A major new study of management practices shows that inherited family firms that are both owned and managed by family members are typically badly managed, particularly if the chief executive is chosen by 'primogeniture' - that is, selecting the eldest son.
The joint research by the Centre for Economic Performance (CEP) and McKinsey & Company reveals that this is a particular problem for the UK, which has an amazingly high share of family-managed firms, especially those that practice primogeniture.
And the key reason is the country's highly generous inheritance tax exemption of 100 per cent for family firms, which make it possible for family ownership to remain concentrated and provides an incentive for even badly managed family firms to be kept within families.
Dr Nick Bloom, who will present the findings at a public meeting today, believes that this exemption from the UK's inheritance tax must be modernised. He calls for a cap on the relief of £1m, with this cap additional to the standard inheritance tax cap of £275,000.
Such a reform would have several benefits:
It should raise approximately £250m to help fund inheritance tax reform
It should improve productivity in the UK economy
It should improve intergenerational equity
It should bring about alignment of the UK tax system
It should provide continued support for small or medium-sized family firms.
The research team have conducted a massive survey of the management practices of over 730 medium-sized manufacturing firms in France, Germany, the UK and the United States, and used it to examine the role that hereditary family management plays in the long-term standing poor managerial performance of UK firms.
They find that firms that are family-owned but not managed by family members are typically well managed. An example is Wal-Mart, which is still largely owned by the Walton family but which has had a professional (non-family) chief executive since the retirement of Sam Walton, the firm's founder.
But while family ownership seems to improve management practices, family management by the children of founders is typically less good. And when the CEO is selected by 'primogeniture' - that is, selecting the eldest son- the management pracitces of the firm tend to be extremely bad.
The survey reveals that, compared with France, Germany and the United States, the UK has a high member of firms that are both family-owned and family-managed.
For a typical medium-sized firm worth $10m or more, the UK also has highly favourable family firm exemptions for inheritance tax - 100 per cent. So, for example, when Richard Branson hands down his privately held Virgin group to his children, no inheritance tax would be due. The comparable figures for France and Germany are roughly 33 per cent and 50 per cent, while in the United States, there are no substantial family firm exemptions.
Nick Bloom said: 'Many traditional family firms have bad management practices - they lack effective monitoring, have dysfunctional targets and limited incentives for staff. These traditional family firms account for half of the UK's long tail of badly managed firms in our survey, and around a third of the UK's productivity gap with the United States.'
He also described some of the practices in family firms: 'When asked about the adoption of continuous improvement processes, one factory manager in a traditional family firm replied "Improvement process - that's something that happens once a year with the Christmas tombola."
'The behaviour of these traditional family firms is quite amazing in a number of ways. For example, professional CEOs were almost all between the ages of 45 and 65, while traditional family firms' CEOs were aged from 21 to 90. The 21 year old took over because the father died suddenly, while the 90 year old was still in charge because no one had the power to move him on. Not surprisingly, both firms were badly managed.'
Dr Bloom concluded: 'Handing down the CEO position from father to son generated difficulties if the father doesn't have kids until his 30s - either he continued running the firm until his 70s or he hands down the CEO position to an inexperienced son. Either way, management practices are likely to suffer.
'Can you imagine if the current England football team was picked from the sons of the team of 1966? We wouldn't win anything.'
Click here to download a copy of Inherited Family Firms and Management Practices: the case for modernising the UK's inheritance tax (PDF)
Contact: Nick Bloom on 07775 862671 or 020 7955 7286.
Inherited Family Firms and Management Practices: the case for modernising the UK's inheritance tax, a Centre for Economic Performance policy analysis, is at http://cep.lse.ac.uk/briefings/default.asp
We gratefully acknowledge the funding of the: Economic and Social Research Council, the Anglo-German Foundation, and the Advance Institute of Management.
This work is being released in a presentation by Nick Bloom at the Economic and Social Research Council's Social Science Week event Can Britain Prosper in the New Global Economy? at 6.30pm on Wednesday 15 March 2006 at One Great George Street, London SW1P 3AA.
Nick Bloom is director of the productivity and innovation programme at the Centre for Economic Performance at LSE, an Advanced Institute for Management Ghoshal Fellow, and an assistant professor of economics at Stanford University.
How corporate deals can resolve succession issues (31 Mar 06)
A recent productivity study by LSE and management consultancy McKinsey has questioned whether family business succession is desirable and capable of producing good results.
Increase family directors' degree of accountability (17 March 06)
Letter in response to research by the Centre for Economics Performance at LSE in "Family-run businesses perform poorly".
What matters is how the family business is handed on (17 March 06)
Five years of research (17 March 06)
Reference to CEP research.
FinFacts Ireland, Ireland
UK London School of Economics/McKinsey study says the best way to ruin a UK family business is to give it to an eldest son (15 March 06)
BBC News Online
Father and son firms under fire (15 March 06)
Family-run businesses 'perform poorly' (15 March 06)
Research by the Centre for Economic Performance at LSE, and McKinsey, the consultancy, into the gap between Britain's productivity performance and that in the US, Germany and France, found that objective assessments of managerial performance were important in explaining why UK companies tended to have lower productivity and profitability. Nick Bloom, LSE and one of the authors, quoted.
15 March 2006