EU Economy
London School of Economics/McKinsey study says the best way to ruin a UK family business is to give it to an eldest son
By Finfacts Team
Mar 15, 2006 - 2:51 PM

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Nick Bloom
Research published today by the Centre for Economics Performance at the London School of Economics and McKinsey the consultancy, suggests that the best way to ruin a UK family business is to give it to an eldest son.

The research into the gap between the UK's productivity performance and that in the US, France and Germany found that objective assessments of managerial performance were important in explaining why UK manufacturing companies tended to have lower productivity and profitability.

However, the finding that surprised researchers involved in the project was that half of the difference between British companies and their overs eas competitors in terms of management practices could be explained by the prevalence in Britain of second or later generation family-run companies. If those were removed from the analysis, British performance did not look nearly so bad.

Nick Bloom, one of the authors, urges the UK Government to scrap the 100 per cent inheritance tax relief given to large family businesses.

Bloom says that if tax relief were to be capped at £1m, it would spur productivity growth, save taxpayers £250m a year and avoid entrenching poor management in Britain's boardrooms. "Can you imagine if the current England football team was picked from the sons of the team in 1966? We wouldn't win anything."

In Ireland, there are special inheritance tax rules for agricultural property and family businesses. The value of agricultural land and buildings for Capital Acquisitions Tax purposes is the market value reduced by 90%. This relief applies when the beneficiary is a farmer. Relief for family businesses is also at 90%. In order to get the full relief, the property or business must be retained in the family for at least 6 years. If it is not, the relief will be clawed back.

The research team examined the detailed performance indicators for 730 medium-sized manufacturing companies in the UK, the US, Germany and France, to try to determine the underlying reasons for the UK's poor productivity performance.

The authors say that what is worrying is not that this study was based on long and detailed examination of dozens of factories across the UK or the United States - or that it was carried out by renowned manufacturing management experts from both sides of the Atlantic - but that it was carried out fifty years ago as part of the 1947 Marshall Plan to reconstruct Europe.

Alfred Chandler and David Landes - prominent Harvard business historians - have claimed that the UK's management problem dates back to around the 1900s.

The authors ask what could be causing this long-standing poor managerial performance of UK firms?

Chandler and Landes argue that hereditary family management has played a major role, describing the way in which second and third generation family members run down successful businesses as a story of clogs to clogs.


Family firms and management practices

Analysis of the data reveals that firms that are family-owned but not managed by family members are usually well managed. This appears to be because family shareholders, who typically have large equity stakes, carefully monitor the managers they employ to run the business on their behalf. An example here is Wal-Mart, which is still largely owned by the Walton family but which has had a professional (non-family) CEO since the retirement of Sam Walton, the firm.s founder.

While family ownership seems to improve management practices, family management is typically less good.

There are two problems with family management:

First, selecting the CEO from among the small group of potential family members severely restricts the available pool of managerial ability. While this may not be a problem for a small fiveperson firm, for a 500+ person firm, the CEO needs to be a highly able, which the family may not be able to provide.

Second, letting family members know that they will get to manage the firm later in life can lead to a Carnegie effect, in which family members work less hard at school and early in their careers safe in the knowledge of a guaranteed family job.

When the CEO is selected by primogeniture - that is, selecting the eldest son - the management practices of the firm tend to be extremely bad. With primogeniture, both the lack of selection and the negative Carnegie effect become much more severe since the CEO position is determined from birth.

Family firms in the UK

Family firms exist across the world so why single out the UK?7 From our survey of manufacturing, it turns out that the UK has a high number of firms that are both family-owned and family-managed. The first row of Table 1 shows that the number of family-owned firms is about 30% in the UK, France and Germany and 10% in the United States. The second row shows that of these firms, the majority are managed by the family in the UK and France, but not in Germany. Moreover, the third row shows that about half of all these family firms in the UK reported handing down CEO control by primogeniture - that is, to the eldest son.

So what explains this high share of family-managed firms in the UK, particularly those that follow primogeniture practices? We believe two factors play a role:

  • A tradition dating back to the feudal societies of the UK and France.

  • Inheritance tax, which for a typical medium-sized firm worth $10m or more, contains no substantial family firm exemptions in the United States, but which has exemptions of roughly 33%, 50% and 100% in France, Germany and the UK respectively.

The feudal traditions of the UK and France appear to have persisted long after the feudal kingdoms themselves collapsed, with primogeniture obligatory under English law until the Statute of Wills of 1540 and de facto in France until the introduction of the Napoleonic code in the early 1800s.

German traditions were based more on the Teutonic principle of gavelkind (equal division among all sons). In the United States, the founding fathers were almost all younger sons of English gentry whose inheritance was given to their elder brothers by primogeniture, so they were never in favour of the practice. After the American Revolution, primogeniture was abolished, with equal treatment by birth order and gender common in the United States by the early 1900s.

The UK's inheritance tax exemptions for family firms were introduced in successive budgets between 1979 and 1992 by Chancellors Geoffrey Howe, Nigel Lawson and Norman Lamont..

The UK provides by far the most generous inheritance tax exemptions to family firms compared with France, Germany and the United States. This makes it possible for family ownership to remain concentrated; it also provides an incentive for even badly managed family firms to be kept within family ownership.

Extract from Policy Analysis report

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