An ethical view of family businesses

Manuel Bermejo. Professor. IE Business School

18 March 2015

Family businesses are an ethical mirror in which we should all take a look, because their management model is based on sharing a project and a set of values which are what give a sense of transcendence to the family legacy

 

The phenomenon of the family business has been widely studied across many fields, from academia to consulting, usually in the context of its problems; an approach which has perhaps been influenced by a less-than-positive psychological perspective.

I must confess that I have always distanced myself from these suppositions. On the contrary, I think family businesses often demonstrate a collection of values that are largely absent in many other areas of our lives. Therefore, it seems to me that we should scrutinize family businesses so as to rediscover an ethical approach to business management; a matter critical, in my opinion, to pulling ourselves fully out of the Great Recession and, above all, addressing a more hopeful future.

The issue is particularly relevant because we are talking about the world’s dominant business model. A recent study by Ernst and Young found that the percentage of family businesses stood at 80% worldwide. The prominent role of the family business extends to the field of large corporations – we should not confuse family business as a whole with poorly-managed family SMEs. It is estimated that 25% of the Top 100 European companies are family-owned. And if we look to emerging economies we find that, according to recent data provided by McKinsey, 60% of listed companies in emerging countries are family-owned, with a total estimated value of one trillion dollars.

The qualitative weight of family business and its contribution to job creation and wealth is also noteworthy. In Spain alone, family businesses are estimated to account for 70% of GDP and to employ around 14 million people.

Moving on from the notorious myths that surround family businesses, I’d like to emphasize that, with reference to the Banca March report drafted by my IE Business School colleague Cristina Cruz, the average stock market return of European family businesses is higher than that of non-family, and also has lower insolvency and market risk. Along the same lines, the data published periodically in the Family Business Barometer prepared by KPMG and IEF recurrently show better performance in family businesses than their non-family peers, characterized in particular by superior, more agile adaptation to the Great Recession and also to our rapidly-changing society, which has been heavily impacted by the phenomena of globalization and digitization.

Bearing these facts in mind, and having spent over two decades advising and training family companies in Europe and Latin America, I can assert that I know of nothing as powerful as a family business that knows how to manage their singularities. The root of this good management lies, without a doubt, in a shared project and values, as values ​​are what give a sense of transcendence to the family legacy. It is this ethical side of family business that I wish to evaluate.

To this end, I have spent the past few years working on my, now complete, doctoral thesis, "An ethical view of family businesses: consequences of account manipulation from the perspective of the shareholder and stakeholder within the family business", some conclusions from which I share below. In order to study ethical behavior, account manipulation has been used as a parameter of study that ultimately assumes that account reports record figures which differ from actual figures. 

A simple observation of reality confronts us with numerous accounting and financial scandals, combined with an unending stream of cases of corruption, illegal financing of organizations such as political parties or trade unions, falsification of accounts and cases of creative accounting... It is not surprising, therefore, that today many institutions of all kinds have been discredited. Furthermore, social networks allow for immediate visibility of and forceful activism against such reprehensible behavior.

A family business is characterized by its unique desire for intergenerational transcendence, its long-term vision, the pursuit of strategic objectives that go beyond economic performance, and the deep involvement of family members in governing bodies and management. These peculiarities undoubtedly give the family shareholders the ability to influence the organization through activities of control and vigilance that affect the decision-making process. In short, family businesses have reduced agency costs between owners and managers by creating conditions that foster strategic alignment between both parties.

Empirical evidence for the study was gathered from a sample of 1,275 non-finance, listed, international companies across 20 counties between 2002 and 2010.

The results indicate lower account manipulation within family businesses. Within a family business, the owners have the power and incentive to control management decisions and prevent opportunism in their managers. The risk of expropriation by managers decreases with highly concentrated ownership structures, due to lower information asymmetries and the greater influence of the controlling shareholders. In short, from an accounting perspective, there is evidence of greater ethical behavior within family businesses.

To elaborate, the evidence also shows that account manipulation increases a company’s market value in the short term when investors and other stakeholders fail to identify these practices. Yet those who engage in manipulation of accounts penalize their companies with a series of negative consequences such as loss of reputation and increased activism by stakeholders and other regulatory bodies. However, these effects are moderated by the presence of family in corporate ownership, which does not only impact monetary aspects, but is also related to the loyalty, inheritance and legacy they leave to the future generations. These features are collectively known as the socio-emotional objectives of a family business.

In short, through this study I intended to demonstrate a concept and reality that those who work with family businesses see clearly. This ethical attitude ends up creating value not only for shareholders, but for all stakeholders. It is the basis for the creation of shared value.

In contrast to apocalyptic views of family businesses, the fact is that they can uncover an important source of competitive advantage in their unique attributes. Starting from the classical theory of resources and capabilities, a family company enjoys a competitive advantage maintained over time and inimitable to its closest competitors derived from its internal resources (human and social capital, values, governance structure, organizational culture, transfer of tacit knowledge, etc.). These factors, among others, mean that the competitive advantage of a family business is created and maintained as a singular and highly valuable resource, because it cannot be imitated by competitors. A new term, ‘familiness’, has been coined in the literature on family businesses (Habberson and Williams, 1999; Sirmon and Hitt, 2003) to describe the distinctive, characteristic features of the internal resources available only to family businesses, as listed above.

For this competitive advantage to flourish, and I maintain that it is sustained by ethics and value-based management, it is essential that members of corporate families become aware of the importance of organizing a strong governance framework which addresses priorities such as:
 

  • Definition of a shared project and values ​​that form the tangible basis of family legacy
  • Design and implementation of a strategic plan for family and business
  • Creation of necessary conditions, for instance the resources, time and energy to build the necessary strategic alignment of interests between shareholders, managers and all employees, so that the entire organization is aware of the ‘big picture’, and the role they play in achieving the company vision
  • Methodical monitoring of the implementation of action plans
  • Development of the concept of adaptive innovation to complement traditional values ​​with the necessary adaptations that a changing society demands in terms of business models, management styles or business development policies.
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