Keeping it in the family: Family firms willing to take risks to retain control

Studies show family-led companies implement better long-term planning and generally have greater internal organizational commitment than public companies. Even so, business researchers have for some time contended that because so few individuals control so much at family firms, executives there are less likely than their counterparts in public firms to take the kind of risks that truly successful companies need to take. This idea that family firms are naturally risk-averse has become a standard line of thinking in business academia. Unfortunately, says W. P. Carey management Professor Luis R. Gomez-Mejia, it's just not true. At least not entirely.

As many as 90 percent of all American businesses are family-owned, and though these firms are paid far less attention than public companies, they form the backbone of the U.S. economy. Studies show family-led companies implement better long-term planning and generally have greater internal organizational commitment than public companies.

They are also surprisingly successful: The Family Firm Institute says these firms contribute 64 percent of the U.S. GDP and employ 62 percent of all U.S. employees, and that 30 percent of all family businesses survive into a second generation. Even so, business researchers have for some time contended that the very thing that makes family business so successful — the heightened level of commitment and the concentration of wealth at the top — puts them at a competitive disadvantage in at least one key area: risk taking.

Several well-respected studies have made a convincing case that because so few individuals control so much at family firms, executives there are less likely than their counterparts in public firms to take the kind of risks that truly successful companies need to take. Over time, the researchers say, this aversion to risk can cost family firms enormously. Today, the idea that family firms are naturally risk-averse has become a standard line of thinking in business academia.

Unfortunately, says W. P. Carey management Professor Luis Gomez-Mejia, it's just not true. At least not entirely. Gomez-Mejia, one of the world's leading experts on family firms, makes his case in a new paper, "Socioeconomic Wealth and Business Risks in Family-Controlled Firms: Evidence from Spanish Olive Oil Mills." In it, Gomez-Mejia argues family firms really aren't risk averse at all.

Worth the risk

Gomez-Mejia says he and his fellow researchers — Kathryn J. L. Jacobson, also from the W. P. Carey School, Katalin Takacs Haynes of Texas A&M University, Manuel Nunez-Nickel of Universidad Carlos III and Jose Moyano Fuentes of Universidad de Jaen — have found that family firms take risks on a regular basis — the kind of risks that can leave outsiders scratching their heads. Family firms shoulder risk for different reasons than public companies. "It's not true that family firms are risk-averse," Gomez-Mejia explains.

"They're willing to take risks. It's just that when they're more willing to take risks, it's often for this reason — to preserve family control of the company." It may be a subtle distinction, but it's an important one. As he is quick to point out, Gomez-Mejia doesn't entirely discount those previous studies — the ones that contended these family firms were risk-averse. He believes, however, that the research didn't go far enough, failing to take into account the unique characteristics of a family firm and the motivations of those who run them.

It's true, Gomez-Mejia says, that family-owned companies aren't as willing as public firms to take big risks on growth strategy or international expansion. In fact, Gomez-Mejia is just finishing another new paper that shows that even when family firms do go international, they are generally inclined to do business only in nations similar to the one in which they're based. What's not true, Gomez-Mejia says, is that family-firm executives aren't willing to take any risks.

According to his team's research — the examination of family-owned olive oil mills in Spain — when executives at family firms feel family control may be threatened, they are willing to take risks. In fact, they're willing to put the very survival of their companies on the line. And the reason why, the team says, is because executives at family firms are concerned not just with financial wealth, but also what they term "socioemotional wealth."

"What I'm saying is that family firms have a different set of [motivations] than other firms," he says. "They're not just concerned with financial things, but other things as well. And they'll accept greater hazard to maintain control and their socioemotional wealth." Gomez-Mejia and his fellow researchers define socioemotional wealth as the "non-financial aspects of the firm that meet the family's affective needs, such as identity, the ability to exercise family influence, and the perpetuation of the family dynasty."

Concern over maintaining this socioemotional wealth, the team says, weighs so heavily on the minds of family firm executives that it can drive them to make decisions that, from the outside, seem not only risky but downright reckless. "It's a somewhat counterintuitive interpretation," Gomez-Mejia says. "But it shows us that the prior perspectives on this issue are too simplistic."

As the team writes: "Using a socioemotional reference point, family firms are likely to place a high priority on maintaining family control even if this means accepting an increased risk of poor firm performance, yet because they must also keep the firm from failing, they may also act more conservatively by avoiding business decisions that may increase performance ability. The possibility that family firms could be both risk-willing and risk-averse hinges on distinguishing between two types of risk: performance hazard risk and venturing risk."

The olive mill study

For the study, Gomez-Mejia and his colleagues studied more than 1,200 family-owned olive oil mills in Southern Spain. Over a period of 54 years, these mills faced the same choice: Join a cooperative that would have given their businesses greater financial security but also robbed them of some degree of family control, or remain independent and preserve their family control while also opening themselves up to greater long-term financial risk.

It was an excellent context in which to look at risk aversion, Gomez-Mejia says: "It was a simple choice — either you remain independent or you join the co-op." The families faced with this decision certainly have struggled with it, but objectively speaking, it's hard to see many legitimate reasons for remaining independent. Gomez-Mejia and his team report that members of the co-ops enjoy major tax benefits, with the most recent Spanish tax laws granting co-ops a 10-year grace period.

Even when the grace period is up, however, the co-ops pay just half of the normal tax rate. There's more. Along with the tax breaks, the co-ops use their size and strength to offer members government subsidization, greater overall efficiency, marketing and managerial support, access to financing, guaranteed pricing and distribution services. Certainly, these co-ops have their advantages. Despite all of this, however, the team found the family firms they studied overwhelmingly decided to remain independent, even though knowledge of the co-ops' advantages were well known.

Wrapping up their findings, the researchers write that "when family firms are faced with a strategic choice dilemma that involves [either] a high degree of certainty of improved financial gains and better probability of survival, but loss of family control, [or] a greater risk of declining performance and catastrophic business failure, but retention of family control, the clear winner is [the latter]."

Even more puzzling, the researchers showed that at the same time these firms were willing to put the very survival of their companies on the line to retain control, they are also more than likely to "avoid investments that increase their performance … as this might exacerbate the performance hazard that they have freely accepted in exchange for continuing family control." In other words, these families short-circuited their potential profits by avoiding the co-ops.

Then they made matters worse by failing to leverage the one thing they preserved in that decision — their independence — toward the possible idea of growing their company for the future. "What you have is family firms preferring to remain independent, namely because if you join, you lose control. The co-op can tell you what to do. The co-op has its own CEO. Therefore they make the choice to remain independent and retain family control, even if that means [lesser returns]."

Bottom Line:

• As many as 90 percent of all American businesses are family-owned. These firms account for 64 percent of the U.S. GDP and employ 62 percent of all U.S. employees.
• Though researchers have long noted that family firms generally have stronger long-term planning and a greater level of commitment than public firms, many business academics have also recently contended that the concentration of wealth at the top of these firms make them more risk-averse than public companies.
• In a new study of family-owned olive oil mills in Spain, however, a group of researchers led by management Professor Luis Gomez-Mejia show that family firms aren't risk-averse at all. Rather, the team says these firms are more than willing to take risks — but mostly only when they feel family control of the company is at risk.
• The team says this is because owners of family firms are concerned not just with financial wealth, but also what they term "socioemotional wealth," which they define as the "non-financial aspects of the firm that meet the family's affective needs, such as identity, the ability to exercise family influence, and the perpetuation of the family dynasty."