Family Businesses as an Economic Phenomenon

Abstract

Increasingly family businesses are being viewed as distinctive and economically significant business entities. This article reviews alternative definitions of family businesses and describes potential sources of conflict that may arise between family members in these enterprises. The authors discuss guidelines to assist in the successful transition of the business from one generation to the next.

Key words: family business, succession planning, intergenerational

1. Robert Kleiman, Ph.D., and Eileen Peacock, Ph.D., are both Associate Professors, Department of Accounting and Finance, Oakland University, Rochester, Michigan, 48309.

 
In the last decade, the phenomenon of the family business has received increasing attention from academics and consultants. Today, family businesses are recognized as a vital and distinct organizational form. This article reviews some of the keys issues regarding family controlled enterprises including (a) the definition of family business; (b) the importance of family businesses in the economy; (c) the competitive advantages of family controlled enterprises; (d) conflicts in the family/business relationship; and (e) the critical role of succession planning.

Definition of Family Business

There are a number of misconceptions about family business. Perhaps the most common is the "mom and pop" image associated with these enterprises. Although many family businesses are small, these enterprises run the gamut with respect to size, and can be either private or public. Recognizable family businesses include such household names as Estee Lauder, Tootsie Roll, Anheuser Busch, Carnival Cruise Lines, Ford Motor, and Forbes.

Shanker and Astrachan (1996) note that a common definition of what constitutes a family business does not exist. Some definitions suggest that the presence of two or more family members in the business qualifies the business as family controlled. Other definitions are based on the ownership and control of the company. In this context, control is considered to be the degree of influence in organizational governance sufficient to influence operating strategies. The broadest definition requires that the family have some degree of effective control over strategic direction, and that the business is intended to remain in the family. The middle category would encompass the criteria of the broadest group, plus it would require that the founder or descendant(s) of the founder manage the company. The narrowest family business definition would require that the business have multiple generations involved, direct family involvement in daily operations, and more than one family member with significant management responsibility.

Ianarelli (1996) observes that the family business offers two separate but interconnected systems of family and business with uncertain boundaries, different rules, and different roles. Family businesses are different from other businesses due to the inclusion of family and relational bonds among family members. Thus, there is the integration of family and business cultures.

The identity of each family member is defined by his/her relationship (or lack thereof) with the family business. Family issues thus place restraints on the businesses. For example, the family has the power to pursue its own objectives even when these are at variance with customary business practices. This authority may include the promotion of a less than fully qualified family member or paying family members at above-market rates.

Novak (1983) and Jaffe (1990) point out that firms which are family controlled also differ in certain other characteristics of their corporate cultures. These include being more socially conscious, caring about providing jobs for people, treating workers fairly, offering greater opportunities for women, and being preferred by consumers. Davis and Taguri (1982) maintain that these characteristics are due to the existence of "bivalent attributes directly derived from the overlap of family, ownership, and management status." These characteristics derive from such things as shared identity, mutual awareness and privacy, and emotional involvement and ambivalence.

The Importance of Family Businesses in the U.S. Economy

In the aggregate, family businesses play a significant role in the United States economy. Ibrahim and Ellis (1994) estimate that approximately 90% of the businesses in the United States are family owned and controlled. The influence of these firms is pervasive as they contribute somewhere between 30% and 60% of the nation's gross domestic product (GDP) and half of total wages paid. Based on current levels of GDP, a conservative estimate of the annual production of goods and services by U.S.-based family businesses would be in excess of $2.1 trillion.

While precise numbers are not available, Dreux (1990) suggests that one could conservatively estimate that there are 1.7 million business entities that are family-owned and controlled excluding sole proprietorships. Furthermore, he estimates that there are at least 2 million family firms with revenues greater than $1 million.

According to Dreux (1990), except for those companies earning over $500 million annually, privately held family firms outnumber publicly traded firms 50 to 1. Thus, he concludes that the family business universe approaches and possibly exceeds the entire publicly owned universe in size and scope of economic activity.

A number of studies have shown that family firms outperform their industry peers and their non-family counterparts. Monsen (1969) found that the average return on equity of family controlled firms was 75% higher than manager-controlled firms. He concluded that family firms provide a higher return on investment, have a better-managed capital structure, and more efficient allocation of resources. Kleiman (1996) found that publicly traded family-controlled enterprises have provided significantly higher stock market returns than the Standard & Poor's 500 market index over the last two decades. In addition, he found that these enterprises also offered higher accounting based returns than their non-family counterparts.

Advantages of Family-Controlled Enterprises

Given the significance of family firms in the U.S. economy, it is instructive to consider the operating advantages of these enterprises. lanarelli (1996) points out that family businesses usually have a long-term orientation, a strong commitment to quality which is related to the soundness of the family name, and care and concern for employees who are often likened to an extended family.

