Friday, September 27, 2019

Rise of the Moderately Capable: Succession in Family Business

How can the prince of an absolute monarch survive and inherit the throne? How can the child of a family business founder take over the business? Two different questions with the same answer: Don’t be too ambitious, and don’t be too capable. This sounds like a bleak story, so I should explain the research behind it.

The theory and evidence are found in a recent article in Administrative Science Quarterlyby Xu Huang, Louis Chen, Erica Xu, Feifei Lu, and Ka-Chai Tam. They look at the problematic situation that parents and successors of family businesses find themselves in. Family business founders believe that success comes from exactly their actions and values, so successors should imitate them exactly. Yet imitating them too closely creates competition, which encourages the parent to dominate the child instead of giving the successor freedom.

How can this domination be avoided? The answer is simple and discouraging. The successor should not be too ambitious or too capable, because these attributes would increase the competition and lead to dominance by the founder. In fact, highly ambitious and capable children will be dominated by the family business founder because they are too good, just as unambitious and incapable children will be dominated because they are not good enough.

The research team found evidence for this through surveys of family business founders and successors in China. But they went further than that: One part of their study looked at how princes of Chinese monarchies before 1000 AD fared, finding that those who were not too ambitious and capable had the best chance of succeeding the king. Of course, not succeeding an absolute monarch is a little worse than not taking over a family business – those who failed might be killed by their father and replaced by a more amenable prince.

So in some ways the world has improved, because the price of being too capable is no longer death. But this research still does not deliver good news. Family businesses are very important in most parts of the world. If only the moderately capable successors gain freedom, these firms will not become as successful as they might, to the cost of the family, the employees, and society. Strictly speaking this effect has been shown for only the founder generation of family businesses, and we could hope that it disappears in the second or third generation.  

Family businesses are complicated because they mix family and business, which are usually kept apart in modern society. In the ancient world family and business were the same thing, and I can’t help wondering whether that meant they had better mechanisms for dealing with the mix than we do now.

Monday, September 2, 2019

Buying Elections: How State-Owned Enterprises Can Serve Politicians

Getting re-elected is much easier when voters are content, such as when the economy is doing well and everyone has work. No wonder we see a president tell media that the U.S. economy is fantastic but also tell the Fed that the economy is in trouble and needs a strong boost from a prime rate cut. This is crude, but if everyone complies it will work. However, in nations with a stronger blend of state and private sectors, more sophisticated approaches are also available.

Scholars have long thought that state-owned enterprises (SOEs) have political uses, and in a recent paper in Administrative Science Quarterly by Carlos Inoue we learn more about how politicians can use them. The trick in this case is over-employment, which has to be done very selectively because voters in most nations are wary of the state, or the enterprises it owns, running up excessive bills that have to be paid through taxes. That’s why the use of SOEs has to be sophisticated, not crude.

What to do? Inoue looked at the water-supply sector in Brazil, which has exactly the blend of municipal authorities, SOEs, and privately owned firms needed to check whether SOEs are special. And indeed, they are special. SOEs hired additional staff exactly during election years (for governors, who are the ones controlling them). To maximize the electoral impact, they were careful to hire more staff in communities with greater poverty. Some SOEs also had private investors, who resisted effectively enough that the over-hiring in election years was less. So we see a sophisticated effort to buy elections through influencing SOEs: hire more when needed, where the creation of jobs is most effective, and whenever possible.

What was the cost of all this? In general, SOEs were not costlier than other firms, because they diverted resources from other areas to create jobs. But they did have lower profitability as a result of the greater employment during election years. They spent money – sacrificed profits – exactly when it was useful for politicians seeking re-election, but not otherwise.

Organizations are used in so many ways, some of which are far away from their original purpose. The water-supply industry is important in any nation, because abundant and clean water helps the society and economy, but at least some of these firms have a second purpose. This is something that both scholars and practical readers dislike, but at the same time we have to admire how skillfully it was done in this case.