Should investors distinguish between family-owned businesses and family-owned - and run - businesses?

  Productivity - family run businesses aren't very good at it, says study           (Photo: Pixabay)

Productivity - family run businesses aren't very good at it, says study         (Photo: Pixabay)

Mid-sized family businesses with little debt and a good set of performance indicators are among the most prized assets in the world. Those seeking to buy into them would typically apply a set of standard financial parameters to help make their decision. But should investors be screening them through another filter as well - whether they are run by family members or non-family members?

Of course, all investors will be looking at the management of the business they plan to invest in as much as any other factor. But they might not necessarily make a distinction between those run by family members and those run by non-family members.

Family CEOs cannot credibly commit to firing employees without incurring reputation costs

Indeed, many investors might have a slight preference towards a business run by family members as opposed to ones that aren’t. That’s most likely to be because of the continuity family members bring to their business. The family know the business and as such are more likely to ensure certainty for a business during the process of transition brought about by an outsider coming in as an investor - so the argument might go.

But there’s probably one thing an investor won’t be looking at when acquiring, or taking a stake in a business, and that’s its productivity levels. If they did consider this, investors might find that those businesses run by members of the family are likely to be less productive than those run by professional outsiders.

A recent study by the Centre for Economic Performance at London School of Economics found that family-run businesses have lower productivity levels than those not run by family owners, or non-family businesses.That’s because family-run businesses are more likely to have poor management practices, say the authors  “We estimate dynastic CEO successions lead to 0.8 standard deviations lower adoption of managerial best practices, suggesting an implied productivity decrease of 5 to 10%,” according to the CEP study, which was written by academics Renata Lemos and Daniela Scur.

The research looks at reasons why family-run businesses are likely to have poorer productivity levels than non-family run businesses. One of the main reasons is family CEOs are more paternalistic towards their staff. They’re less likely to make them redundant and as a result less keen to bring in technology that might improve productivity levels.

“Family CEOs cannot credibly commit to firing employees without incurring reputation costs,” says the CEP study. “This induces lower worker effort and reduces the returns to investing in better management. We find empirical evidence that, controlling for lower skill levels of managers, reputational costs constrain investment in better management.”

It’s unlikely that productivity levels in themselves will determine whether an investor buys into a business or not - the standard set of financial performance indicators will continue to be the biggest determining factor. But investors might like to add another screen to their decision-making process when buying a family business. And that screen would be to ensure they apply an extra level of due diligence to family businesses run by family members, compared with those run by outsiders.