: Socioemotional wealth preservation in family firms. Academy of Management Annals, 5 (1): 653–707. Hoy, F., and T. G. Verser (1994). Emerging business, emerging field: Entrepreneurship and the family firm. Entrepreneurship Theory and Practice, 19 (1): 9–23. Tagiuri, R., and J. Davis (1996). Bivalent attributes of the family firm. Family Business Review, 9 (2): 199–208 Villalonga, B., and R. Amit (2006). How do family ownership, control and management affect firm value? Journal of Financial Economics, 80 (2): 385–417. Westhead, P., and M. Cowling (1998). Family firm research: The need for a methodological rethink. Entrepreneurship Theory and Practice, 23 (1): 31–56. Whiteside, M. F., and F. H. Brown (1991). Drawbacks of a dual systems approach to family firms: Can we expand our thinking? Family Business Review, 4 (4): 383–395. Zellweger, T., K. Eddleston and F. W. Kellermanns (2010). Exploring the concept of familiness: Introducing family firm identity. Journal of Family Business Strategy, 1 (1): 54–63. 3 Prevalence and economic contribution of family firms In a famous article, Aldrich and Cliff (2003, p. 575) wrote that ‘one hundred years ago, “business” meant “family business”, and thus the adjective “family” was redundant’. Business was family business. And to a certain degree, this remains true today. The following sections explore this issue by addressing the prevalence and economic contributions of family firms around the globe (for further discussion, please refer to Bertrand and Schoar 2006). 3.1 Prevalence of family firms worldwide Depending on the definition one uses, roughly 70% to 90% of all firms across the globe are family firms. However, given the lack of a shared definition among the studies on this topic, the exact estimates and their international variation should be taken with a grain of salt.1 For some regions we have more fine-grained data illustrating the link between the definition used and the significance of the family firm phenomenon. The following subsections explore these links in more detail. 3.1.1 United States For the United States, Astrachan and Shanker (1996) suggested that family firms make up 74.9% of the 27.09 million total firms located in the United States2 when family firms are defined as businesses with at least limited involvement of the family in ownership, board and management. This share drops to 45.0% of firms if we require the firm to be run by a family member, and to 15.1% of firms when we require a family firm to be under the control of the same family for more than one generation and that more than one family member is involved in management. 3.1.2 Europe The European Commission, which uses a fairly narrow definition of family business, finds that 70% to 90% of all firms in the European Union are family firms.3 The European Commission defines a private family firm as: A firm, of any size,... if: 1) The majority of decision-making rights is in the possession of the natural person(s) who established the firm, or in the possession of the natural person(s) who has/have acquired the share capital of the firm, or in the possession of their spouses, parents, child or children’s direct heirs. 2) The majority of decision-making rights are indirect or direct. 3) At least one representative of the family or kin is formally involved in the governance of the firm. We can assume that these criteria are cumulative (i.e., a firm must meet all three criteria to be classified as a family firm). For the case of publicly listed firms, the European Commission suggests: 4) Listed companies meet the definition of family enterprise if the person who established or acquired the firm (share capital) or their families or descendants possess 25 per cent of the decision-making rights mandated by their share capital. Country-level data on the prevalence of family firms across Europe can be found in Mandl (2008). The following overview of the share of family firms in Europe (Table 3.1) was adapted and extended from Flören, Uhlaner and Berent-Braun (2010).4 Table 3.1 Share of family firms across various European countries Country Share of family firms in % Austria 80 Belgium 70 Finland 86 France 75 Germany 95 Italy 93 Netherlands 69 Spain 75 Sweden 80 Switzerland 88 United Kingdom 69 3.1.3 Asia and Pacific Rim Information on family firms is less comprehensive for this region. In Australia, a KPMG family business survey (2013a) suggests that 67% of all firms are family controlled. In China, we have only sparse data on the prevalence of family firms. However, an increasing number of studies is investigating publicly quoted family firms in this country, and there is some evidence suggesting that family business is the organizational form of choice of most non-government-controlled business activity. For instance, it has been suggested that Chinese family firms control a proportion of the country’s economic wealth that is larger than their relative share in the population of firms (see Lee 2006). Sun Yat-sen and Zhejiang Universities estimate that 85.4% of China’s private enterprises are family owned. In Singapore, 80% to 90% of industrial companies are reported to be family firms (Lee 2006). 