The family way: how socioemotional wealth drives decision-making

Family firms do business differently, and Regents Professor of Management Luis R. Gomez-Mejia has made it a priority to understand how. In a comprehensive study of research on family firms throughout the world, Gomez-Mejia and colleagues have found that family firms with dominant levels of ownership control tend to make business decisions that preserve their socioemotional wealth — even at the expense of financial gain.

What is socioemotional wealth? Also referred to as “affective endowments,” Regents Professor of Management Luis R. Gomez-Mejia and colleagues coined the term to describe the perceived value of non-economic factors, such family values, family dynasty, longevity, altruism, transgenerational vision, pride, and emotional connection.

“Emotion is a key differentiator for family firms,” says Gomez-Mejia. “There is an emotional currency that intensifies with increased family ownership, especially with the founder at the managerial helm, and sets a tone and decision-making process markedly different from public corporations with dispersed or non-related shareholders.”

Money isn’t everything

The study, titled “The Bind that Ties: Socioemotional Wealth Preservation in Family Firms,” describes how family-owned companies approach strategy, management processes, corporate governance, stakeholder relations, and business ventures with unique criteria weighted more toward kinship, legacy, and reputation than sheer financial profitability.

“The body of research revealed a different value set between family-owned and non-family firms,” says Gomez-Mejia. “In today’s business world, a casual observer may label a decision that works against revenue growth as irrational. However, a family business tends to uphold non-economic factors, such as preserving bloodline succession, values, and legacy — intangible qualities that evoke strong emotion, are difficult to measure, and make absolute sense to them.”

Control: It’s a family affair

In a study of family-owned olive mills in Spain, when the local cooperative extended an invitation to join, offering clear financial benefits and market security, in most cases the firms declined, preferring to maintain family control, independence, and legacy potential, even if it meant performing at reduced levels.

This might seem like bad business, but there are positives as well. Placing high importance on their values, reputation, and community standing, family firms are more likely to engage in social responsibility initiatives that reap gains of pride and positive external regard more than any measurable revenue growth. In the same spirit, they tend to avoid tax aggressiveness and are conservative in earnings management, avoiding any perception that could damage the family name, identity or legacy value.

Even operating within a different value system, the profitability of family-owned versus non-family owned seems to be evenly matched, if not slightly higher in the family-owned businesses.

For most businesses in the world, this socioemotional-driven behavior is an integral part of life, given that 95 percent of all businesses in Asia and the Middle East are family-owned. In the U.S., 70 percent of all publicly traded firms are family-founded or owned, employing 80 percent of the national workforce. Remember, too, that giants like Microsoft, Hewlett Packard, Cisco, and Motorola started as home-based businesses.

Founders, keepers

Typically, the closer the company is to its founder, in terms of ownership or management, the stronger the culture of affective endowment. In our era of business immediacy, where executives often prioritize quarterly earnings reports over long-term gains, family-owned businesses tend to favor continuity for better or for worse. In family-owned businesses, CEO relatives tend to stay in the top position seven years longer than non-relatives, even when the likelihood of executive failure is high. Assured the benefit of the doubt, and valuing the security of their role, these kindred leaders also will accept lower salaries.

As successive generations take control of the business, stepping into their forbearers’ shoes, the emotional connection becomes diluted in strength, the “family handcuff” loosened over time. Much to their grandparent’s or great-grandparent’s dismay, the skip-generational descendants may likely be more open to including non-related professionals, specialists, and partners in managing the business.

Socioemotional priorities: key points on the family firm landscape

Given that more than 80 percent of the U.S. workforce is currently employed at a family-owned company or organization that still bears its founder’s name, understanding the dynamics of socioemotional politics can be useful, especially when interacting with smaller firms that may be less open to “outsiders.”

• Control — The family’s primary agenda is to maintain control of the business. If you’re not with that, you’re against them.
• Long-term strategy — It’s not just about the bottom line. Family firms tend to think of the future as a longer time-horizon and, thus, may make strategic decisions that curtail short-term returns in lieu of longer-term results for legacy purposes. Any non-family member or investor interested in short-term financial returns will be at a disadvantage.
• Consistency over expansion and innovation — Family firms are less likely to diversify or participate in acquisitions, and to invest in research and development. Similarly, they avoid aggressive tax practices that may lead to an embarrassing audit.
• Management processes — Much like the royal families of old, succession is based primarily on bloodline. Professionalization or involvement of specialty professionals is limited. Human resources policies are loosely enforced.
• Corporate governance — While a board may lend the appearance of legitimacy to a family business, decisions it may make that are contrary to the socioemotional agenda will likely experience strong opposition.
• Risk/reward — Often risk averse, they will take risks to protect their socioemotional wealth.
• Stakeholder relations — Corporate social responsibility activities are actively sought to portray a positive external image to the community, regardless of return on investment.
• Business ventures — The family firm is less likely to jump into new ventures, and if it does, will likely stay close to its core business.
• Values in the mirror — The corporate values often mirror the family’s personal values or credo.
• Connected culture — Family businesses notably have lower employee turnover, due to a stronger feeling of connection to the family or that the family cares more about them. That is, if you get along with the family.
• Social capital — Relationships are important social capital, where a network of long-term or close associations is preferred to new players.
• Heart of business — Often seen as irrelevant in the corporate world, emotions are at the heart of the family business, in terms of the commitment, dedication level, and close relationships.
• Nepotism — Hiring decisions are more likely to be based on family relationships.
• Cronyism — Jobs may be filled with friends or close associates over more qualified candidates.

“At first, when I started delving into the research, I was more critical,” says Gomez-Mejia. “Now, I see more of the positives of working with a family firm. Being less likely to fire someone, they promote stability, loyalty, and longevity. In our current business environment, those are all good things.”