Why damaging nepotism persists in family businesses

• 70 per cent of family businesses fail after the first generation
• Nepotism dominant in family businesses
• Even when overcome own bias family ties still lead to choosing offspring
• Family firms need strong selection procedures to overcome nepotism bias

Even when seemingly putting family connections aside while considering succession, leaders of family firms still tend to favour their relatives and friends when making a final decision, new research has found.

This is often to the detriment of their company with evidence to suggest more than 70 per cent of them fail after the first generation primarily due to poor succession decisions.

Chengwei Liu, Associate Professor of Strategy and Behavioural Science, believes succession is one of the most important decisions a leader can make to ensure sustainable business performance, and yet research shows firms often stick with what they know, rather than taking a risk on an unknown quantity.

Dr Liu said: “One common characteristic of leaders' succession decisions in family businesses is that they tend to assign offspring as their heir, a form of nepotism. Nepotism in family business succession tends to lead to decline or even bankruptcy.

“In our research, we argue even when a leader can overcome individual decision biases, a bias from their strong ties with family can still allow a leader to wrongly conclude family members are better qualified than external candidates, when often the opposite is true.”

Bad succession planning

Dr Liu, alongside Dawn Eubanks and Nick Chater, of Warwick Business School, use the example of Jack, a family business owner, to illustrate their argument in the paper The weakness of strong ties: Sampling bias, social ties, and nepotism in family business succession published in The Leadership Quarterly.

Jack is considering two candidates to succeed his position, his nephew Tom, and another non-related candidate Sam. Although in the example neither get the job initially, Jack later hears Tom is doing well in a new job and then offers him the role. The same luxury is not afforded to the second candidate, however, as he is not part of Jack’s social network.

The researchers used computer simulation models to explore the implications of a decision-making scenario focused on a leader's decisions about succession planning in a family business.

Dr Eubanks, Associate Professor of Behavioural Science & Strategy, added: “In the case of Jack, it is likely threats were identified when selecting an outside CEO. Because of this leaders become more risk averse and decide to stick with the ‘safer’ option of selecting a family member.

"They focus on the positive aspects of selecting a family member and the threats associated with selecting an external candidate.”

The researchers used simulation analysis to show leaders may wrongly conclude that family members are more qualified than external candidates due to the sampling biases resulting from strong family ties.

Based on the research, Professor Chater suggests some ways in which family firms can look to avoid making such errors.

The Professor of Behavioural Science said: “Information from strong ties makes family members less likely to be underestimated than their external counterpart. Strong ties have advantages, but tend to be weak in terms of accessing information on candidates outside the family.

“If leaders can use some contacts that enable information to be collected about external candidates, the sampling bias induced nepotism can be weakened. So looking back at our example, Jack may have given Sam the same second chance he gave Tom.

“Re-arranging organisations to facilitate updating their records on how external candidates who failed to get the job are getting on in their career can in turn help avoid the weakness of strong ties.

“Our results suggest leaders have to act against their natural tendency and sample those external candidates with initial negative impressions to avoid hidden gems being wrongly dismissed.”

Unknown staff are good

Dr Liu argues leaders of family firms have to allocate resources to formalise the evaluation processes because succession decisions are crucial for the long-term survival of family businesses

He said: “It makes sense to introduce staff with weak ties to the family, but whether a leader who understands such dynamics will be willing to adopt it is an issue that requires more research."

Another possible solution to nepotism is to draw lessons from Japanese family businesses. Family businesses in Japan have taken to adoption to find an appropriate successor, with adoption of males between 25-30 making up 98 per cent of total adoptions.

“For these Japanese firms the proof is in the pudding as research shows Japanese family businesses outperformed," added Professor Chater. “The opposite is true for the rest of the developed world.

“The new heirs can either spur on their new siblings, or displace those that are unworthy. Of course whether such a solution works across cultures needs further investigation, however.”

Chengwei Liu teaches Behavioural Sciences for the Manager and Strategic Advantage on the Executive MBA. He also teaches Strategic Advantage on the part-time Executive MBA taught out of WBS London at The Shard and on the Distance Learning MBA. Dr Liu also lectures on Quantitative Methods for Business on the suite of MSc Business courses.

Dawn Eubanks teaches Acquiring Research Skills and Leadership on Warwick Business School's Undergraduate programme. She also lectures on Behavioural Sciences for the Manager and Leading for Innovation on the Executive MBA, which she teaches on the suite of MSc Business courses as well. Dr Eubanks also teaches Innovation and Creativity in Organisations on the Full-time MBA.

Nick Chater lectures on Behavioural Sciences for the Manager for the Executive MBA, Emotions in Business on the school's Undergraduate programme and Principles of Cognition on the suite of MSc Business courses.