Family values: Research suggests nepotism may not be all bad

Research suggests nepotism may not be all bad

When it comes to hot topics for the water cooler, you might say that nepotism ranks right up there with office romances, pink slips and boardroom shakeups. There is, after all, something deeply unsatisfying, patently unjust and downright irritating about the idea that the boss's know-it-all son has landed that plum promotion you've had your eye on for some time.

Whether it exists at the entry level or all the way up the corporate ladder at a billion-dollar firm, the notion that nepotism is simply bad for business continues to persist. Just look at what happened to the Eaton and Bronfman family dynasties, right?

Not so fast, says Adam Bellow, author of In Praise of Nepotism: A History of Family Enterprise from King David to George W. Bush (Knopf Publishing Group, 2004), whose book makes the controversial argument that favouring one's kin in the hiring process is entirely natural and can actually be good for a business's bottom line–and its employees. “We've made a big fetish out of blood kinship, but when you look at nepotism it's very difficult to make any meaningful distinction between favouritism shown to a blood relative and favouritism shown to a college roommate,” says Bellow, an executive editor-at-large for Doubleday/Random House in New York and son of Nobel Prize-winning author Saul Bellow. “There's a further presumption that people related to you are less likely to be competent. That's utter nonsense, of course. It's well established that talents and abilities run in families.”

Contrary to the notion that nepotism is a corrupt practice that flies in the face of democratic values, Bellow argues that kin-based networks can be more effective, more efficient and more competitive.

According to a study published in The Journal of Finance in 2003, U.S. family-controlled businesses were about 5% more profitable and tended to be valued 10% higher by stock markets than their non-family run counterparts. In Canada, comparable figures are difficult to come by because of the secretive nature of many privately held family companies. According to various estimates, family firms (including mom-and-pop shops) make up 75% to 90% of all businesses and account for more than half the country's economy and its employment. In addition, roughly 40% of the largest 100 companies by market cap on the TSX have handed down control to a second, or even later, generation.

Danny Miller, a strategy professor at HEC Montréal and author of Managing for the Long Run: Lessons in Competitive Advantage from Great Family Businesses (Harvard Business School Press, 2005), says that although most corporate dynasties don't openly trumpet their successes, there is evidence to suggest that, in many cases, family-controlled firms outperform their non-family peers. Miller, who co-authored the book with his wife, Isabelle Le Breton-Miller, a human-resources consultant and senior research associate at the University of Alberta, took an in-depth look at dozens of international public and privately held family enterprises (including Canada's Bombardier and O&Y Properties) to gain insight into how these organizations operate and how their performance compares to their competitors.

What they found was surprising. “We went into these family businesses expecting that they didn't perform too well,” says Miller. Wrong. “They outperform. Secondly, we expected to see if they did perform well that they would be paragons of modern managerial practice–lots of strategic planning and competitive analysis. We didn't find much evidence of that either. And charismatic leadership? Please. There were one or two–but, for the most part, these are people walking around in their overalls driving beat up cars. They seem to be going against managerial practice.”

So what exactly is it that gives family dynasties such as the Westons, Desmaraises, Thomsons and Irvings their edge? Miller and his wife argue that several of the characteristics of family-controlled businesses that are often vilified–including stable strategies, clan cultures and lifetime tenures–have actually led to unique competitive advantages. “If your fortune, your reputation and your children are at stake, what bigger incentive is there?” Miller asks.

Continuity, community, connection and command–or what Le Breton-Miller refers to as the “four Cs”–are the priorities that she says allow family-controlled corporations to become century-long market leaders, even at the expense of short-term profits or growth. Unfortunately, she adds, such businesses often get a bad rap because of messy infighting and governance issues that tend to overshadow the good stuff going on behind closed doors. Where many firms stumble, she acknowledges, is in the passing of the torch from one generation to the next, hence the proverb, “From shirt sleeves to shirt sleeves in three generations.”

