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Family firms are different.

Family Firms Are Different

Is there a difference in the management styles of family firms as compared with businesses run by professional non-family managers? The answer is likely to be yes, but strangely, there has not been too much research into this question until recently in spite of their numbers and importance. Part of the reason for this lack of research may be the difficulty of distinguishing firms which are family owned and operated from those which are not; the former tend to be small and difficult to gain access to for research purposes. We became interested in this question, and have suggested two ways of making the distinction. We also briefly discuss some of the reasons why differences in firm ownership and control affect organizational processes. This can be useful for improving managerial processes in general.

It has been suggested that one of the reasons why family firms have been relatively overlooked is the acceptance by social scientists of the Berle and Means thesis. This is the idea that the control of American businesses has shifted from their owners to professional managers. Recently, however, research into family firms has gained more attention due in part to their economic importance (e.g. Dyer 1986; Handler 1989). They are the most prevalent form of enterprise in the US today, generating between 40 to 60 percent of GNP (Ward and Aronoff 1990).

Just because family firms are common does not automatically make them suitable subjects for research. Why are they interesting for research purposes? The reason is the possibility that differences in ownership and control of firms do affect the way they are run, but there are few explanations. One set of possible explanations derives from agency theory (e.g. Fama 1980). What this suggests is that family firms may be lower cost, and therefore by implication, more efficient. The reason is that professional managers (the agents) impose extra costs on the firm. The first type of cost is due to the different interests of owners and managers; the second is due to the moral hazard and potential for opportunism when control is separated from ownership. Owners obviously have a personal stake in the firm's success, but the professional manager's interest is limited to the specifics of the employment contract. Managers, in addition, seldom stay with one firm for their entire work life, and loss of a job or even failure of the business is unlikely to be as disastrous for the professional manager as for the founder-manager.

This distinction arises because the professional culture of managers is characterized by a unique set of values and beliefs based on individual motivation and achievement. This encourages a focus on monetary rewards and tangible benefits; personal gain comes through advancement and promotion within the organization and increased compensation rather than a sense of pride in the organization as such. Comparing top management compensation, organizational performance is correlated with compensation in owner-controlled firms but with size in professionally-managed firms. This in turn may help explain the shorter time horizon of professional managers compared to owner-managers.

Another distinction is noted in decision-making. Founder-run organizations tend to be more centralized, with one or a few individuals dominating a rather secretive decision-making process, and not encouraging dissension due to their desire to retain control.

Distinguishing Factors

If these differences in styles and motivations exist, then there may be several characteristics of firms that will enable us to distinguish between family owned and managed and professionally managed enterprises. These are firm size, firm age, strategy and the use of internal control systems.

Firm Size. If managers act in their own self interest seeking personal gain rather than firm profits, it is likely that the professionally managed firm will be larger than the family firm. There are the reasons for this. First, large firms often have excess capacity (slack resources) which can be used to buffer the consequences of poor decisions or smooth out variations in performance - this will make them look more efficient than they really are. Second, executive compensation is often based on size and growth rather than on firm profitability. Third, in a growing firm, there will be more opportunities for managers to get ahead. This is not an important consideration for owner-operators, and dealing with the growth of family firms in fact can be difficult (Alcorn 1982).

Firm Age. The professionally managed firm is also likely to be an older, more established firm. This is because most family owned firms do not survive past the first generation, while professionally managed firms do not depend on succession plans controlled by the founder/family.

Firm Strategy. Professionally managed firms are likely to grow at a faster rate, thus there should be differences in strategy. This is related to the managerial culture: Professional managers are likely to follow more active, growth-oriented strategies because these fulfill their interests better.

Internal Control Systems. Professionally managed firms are likely to rely more on internal control systems to monitor firm operations in order to control the moral hazard and opportunism problems; these procedures can offset the effects of managers' self-interested actions. In contrast, less formalized systems characterize family owned and managed firms, where there is no need to account for actions to a "disinterested owner." Formal measurement procedures are also less likely while a centralized appraisal system is more likely.

Research Study

We performed a field survey to see whether these four measures do accurately differentiate between family and non-family firms, and the results were very good: nearly three quarters of the cases were correctly classified. Our sample included 486 small manufacturers in Indiana, randomly selected by two-digit SIC codes from the 1988 Harris' Industrial Directory. We made three requirements for inclusion: the firm must be primarily a manufacturer (SIC codes 20-39); have fewer than 500 employees; and have sales under $30 million. Fifty three percent of the sample were professionally managed; the reason this is less than the national average is most likely due to the size restraint and our concentration on manufacturing firms. The manufacturers in the sample were on average 43 years old, which is longer than the tenure of most founder/entrepreneurs. In addition, manufacturing usually requires larger amounts of capital, and getting such financing may involve a loss of family ownership and/or control.

Because we were interested in the agency problem which occurs when ownership is separate from control, we split the sample into two categories: family owned and managed (representing a unifcation of ownership and control) and professionally managed (capturing all other combinations where ownership and control are separated).