Family enterprises are more inclined than other types of corporations to re-invest in themselves in an attempt to perpetuate wealth to succeeding generations. Unlike their widely held publicly traded counterparts, these firms are able to resist the pressures of security analysts to maximize short-term returns. Kleiman (1996) notes that family firms typically have higher reinvestment rates than firms that comprise the Standard & Poor's 500. Dreux (1990) also contends that family businesses generally tend to be overcapitalized, with lower levels of debt and substantial liquidity. These operating characteristics reinforce the long-term orientation of family controlled firms.

The operating philosophy of family firms is often guided by a personalized mission related to the integrity of the family name. Successful family enterprises offer family members prestige and prominence in their communities. In order to preserve their reputation, Lyman (1991) argues that family firms are more involved with customer service and more committed to quality than their non-family counterparts.

The downsizing—particularly of middle management over the past decade in large and publicly-held corporations—has decreased employees' sense of loyalty to their employers. On the other hand, founders and their successors in family firms tend to be accountable to themselves and tend to maintain both a strong sense of family and community responsibility. As a result, family enterprises offer greater opportunities for mutual loyalty, responsibility, and accountability between the organization and its employees.

Family businesses also generally provide for more direct contact with management, are less bureaucratic, have a built-in trust factor, and enable the next generation to gain early exposure to the business through hands-on training. These factors, in turn, lead to a continuity in management policies and operating focus and enable firms to react more rapidly to changes in their operating environments.

These enterprises also provide a unified management-shareholder group since managers and shareholders are one and the same. Thus, there are less likely to be conflicts of interest (termed agency conflicts) between the firm's managers and shareholders. Financial theory suggests that firms experiencing lower levels of agency costs generally provide superior financial performance.

Conflicts in the Family/Business Relationship

Despite their many competitive advantages, family businesses have to contend with several issues in addition to standard business concerns including generational disputes, sibling rivalries, and succession issues. The same characteristics which are sources of strength for family firms (e.g., long-term commitment, patriarchal leadership) can also be sources of concern, particularly during leadership transitions. The interplay between the family and the business may become critical in these situations. Conditions that may exacerbate problems include the existence of role ambiguity, communication difficulties among family member, and business decisions which negatively affect families.

Harvey and Evans (1994b) report that family firms are fertile grounds for conflict. Conflict often occurs when a corporate culture of the family business which has been formed "by the personality, values, and beliefs of the founding generation" conflicts with the culture of the family units. Disharmony that is allowed to linger without being addressed may result in very complex problems which affect both the business and the family. Often family business members cannot identify the cause of disharmony or find ways to resolve the conflict. However, being able to forecast when friction may arise helps in the resolution of that conflict.

Research has shown that family businesses evolve through a set of phases. These are the creative/definition phase, the enterprising phase, the stabilization phase, the early growth phase, sustained growth phase, and the planned maturity growth phase. If one can understand and identify the phase, one can often predict the conflict issues which may arise. Three levels of conflict have been identified, and the resolution of conflict in the family organization is contingent on the level of conflict (Harvey & Evans, 1994b). Each level of conflict is associated with the number of constituencies involved in the conflict: the business, the family, and the external stakeholders. When only one is involved—for example, the business alone—resolution is the easiest; when two are involved—the business and the family—there is a compounding of the conflict. When all three constituencies are involved, the conflict level is at it greatest and is the hardest to resolve.

Change is one of the major sources of conflict. Although change occurs in non-family businesses, change as a source of conflict is more likely in family businesses dominated by a strong founder. These firms tend to be characterized by a less participative management system, a lack of structure in the organization to handle the change, the interplay/ overlap between the family and the business roles, and, finally, the lack of definition of a family business member's role in the organization.

Conflict will be a continuing dysfunctional occurrence for family businesses if it is not dealt with. If families have knowledge of this dynamic, knowing when conflict is going to occur assists families in effectively managing conflict situations.

Succession Planning

Succession planning entails the transfer of assets, capital, contacts, power, skills, and authority from one generation to the next in a family business. Although this process is essential to the continuity and economic well being of both the company and the family, succession in family business is problematic. Ward (1987) has estimated that only 3O0% of family firms make it to the third generation, and only 15% to the fourth. As larger numbers of family-held companies change hands from one generation to the next, more and more family legacies are lost due to poorly planned transitions. It is estimated that approximately nine out of ten U.S. businesses that are family owned and run have problems with succession. Accordingly, Aronoff and Ward (1992) view succession planning as the ultimate management challenge.

To be effective, succession planning requires a balancing of personal aspirations and family goals. Accordingly, the generation in power must let go and the succeeding generation must desire to be involved in the business. To survive as a family business, the family must produce heirs with the requisite skill, values, and motivation. Often members of the succeeding generation do not have the same drive and commitment as the company's original founder. As a result, the impact of the transition is often negative, both in terms of company financial performance and influence on family members.