Research conducted by University of Alberta finance professor Randall Morck appears to back up this observation. He found that Canadian family firms outperformed their non-family counterparts when founding members owned a controlling stake of the company–but “heirs with controlling blocks” are associated with depressed performance. “If you restrict selection of the CEO to a very small pool of people, you're not going to get the same quality that you get if you can hire the very best graduates from the best business schools,” says Morck, currently on sabbatical at Harvard University. “If Eaton's stores had told the Eaton family to just stay out of it, and they brought in the very best MBA student in retailing from the very best business school in Canada, I think they might well still be here.”

Jeff Hull, an independent financial adviser in Mississauga, Ont., who has spent the past year looking for a Canadian candidate to add to Warren Buffett's multibillion-dollar Berkshire Hathaway Inc. portfolio–one that includes many privately held family enterprises–is also aware of the unique challenges faced by family firms. “The most difficult thing I'm having trouble finding is a company that's family-controlled where the family all gets along,” he says. “Far too many companies handed from the originating generation to subsequent generations often experience a decay in the passion for the company and instead have passion for money.”

So far, Hull, who wrote and produced a TV documentary on Buffett that aired this year, has identified three companies–two of them privately owned billion-dollar family firms–that fit the bill. He will present his picks to the Oracle of Omaha at an upcoming meeting. Until then, he says with a laugh, his lips are sealed.

Despite the common perception that relatives at family firms can't seem to get along, Bellow says many of these companies are not “rife with personal conflict and discontent and resentment.” As he sees it, the paternalistic corporate culture of many family businesses often leads to better workplaces for employees unrelated to the boss. “They don't get laid off as frequently, relatives of existing employees are hired in preference–and there's more opportunities for women than in non-family firms.”

That is not to say that family businesses don't have problems, Bellow adds. “But the executives at Enron managed to screw their affairs up pretty well without being related to one another.” Bellow, who takes a Darwinian approach to nepotism, believes that companies that “practise nepotism badly” will be punished by the markets, their shareholders or their employees. “If they make bad judgments, if they promote incompetent relatives and drive away talented, non-family members, then they deserve to suffer–and they do,” he says. “It's survival of the fittest.”

Unfortunately, Bellow says, many companies are still reluctant to admit they prefer to hire the relatives or friends of existing employees–even though the practice is widespread. “People don't want to give the appearance of doing something improper. They always have an eye on Wall Street and on their investors and because nepotism is considered to be bad for business, they don't like to give the impression that they're practising it.”

But love it or leave it, Bellow insists nepotism is here to stay. “If you don't like it–go and start your own dynasty.”

The four Cs
What family companies need to do to ensure they survive–and prosper

Continuity: Most family firms are in it for the long haul. Theirs is a “lasting and substantive mission, not a dollar-driven strategy,” says researcher Isabelle Le Breton-Miller. By focusing on core capabilities instead of getting sidetracked on other ventures, family firms are able to focus on what they do best. “They don't stay stagnant, but when they develop their core capabilities, it's around what they know,” she adds.

Community: Informal work groups and fewer bureaucratic rules make it easier for family firms to focus on breeding innovation and entrepreneurial spirit from the ground up. An increased emphasis on individual mentorship and training also helps them promote loyalty among employees. Despite this “caring collective,” HEC Montréal's Danny Miller warns expectations can be very high: “If you don't fit, you'll leave pretty quickly,” he says.

Connection: By securing generous relationships instead of “one-stop bargain deals,” family firms are able to establish long-term connections with suppliers and community members. “They invest in relationships even though it may take five or 10 years to pay off,” says Le Breton-Miller. “It's risky, but the payoffs can be enormous.”

Command: For many privately owned family firms, the option of “being free to act” instead of becoming “a servant of the shareholder” can lead to competitive advantages, says Le Breton-Miller. “They're courageous and they can implement real strategies versus little tactics to make the next quarter look good,” she says. “They just have a lot of discretion to be innovative and risk-taking.”