We used two separate methods to make this distinction. First, using the Harris directory, a firm with two or more individuals with the same last name listed as officers was designated as a family managed firm, while the others were designated as professionally managed firms. We checked the validity of this categorization by telephoning a random sample of 30 firms. Each was asked a structured set of questions in order to determine the ownership and management of the firm. Question (1) was "In 1988, were there top/key managers related to the owner working in the business?" If the answer was yes, the firm was categorized as a family owned and manged firm. If no, question (2) was asked: "Are there other managers who are not related to the owner?" If yes, the firm was categorized as a professionally managed firm. If no, the final question was asked: "Then there are no other managers?" If the response was in agreement, then the firm was classified as a family owned and managed one, following the argument that a firm managed by the owner may eventually pass on ownership and control to a family member not currently operating in a management capacity.

Results of both methods gave a high degree of convergence in correct categorization: 27 of the 30 firms sampled were in agreement with the original directory method.

Survey

Surveys were then sent to the owner/operator of each firm, with a follow-up letter sent four weeks later. Nine were returned as non-deliverable and therefore not included in the calculation of the response rate, which was 39% (186 surveys). The usable response rate was .215 (104 surveys) which included only returns from the individual directing the firm (54 owners of family firms; 32 presidents and 18 general managers of professionally managed firms). Hence we had representatives of both types of firm.

We found that organizational size was captured by the number of full time employees which was highly correlated with sales volume. Firm age was captured by number of years in business. The use of formal internal controls was assessed using six items: use of information systems, quality control, cost control, cost centers, profit centers and formal appraisal of personnel. We used Miles and Snow's (1978) typology of defender, prospector, analyzer and reactor to indicate firm strategy.

Results

As noted earlier, we had excellent results indicating that there are valid differences between family and nonfamily firms with respect to these four measures. As they do differentiate between the two ownership structures, the study will be of significant help to other family firm researchers by providing an efficient way of accessing and categorizing any given sample of firms. That is, firms can be categorized from an archival source such as the directory we used, and then further checked by means of a telephone follow up of a small subset.

We also found that professionally managed firms were larger, most likely due to the positive relationship between executive compensation and firm size and the need for these firms to grow so as to accommodate the advancement of managers through promotion. On the other hand, growth and development of family firms is likely to be stunted: they are likely to be dominated by a founder who is unwilling to allow the firm to grow if this means a loss of personal control - this inability to yield control to other capable people limits expansion. Unless there is a recognition of the need to involve others - either family or non-family - the family run firm cannot continue to grow.

Growth is a problem, and the reluctance of family firms to plan for the succession of the founder so as to remain family owned shows up in their higher mortality rates: only 30% survive past the first generation (Ward 1987). This problem does not apply to the professionally managed firms which survive beyond the working life of the founder; thus these firms will be older than family firms.

We also found that family run firms rely less on the use of formal internal control systems, probably due to the desire of the family to maintain personal control rather than use impersonal, formalized procedures. Use of the latter in professionally managed firms is also likely to be a function of their larger size.

Finally, there were differences in firm strategy. The most significant differences between the two groups were that family businesses were more highly concenrated in the defender category, while professionally managed firms were over-represented in the reactor category (which tend to have the lowest performance).

In conclusion, this study marks a significant step in providing a methodology for research in family business. It has implications for the management of firms and by helping us understand the differences in operating techniques, may assist the survival of a significant element of American enterprise.

References

Alcorn, P.B. 1982. "Success and Survival in the Family-Owned Business."

New York: McGraw Hill. Berle, A.A. and G.C. Means. 1932. "The Modern Corporation and

Private Property." San Diego: Harcourt Brace Jovanovich. Dyer, W.G., Jr. 1986. "Cultural Change in Family Firms." San Francisco:

Jossey-Bass Publishers. Fama, E.F. 1980. "Agency Problems and the Theory of the Firm."

Journal of Political Economy, vol. 26, pp. 327-349. Handler, W.C. 1989. "Methodological Issues and Considerations in

Studying Family Businesses." Family Business Review. vol. 2, pp.

257-276. Kirchhoff, B.A. and J.J. Kirchhoff. 1987. "Family Contributions

to Productivity and Profitability in Small Businesses." Journal of

Small Business Management. 25:4, pp. 25-31. Miles, R.E. and C.C. Snow. 1978. "Organizational Strategy, Structure

and Process." New York: McGraw Hill. Ward, J.L. 1987. "Keeping the Family Business Healthy." San Francisco:

Jossey-Bass Publishers. Ward, J.J. and C.E. Aronoff. 1990. "To Sell or Not to Sell." Nation's

Business. 78:1, pp. 63-64.
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Article Details
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Title Annotation:Symposium: Family Business
Author:Daily, Catherine M.; Dollinger, Marc J.
Publication:Review of Business
Date:Jun 22, 1991
Words:2061
Previous Article:Family business: a closer look.
Next Article:The Institute for Family Business at Baylor University.
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