3.1.4 Middle East/Gulf countries The Middle East is a particularly interesting context for the study of family firms. According to Tharawat magazine, around 75% of the region’s private economy is controlled by roughly 5000 families. Here, not only do family businesses dominate the economy, but family control is also concentrated in the hands of a few very powerful families. This observation points to an underlying social pattern that distinguishes the Middle East regional economy from most Western economies—or, at least, from common depictions of Western economies. While business-controlling families in the Western world are often described as solitary actors, in the Arab world the web of familial relationships tends to reach beyond the immediate family and encompass a larger number of people. This social form is reflected in a concentrated network of economic activity in which the ultimate owner of a business is not a single family as defined in narrow Western terms, but an extended group of family members who pool their economic activity, wealth and resources. In the Arab world, the type as well as the execution of family influence matters to a particular degree. For instance, control structures and management styles may depend on the owner’s religious affiliation, as the wide array of Islamic sectarian groups fosters different management styles, from authoritarian to consultative (Raven and Welsh 2006). These divergent styles make it difficult to impose a clear-cut definition of the family firm or degree of family influence. In an authoritarian setting, for example, the controlling family may seem to have a relatively small share of involvement in the executive board, but may actually control a large fraction of power. 3.1.5 Latin America Looking to Latin America, we again find that family firms play a very prominent role in the regional economy. Depending on the data source, between 65% and 98% of all businesses are reported to be family firms (Flören 2002). For the overall prevalence of family firms as part of the total population of firms, only limited data is available. Nevertheless, the Latin Focus Consensus Forecast suggests that in Brazil the majority of all firms are family controlled, and that in Chile family control is the dominating governance form to the extent that 90% of all firms are under family control. 3.1.6 Africa Rosa (2014) provides a rare glimpse into the particularities of family firms in Africa. As he reports, until the nineteenth century, most Africans lived in small tribal societies pursuing a mixture of traditional subsistence-based hunting, gathering and agriculture. The isolation of most African peoples from developments in Europe and Asia meant that until the arrival of Portuguese traders in the sixteenth century, followed by the Dutch and the English in the eighteenth century, family businesses as economic entities that manage resources to achieve a monetary profit were largely absent on the continent. Family businesses thus did not really take off in Africa until the height of the colonial period in the mid-nineteenth century. In the nineteenth century, some colonies in Africa opened up for European settlement (such as those in modern-day South Africa, Angola, Mozambique, Kenya and Congo). Rosa (2014) reports that today there are still two South African families of European origin who appear prominently on the Forbes list of the world’s wealthiest people—namely, the Rupert family, which controls the luxury conglomerate Richemont, and the Oppenheimers, who own the De Beers diamond empire. In other African countries, where white settlement was either banned or discouraged by the colonial governments, the gap tended to be filled by South Indian and Middle Eastern (mainly Lebanese) migrants. Balunywa, Rosa and Nandagire-Ntamu (2013) report that the development of (family) businesses by African natives themselves was severely handicapped by European powers and local governments in the colonial and the post-colonial periods. In the colonial period, the incentives of the colonial governments favored non-Africans. From the time of national independence until the 1990s, the socialist policies of many African governments suppressed the development of indigenous capitalism. This trend against the development of local businesses was exacerbated by political instability and civil wars in many former colonies. In his intriguing account of the evolution of family firms in Africa, Rosa (2014) distinguishes the following types of family businesses in sub- Saharan African countries today: 1. Traditional trading merchant businesses of mostly Muslim business families, many with an ancient trading tradition stretching back to medieval times and beyond. These may survive in some East African coastal areas, in Ethiopia and in areas of cross-Saharan trade. 2. Family businesses of Europeans who settled in Africa, the oldest of which in South Africa date back to the eighteenth century. These are most common in former colonies with significant white settlement. 