There have been a number of studies that have tried to identify factors which enhance a successful succession. These factors include the need for participation of the next generation in the succession process, the problems of selecting successors and managing the succession process from the founder's perspective, and the assessment of the family business succession from the next generation's viewpoint. (For a review see Harvey and Evans, 1994a.) In general, it is suggested that succession should be seen, not as an event, but rather as the result of a significant planning process.

Despite the existence of a planning process, sometimes succession occurs unexpectedly. Events such as a death in the family, divorce, inheritance or the departure of a key employee may precipitate the entry of a sibling into a managerial role in the family business. The possibility of this type of event emphasizes the need for succession planning.

In most studies, effective is defined as those successors who have managed to increase the revenues and profits over a period of not less than five years. A recent study attempted to elicit the characteristics of effective successors of family-owned businesses. Several factors appeared to influence the ability to succeed: the organization of the family business, the competitive environment, family relationships, and the succession planning process (Goldberg, 1996).

Researchers (e.g., Harvey & Evans, 1994a) have also suggested that the timing and type of the entry into the family business might be determinants of a successful handing over to a second generation. The timing of entry of siblings can be linked to stages in their career development and in the family life cycle. Families contemplating the involvement of a new generation in the family firm need to define rules for the employment of offspring in the business. lanarelli (1996) recommends three standards. First, the heirs should have education appropriate for the job sought. Second, the heirs should have three to five years of suitable work experience. Finally, the children should enter the firm into an existing, needed job with precedents for both compensation and performance expectations.

Aronoff and Ward (1992) contend that succession planning is ineffective when the senior generation does not allow the junior family members the opportunity to grow, gain the necessary skills, and eventually assume the leadership of the business. As a result, relationships between parents and children may deteriorate, and communication between family members breaks down. The transition is more likely to be successful when children have a positive image of the family business. This is more prone to happen when the children have gained substantial exposure to the family business and when participation in the family business is viewed as an opportunity rather than an obligation.

Unfortunately, founders often do not make good mentors for the younger generation. Teaching requires patience and the relinquishment of control. Frequently, however, founders are ill suited for a teaching role because they tend to be impatient, action-oriented individuals who can not let go. Only rarely can business owners retire "cold turkey." Normally, they need several years to prepare for retirement and substantial outside interests to look forward to.

A Prescription for Successful Succession?

If a prescription for successful succession could be written and implemented, many families would survive into the second, third, and fourth generation. However, there is no one prescription which can be written. Family businesses, by nature, are not homogenous. For successful transition from one generation to another, families must recognize that there will be problems which may cause conflict. While conversations regarding the need for transition planning are difficult to initiate, the family must engage in discussions of future management. This discussion most likely will cause some controversy. However, it is better that this controversy occurs when the business is still being successfully managed rather than when there is a breach in management due to the sudden death or change in the family situation. Proactive engagement is the key to successful succession.

References

Aronoff, C., & Ward, J. (1992). Family business succession: The final test of greatness. Marietta, GA.: Business Owner Resources.

Davis, J. A., & Tagiuri, R. (1982). Bivalent attributes of the family firm. Santa Barbara, CA.: Owner Managed Business Institute.

Dreux, D. R. (1990). Financing family business: Alternatives to selling out or going public. Family Business Review, 3, 225-243.

Goldberg, S. (1996). Effective successors in family-owned businesses: Significant elements. Family Business Review, 9, 185-197.

Handler, W. C. (1989). Methodological issues and considerations in studying family businesses. Family Business Review, 2, 257-276.

Harvey, M., & Evans, R. E. (1994a). The impact and timing and mode of entry on successor development and successful succession. Family Business Review, 7, 221-237.

Harvey, M., & Evans, R. E. (1994b). Family business and multiple levels of conflict. Family Business Review, 7, 331-348.

lanarelli, C. (1996). Family owned businesses. In J. Maurer, J. Shulman, M. Ruwe, & R. Becherer (Eds.), The Encyclopedia of Business. Detroit: Gale Research.

Ibrahim, A. B., & Ellis, W. H. (1994). Family business management: Concepts and practice. Dubuque, IA: Kendall/Hunt.

Jaffe, D. T. (1990) Working with ones you love: Conflict resolution and problem solving strategies for a successful business. Berkeley, CA: Conari Press.

Kleiman, R. T. (1996). The NetMarquee-Kleiman family business index. Needham, MA.: NetMarquee On-Line Services.

Lyman, A. (1991). Customer service: Does family ownership make a difference? Family Business Review, 4, 303-324.

Monsen, R. J. (1969). Ownership and management: The effect of separation on performance. Business Horizons, 12, 46-52.

Novak, M. (1983). Business faith and family. Loyola Business Forum, 4, 6-8.

Shanker, M. C., & Astrachan, J. H. (1996). Myths and realities: Family businesses' contribution to the U.S. economy," Family Business Review, 9, 107-124.

Ward, J. L. (1987). Keeping the family business healthy: How to plan for continuing growth, profitability, and family leadership. San Francisco, CA: Jossey-Bass.