Why are family businesses sometimes so nasty?

The news that Wal-Mart is to give 500,000 of its employees a pay-rise is worth cheering. Employees at the firm, which is owned by the Walton family, will now all earn at least $10 an hour. The increase in wages will cost the firm $1bn, a small but not insignificant share of its $30bn operating profits. 

That sounds good, but critics have pointed out that the retailer can well afford it, as it paid its CEO $26m last year, and that as unemployment is falling and wages are rising, the market might have seen to this rise without any outside help. It has also taken its time making the change – campaigners have been tutting about its low pay for years. So, two cheers for Wal-Mart.

Family business advocates might be surprised that Wal-Mart has taken so long to make these changes, given that family businesses are widely  believed to be more “moral” or “socially responsible” than other firms. Famously, American family-owned companies like Levi Strauss and Hallmark Cards are generous philanthopists. Clothes retailer LL Bean was an early adopter of the stakeholder model.

Anecdotal evidence suggests that families do care more – Family Capital knows of a Danish family firm where the family head thinks nothing of paying medical or legal bills for employees because it is “the right thing to do”. Family firms often pay more than the going rate – an example is the outdoor clothing manufacturer Vaude, which pays employees in its Asian factories 115% more than the average. Others keep production in their home town out of a feeling of responsibility for the people there, like the giant German brewer Warsteiner, which is still based in the village whose name it bears. 

It would be reassuring to think that family firms are nicer than others. But the evidence suggests that they are not always – or not consistently, anyway. A paper called Are Family Businesses Really More Socially Responsible? by Spanish academics including Cristina Cruz from IE business school discovered that – oddly – family firms are both better and worse than others, depending on whether you look outwards or inwards.

The study looked at 598 listed European firms with a market cap of $50m or above from 22 countries over a period of four years, and their CSR scores as recorded by CSRHub, an independent organization that rates firms’ CSR (corporate social responsibility) behaviour. It found that because family businesses are more “concerned with their image and reputation” than others – because the family’s name is at risk from poor behaviour, perhaps – “they are likely to be more responsive to external stakeholders’ demands (more specifically, the environment, the community, and their customers) than non-family firms”.

However, when it comes to their own employees, family firms are not so benevolent. “Family ownership is often associated with the design of unfair compensation systems, use of lower peer appraisal processes, managerial entrenchment, nepotism, scapegoating of non-family executives and employees, and gender discrimination,” the paper said. The victims are normally non-family, rather than family, stakeholders.

Why does this happen? “Due to the type of social links family members have with their firms, family companies become the place where their needs for affection and belonging are satisfied”, argue Cruz et al. This creates a strong bond among family members which differentiates them from those who are non-family, and often a different – and less nice – set of rules apply to the outsiders.

Also, the family’s need for control can lead to behaviour that is unfair to others, such as promoting underqualified relatives. Corporate governance is adopted that entrenches the family’s control, and reduces the power of non-family employees, and the family is reluctant to introduce fair procedures because they might undermine family control.

Family firms come out of this looking less fluffy than you might expect, In fact, some look pretty bad: nasty to outsiders, dysfunctional in sacrificing good governance for family control, and cynical for supporting CSR initiatives that make them look good in their local community. In most cases the families’ aims are laudable. It is a peculiar feature of family businesses that good intentions can easily produce bad results.