3. Family businesses of Asians who came to Africa in colonial and more recent times and established businesses. They are particularly common in East and Southern Africa. New waves of South Asian as well as East Asian migrants are still coming over in the early 2000s, adding to the stock of family businesses of Asian origin. 4. Small-scale family businesses of indigenous Africans who are enjoying the freedom to participate in business after years of discouragement during the colonial and early post-colonial periods. These are very common in all countries, and range considerably in size and dynamism within the overall small-scale category. 5. Large-scale indigenous African family businesses that have blossomed in countries where liberalization and capitalism have been encouraged  by governments. The twenty-first-century generation of entrepreneurs is particularly dynamic and forms the base of a new group of indigenous African family businesses with highly educated founders. Africa thus presents a rich context in which to study the impact of colonial forces and migration on the evolution of family firms. Despite wide regional variance in the origin of these firms and the infancy of the research on family firms in Africa, the results so far show that family firms are emerging in Africa at a very fast rate and that they represent the largest share of all firms on the continent. As elsewhere, the micro family firms are an especially large group. These small family firms, whether created out of necessity or opportunity, significantly contribute to the economic growth of African countries. 3.1.7 Summary All in all, we find an emerging picture of the family business phenomenon with two central facets. First, family firms are the dominant form of organization across the globe, in emerging as well as in more established economies. In all countries in which studies on the topic were conducted, family firms represent the majority of firms, even when the definition of family firm is rather narrow. Given the evidence, it seems reasonable to assume that families control between 70% and 90% of all firms worldwide. Second, an international comparison of the prevalence of family firms is challenging given that the studies exploring the phenomenon use very different family firm definitions. On the one hand, this lack of comparability is frustrating. On the other hand, it is questionable whether a ‘one-size-fits-all’ definition can realistically render the family firm phenomenon across such different national and cultural contexts. Given the variations among corporate governance regulations and preferences, as well as among definitions of family, a globally standardized definition of family business will likely over- or underestimate the phenomenon in local circumstances. 3.2 Economic contribution of family firms If, as we estimate, 70% to 90% of all firms are controlled by families, one may wonder what their contribution to the economy is (e.g., in terms of employment or GDP). The economic contribution of family firms will likely depend on these firms’ average size. If, on average, family firms are smaller than their nonfamily counterparts (e.g., in terms of employment, total assets and sales volume), the share of their contribution to the economy will likely be smaller than the share these firms represent of the total number of firms. 3.2.1 Size of family firms Family firms are particularly prominent among small to mid-sized enterprises (SMEs), a pattern that tends to be consistent around the globe. For instance, in her study on family firms in the European Union, Mandl (2008) finds that the family business sector is dominated by SMEs, and particularly by micro enterprises with fewer than ten employees. For Germany, among companies with an annual sales volume of less than €1 million, the share of family businesses is as high as 97%. The share of family firms decreases to 86% among those with €1–5 million in annual sales volume, to 74% among those with €5–10 million and to 58% among those with €10–50 million.5 However, this trend should not lead us to expect family firms to be absent among large firms or, in particular, among publicly listed firms. In Germany, according to the Institut für Mittelstandsforschung as many as 34% of companies with an annual turnover of more than €50 million are family businesses. Similarly, in Luxembourg, Norway and Sweden, research suggests that about 30% of the largest companies are family businesses. In Belgium, the share of family firms among large companies is even higher, at about 50%. And as the International Family Enterprise Research Academy (IFERA) pointed out in 2003, not only is Walmart, the world’s largest enterprise, a family business, but 37% of Fortune 500 companies are also family firms. Evidence of the economic power of the largest family firms in the world can be found in the Global Family Business Index (for more details about the largest family firms in the world refer to www.familybusinessindex.com). 