Dwight Cass
01/01/2005
Founder-CEOS create value in family businesses. Second-generation CEOs destroy it. And third-generation family CEOs build it up again.
These are the somewhat startling conclusions of a research paper published last summer by Professors Belén Villalonga of Harvard Business School and Raphael Amit of the Wharton School at the University of Pennsylvania. The two set out to examine how family ownership, control and management affect firm value by analyzing the performance of Fortune 500 firms between 1994 and 2000.
Villalonga and Amit found that the family businesses on the list that still had their founder in the CEO’s office, or serving as a chairman alongside a professional, nonfamily CEO, enjoyed the best performance. (They determined this by calculating each company’s Tobin’s Q, a gauge of the quality of a company’s investment decisions, computed by dividing the market value of its assets by their replacement value.) Companies with second-generation CEOs and no involvement by the founder saw their Tobin’s Q plummet. The performance of those with third-generation management rebounded; their Tobin’s Q was in line with professionally managed nonfamily businesses. “Third- and later-generation family firms are not significantly different in value from nonfamily firms,” Villalonga and Amit concluded.Many observers have noted the decline in performance of family firms under the auspices of the children of entrepreneurs; the conventional wisdom holds that they fail to develop their own skills and independence while laboring under a charismatic, talented founder. Many second-generation managers also see themselves as stewards of the family legacy, and are therefore more conservative in their management, which may also lead to underperformance. As noted in “Wrestling for Control of the Family Business” (Worth, December 2004, page 61), intergenerational conflicts can also take their toll.
Generation X-CEL
None of this explains why third-generation managers should be more successful at creating value than their immediate forebears. One possible reason: There are far fewer of them. The Family Firm Institute, a research group, estimates that only 30 percent of all family businesses survive to the second generation, and fewer than 12 percent make the leap to the third.
Certainly some variant of natural selection is at work in the realm of family businesses. Those that endure to the third generation usually have done so by taking extraordinary steps to ensure their survival: embracing industrial-strength governance and management policies, aligning the family’s interests with the business in such a way to allow needed sacrifices to fall equitably among owners and so on.
The third-generation families running these surviving companies have evolved beyond the first generation’s often-paternalistic management style, characterized by a rigid hierarchy, close supervision and distrust of outsiders. They have embraced the sort of meritocratic management that relies on nonfamily professional specialists, or have invested in developing training programs and vetting procedures for family members who wish to participate in running the business.
These hardy specimens have also tackled the family governance issues that plague third-generation enterprises. These can be knotty: The interests, values and appetites of cousins diverge more than do those of siblings. Bringing an exponentially larger group together to make, or at least ratify, decisions is a challenge that some nine out of 10 families fail to meet. 
Indeed, governance problems in the third generation can slowly suffocate a firm. Villalonga and Amit, in their recent paper, report that family businesses that indulge in mechanisms to limit control to a select group (such as special voting-rights shares) underperform, presumably because these mechanisms reduce the pressure on management to excel. Weak corporate governance, they note, usually leads to weak and vulnerable companies.
The confluence of family and business challenges facing the third generation make it tempting to throw in the towel. Those who remain steadfast, such as the Blommer, Mitchell and Young families profiled in the pages that follow, have found the right alchemy to blend the vision and energy of entrepreneurs with management skills and governance policies.
Generational Shadow
The founders of a multigenerational family firm cast what some observers call a “generational shadow” over their heirs, occasionally reaching to the third generation through either their own presence or the legacy and standards they embed in the company’s culture and management structures. This can often be positive, especially when the founder provides useful strategic guidance to the second and third generation of managers, and a clear articulation of the firm’s motive and values.
However, it can also hamper the subsequent generations in attempts to make the company their own, constraining them in ways that may hurt the company’s performance. Structural legacies may end up hampering performance; these researchers say heirs need the flexibility to adapt the company to changing times, and the governance procedures to the changing size and nature of the family.
Illustrations by Jonathan Barkat.
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