Poor Performance of family run businesses

Five years of research by the Centre for Economics Performance at the London School of Economics, and the consultancy McKinsey, into the gap between Britain's productivity performance and that in the US, France and Germany, has resulted in the stark conclusion that family-run firms are largely to blame.

The research team spent years studying performance indicators for 730 medium-sized manufacturing companies in the UK, the US, Germany and France. Their aim was to try and discover the reasons for Britain's poor productivity performance. The surprising results of the study found that firms which have handed control over to the next generation account for a third of Britain's productivity gap with the US.

In general, family-run firms have poor management practices. 'They lack effective monitoring, have dysfunctional targets and limited incentives for staff', says Nick Bloom, one of the report's authors. The researchers found strong statistical links between management scores and sales, productivity, profitability and the likelihood of bankruptcy.

The results were so strong that Nick Bloom urged Gordon Brown to scrap the 100 per cent inheritance tax relief given to family businesses. He advised instead that a £1m cap be imposed to discourage the handing over of large private companies to the eldest son or daughter. Such a move would raise £250m a year for the government.

So why is it proving so detrimental to hand the family business down to the next generation? It seems that passing down ownership in itself does no harm at all - it is when the running of the company is passed down as well that productivity begins to suffer. There are two major problems with family succession. The first is that selecting a Managing Director from a small group of family members imposes a severe restriction on the pool of managerial ability. The larger the company, the larger the problem this is. While it may be feasible to pass on the running of a small shop to the eldest son, the running of a large corporate firm will require someone with considerable skill. Compounding the problem is the fact that many men do not have children until their 30s or 40s, meaning that by the time they retire, they may be handing over the business to a young, inexperienced, successor.

The second major problem with family succession is what's known as the 'Carnegie effect', whereby the eldest child may lack motivation to work hard at school or early in their career because they have a guaranteed job waiting for them. Thus they are unlikely to have developed the skills necessary to do a good job. Also, morale is likely to be lowered amongst the rest of the staff as their opportunities for promotion are limited.

If Britain is to close its productivity gap with the US, it seems owners of businesses would be better off passing equity stakes onto their children, but handing over the running of the company to someone else.

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