3.2.2 Contribution to employment As we might expect given the negative link between firm size and family firm prevalence, we find that family firms contribute to employment at lower levels than their fraction of total companies would suggest. Nevertheless, family firms employ a large portion of the workforce worldwide. Astrachan and Shanker (2003) suggest that family firms employ 62% of the workforce in the United States. In the European Union, family firms account for about 40% to 50% of employment (Mandl 2008). And in the Middle East, Tharawat suggests that family firms create about 70% of employment. Even taking into account the limitations of the available data and the variance across regions, these figures show that family firms are responsible for significant economic contributions around the globe. 3.2.3 Contribution to GDP The available data on the contribution of family firms to GDP is very limited. For the United States, Astrachan and Shanker (2003) suggest that family businesses are responsible for 64% of GDP. For the European Union, we find a wide spectrum of estimates. Depending on the definition of family business—and also on the use of aggregate economic output metrics, such as GDP versus GNP—the share attributed to family firms ranges from about 40% to 70% (Mandl 2008). In the United Kingdom, there is data suggesting that family firms contribute roughly 25% of GDP (Institute for Family Business 2011). Meanwhile, in Switzerland, the share of GDP attributed to family firms is estimated at about 60% (Zellweger and Fueglistaller 2007). And in India, KPMG (2013b) estimates that family firms account for two-thirds of GDP, 90% of gross industry output, 79% of organized private sector employment and 27% of overall employment (for additional information on the structure and challenges of Indian family firms, see Ramachandran and Bhatnagar 2012). 3.2.4 Summary In sum, we find that family firms have a dominant influence on the economic landscape around the world. More specifically, family firms are more prevalent among small firms than among large ones. Still, some of the largest firms across the globe are family controlled. Worldwide, we estimate that family firms account for about 40% to 70% of employment and GDP. 3.3 Institutional setting and the prevalence of family firms The findings on disparate family firm presence across the globe are not only caused by variance in the definition of the family firm. More fundamentally, family firms may be more or less prevalent in different regions because of underlying social forces that affect their success (e.g., industries or political contexts). To illustrate this proposed link between the institutional setting and the prevalence of family firms, we will examine the industry affiliation and stock market listing of family firms. 3.3.1 Industry affiliation of family firms An often-heard argument for the superiority of family firms is that family control equips a firm with specific abilities. For instance, the long-term commitment of families and employees, the atmosphere of mutual trust and benevolent relationships, and the close ties to the local community that are characteristic of family firms should allow them to develop some competitive advantages over nonfamily firms. If this is true, family firms should be particularly successful and ultimately prevalent in industries in which stable personal relationships and trusted community ties are important. Think, for example, of the food retail and gastronomy industries, in which customers tend to favor trusted retailers, restaurants and hotels. For these services, which deal with products that are important for daily life, it may be particularly important to ‘know what you’re getting’ and from whom you’re buying. Customer loyalty is more likely to develop in this context when the supplier and the customer get to know each other over multiple interactions. It is not surprising, then, to find that family firms are particularly present in service industries. For the United Kingdom, one finds the highest concentrations of family firms (next to agriculture) in hotels and restaurants (85%) and in wholesale and retail (77%) (Institute for Family Business 2011). Likewise, a study investigating sector distribution among publicly listed German and Swiss firms finds that 67% of all firms in the food industry are family firms (compared to roughly 35% of all publicly listed firms). In the wholesale and retail industries, family firms represent 70% and 55% of all firms respectively. Similar findings about the prevalence of family firms in service-based industries are reported for other European countries (Mandl 2008) and for India (Ramachandran and Bhatnagar 2012). Conversely, industries in which family firms tend to be underrepresented include manufacturing, high-growth industries and financial services (Willers 2011). Along with the service industry, family firms seem to be particularly prominent in the agricultural industry (Institute for Family Business 2011). For instance, 89% of all firms in the UK agricultural industry are family firms. Comparable results are reported for other countries such as India. For Brazil, São Paulo Business School suggests that family-owned farming enterprises comprise 84% of the rural firms in the country. In Chile, family firms are concentrated in agricultural and related industries, such as farming, food and beverage services, mining, textiles, fishing and fish processing, and forestry (Latin Focus Consensus Forecast). In addition to the service industry and the agricultural sector, several industries stand out for their tendency toward family control. The global beer industry is an impressive example of this phenomenon: ABInBev, SABMiller, Heineken, FEMSA, Carlsberg and many smaller companies are still controlled by their founding families. Some of the world’s largest car manufacturers—including Volkswagen, Ford, Toyota, PSA Peugeot Citroën, Fiat, BMW and Tata—are also under family control. In the United States, six of the seven largest cable system operators, including Comcast, Cox, Cablevision and Charter Communications, are controlled and partly managed by their founders or the founders’ heirs. Eleven of the twelve largest publicly traded newspaper companies in the United States are also family controlled. This finding is particularly noteworthy given the important social and political impact media companies can have in national and regional markets. Investigating family control across industries, Villalonga and Amit (2010) find that, consistent with the hypothesis that family firms have a competitive advantage in certain industries, firms and industries are more likely to remain under family control when their efficient scale and capital intensity are smaller, when the environment is more noisy (and monitoring needs are therefore greater) and when there is less stock turnover (reflecting longer investor horizons). Summing up, we find family firms to be particularly prevalent in the retail, wholesale, agriculture, food manufacturing, gastronomy, hotel and media industries. Family firms are less prevalent in capital-intensive industries and in the financial industry. 3.3.2 Stock market listing of family firms Another often-heard argument is that family control is an efficient response to weak formal institutions. That is, family control can help mitigate the weak protection of property rights and rule of law that firms may experience in emerging market countries (Gedajlovic et al. 2011). For instance, where the protection of property rights is underdeveloped, leaving minority owners with few possibilities to fight against expropriation by majority blockholders, the trust developed by the family may help ease investor concerns. Similarly, where legal enforcement of contracts is limited and capital markets are inefficient, family ties and the trust-based relationships, support, familial resources and networks associated with them may serve as a substitute for the lack of institutional quality. Family firms should thus be particularly prevalent in settings with weak formal investor protection, as trusted relationships with family members, the family’s reputation and strong social ties should help these firms enforce contracts and access critical resources in an otherwise resource-scarce environment. This institutional perspective on family firms is partly reflected in an analysis of the presence of family firms on the global stock markets. La Porta, Lopez-De-Silanes and Shleifer (1999) find that the prevalence of family firms on the stock market rises with the decreasing quality of minority owner protection (see also Faccio and Lang 2002). In cases where minority owners have less protection—for instance, in a dual-class share structure with voting and nonvoting shares—it may be particularly attractive for family owners to take their firms public, as family blockholders can retain control despite listing the firm on the stock market. In general, family firms seem to prevail when the institutional environment is relatively weak, supporting the argument that family firms may be better placed to navigate less regulated environments. Interestingly, even in the United States and many other Western countries, where institutions are presumed to be relatively strong, up to 30% of all firms listed on the stock market are family controlled.  REFLECTION QUESTIONS 1. What is the estimated contribution of family firms to GDP and employment? What is their share among the total population of firms? 2. Why are family firms more prevalent among small firms than large ones? 3. In which industries are family firms particularly prominent? And why might this be so? 4. Why are family firms more prevalent in countries with weak formal institutions? 5. What is your assessment of the predominant role of large family firms in many developing countries for the overall economic development of these countries? 6. Why are family firms more prevalent on the stock market in countries with relatively weak formal institutions? 7. What are the advantages and disadvantages of applying the same family firm definition in different national and regional contexts? NOTES 1 For data on the significance and economic contributions of family firms in various countries, see the online repository of the Family Firm Institute, www.ffi.org, and there the section on Global Data Points. 2 Data retrieved from the US Bureau of the Census, 2007 Economic Census: Survey of Business Owners. 3 The respective report can be downloaded at: http://ec.europa.eu/enterprise/policies/sme/promoting-entrepreneurship/family- business/family_business_expert_group_report_en.pdf. It provides an interesting overview of the structure and challenges of European family firms. 4 For a detailed study of family firms in Germany, see Klein (2000). 5 Source: Institut für Mittelstandsforschung, IFM, Bonn. For the United Kingdom, refer to the Institute for Family Business (2011). For more details see also Flören (1998) and Frey et al. (2004). BACKGROUND READING Aldrich, H. E., and J. E. Cliff (2003). The pervasive effects of family on entrepreneurship: Toward a family embeddedness perspective. Journal of Business Venturing, 18 (5): 573–596. Astrachan, J. H., and M. C. Shanker (1996). Myths and realities: Family businesses’ contribution to the US economy—A framework for assessing family business statistics. Family Business Review, 9 (2): 107–123. Astrachan, J. H., and M. C. Shanker (2003). Family businesses’ contribution to the US economy: A closer look. Family Business Review, 16 (3): 211–219. Balunywa, W., P. Rosa and D. Nandagire-Ntamu (2013). 50 years of entrepreneurship in Uganda, ten years of the Ugandan global entrepreneurship monitor. Working paper, University of Edinburgh. Bertrand, M., and A. Schoar (2006). The role of family in family firms. Journal of Economic Perspectives, 20 (2): 73–96. Faccio, M., and L. Lang (2002). The ultimate ownership of Western European corporations. Journal of Financial Economics, 65 (3): 365–395. Flören, R. (1998). The significance of family business in the Netherlands. Family Business Review, 11 (2): 121–134 Flören, R. (2002). Family business in the Netherlands. Crown Princes in the Clay: An Empirical Study on the Tackling of Succession Challenges in Dutch Family Farms. Breukelen, the Netherlands: Nyenrode University, Chapter 1. Frey, U., F. Halter, T. Zellweger and S. Klein (2004). Family Business in Switzerland: Significance and Structure. IFERA, Copenhagen. Gedajlovic, E., M. Carney, J. Chrisman and F. Kellermanns (2011). The adolescence of family firm research: Taking stock and planning for the future. Journal of Management, 38: 1010–1037. Insitute for Family Business (2011). The UK Family Business Sector. Oxford Economics. Klein, S. (2000). Family businesses in Germany: Significance and structure. Family Business Review, 13: 157–181. La Porta, R., F. Lopez-De-Silanes and A. Shleifer (1999). Corporate ownership around the world. Journal of Finance, 54: 471–517. Lee, J. (2006). Impact of family relationships on attitudes for the second generation in family businesses. Family Business Review, 19 (3): 175–191. Mandl, I. (2008). Overview of Family Business Relevant Issues: Final Report. Conducted on behalf of the European Commission, Enterprise and Industry Directorate-General: KMU Forschung Austria. Ramachandran, K., and N. Bhatnagar (2012). Challenges faced by family businesses in India. Indian School of Business, Hyderabad. Raven, P., and D. H. B. Welsh (2006). Family business in the Middle East: An exploratory study of retail management in Kuwait and Lebanon. Family Business Review, 19 (1): 29–48. Rosa, P. (2014). The emergence of African family businesses and their contribution to economy and society: An overview. Working paper, University of Edinburgh. Villalonga, B., and R. Amit (2010). Family control of firms and industries. Financial Management, 39 (3): 863–904. 4 Strengths and weaknesses of family firms Any chapter-length discussion of the typical strengths and weaknesses of family firms will be unable to fully account for the tremendous heterogeneity within this group of organizations. As we have already seen, family firms vary widely in terms of size, industry, regional context, and the type and level of family involvement. Still, an overview of the most common strengths and weaknesses of family firms is useful because it should point to the most critical aspects of running a family firm. From a practical standpoint, the list of typical strengths and weaknesses may serve as a self-assessment tool indicating critical issues and opportunities for improvement in a given firm. The strengths and weaknesses discussed in this chapter thus represent potential sources of competitive advantage and disadvantage which will be important for the strategic positioning of the firm. 4.1 Typical strengths of family firms 1. Fewer conflicts of interest between owners and managers One important strength of family firms is the alignment of the interests of owners and managers who are from the same family. Interest alignment may spare family firms costly control and incentive mechanisms and lead to fewer agency conflicts between owners and managers. In order for a firm to see these benefits, however, two conditions must be met: first, family members must be present