A question of succession: Passing the baton in family business

When Ratan Tata stepped down as chairman of India’s giant Tata group in 2011, much attention was focused on who would succeed him. For a century and a half the top job at the Tata group had been in family hands – Ratan Tata was the fifth member of the family in the post, a job he held for more than five decades.

Even insiders who have worked for the firm for many years may find their access to resources blocked by the exclusive nature of family ties

But rather than continue the dynasty, the group chose to appoint a non-family insider to take over.

In emerging Asian economies, where family firms are a key pillar of business, the question of leadership succession is a challenging one with significant implications for firm strategy and performance. Many of the most renowned family firms were established after the Second World War and as a result are now experiencing their very first leadership transition – from the founding entrepreneur to the next generation.

So, what kind of successor is most conducive to an organization’s survival and effectiveness in an emerging economy: outside professionals, family members or a non-family insider?

In my research with a colleague at INSEAD we find that the social context in which a succession occurs plays a critical role. For example, different successor origins will determine not only the type of knowledge and skill brought to the job but also the degree of access to network resources in different contexts.

The way a successor is perceived by stakeholders will also vary from one context to another; those who are well connected and welcomed by stakeholders will be more effective in acquiring resources, minimising transaction costs, and facilitating firm performance.

This is of vital importance in emerging economies often facing challenges caused by weak market infrastructure and limited access to resources.

‘Performance premium’

ThinkAloud4Examining firms listed on Taiwan’s Stock Exchange over the period 1996-2005 we found that, in general, succession by professional executives ensured greater firm profitability, even after allowing for variables such as educational background and work experience.

From this we believe that the “performance premium” of outside managers is related to the fresh perspective and change orientation that they bring in a context of rapid change. Given the wave of deregulation and privatization that has swept through emerging economies, family firms are facing unprecedented circumstances and can no longer rely on strategies that were successful in the past.

Conversely, the performance premium of outsiders is reduced in family-dominated firms, as well as in those affiliated with a business group. Where a family owns a large shareholding and is extensively involved in management, family successors enjoy the benefit of accessing the network resources of the firm. Carefully maintained intra- and inter-organizational relationships facilitate the succession process and ensure support for the new direction taken by the successor.

These social ties and network resources are simply not available to outside managers. Even insiders who have worked for the firm for many years may find their access to resources blocked by the exclusive nature of family ties.

The same applies in firms which are members of business groups. Business groups are pervasive network structures in emerging economies and nurture informal social links based on family and friendship.

So in group-affiliated firms, a family or insider successor will more easily secure access to the group’s information network and resources than someone from outside.

Meritocracy

We also found that the “outsider premium” was amplified in a number of specific contexts, such as the tech sector – an industry which is increasingly prominent in emerging economies.

Here institutional attitudes imported from Silicon Valley – those that value innovation, achievement and professional management – tend to prevail. Leadership succession is therefore shaped more by meritocracy and performance than by social relationships.

Appointing an outside successor is synonymous with professional excellence, fresh perspectives and accepted notions of job mobility, whereas a family successor may be viewed as having made it to the top through personal ties and influence.

Professional successors are favoured in these industries because they boost firm access to resources and support from key stakeholders.

Family banned

A case in point is Stan Shih, founder of Acer Computer, who not only banned his family from participating in the business, but passed the top position in 2005 to a veteran executive – Jeng-tang Wang – who had helped Acer establish its brand in Europe. This move won praise from suppliers, customers and investors alike, thereby enhancing Acer’s reputation in the labour market.

This outsider premium also showed up in firms with high levels of foreign institutional investment.

Since foreign institutional investors (most of whom are US- or UK-based) follow the shareholder-based governance model, they may regard the appointment of family or insider successors as less legitimate.

While the shareholder model favours professional management, transparency and shareholder rights, family succession seems to run counter to these principles and to compromise investor interests.

The appointment of an outside professional successor signals that strategic decisions will be based on corporate rather than family or personal interests – and will be rewarded by investor support for the new leader.

For family firm founders/owners in emerging markets the lesson from our findings is that there is no single best solution – what matters is the alignment or fit between contextual conditions and successor origin.

For firms where family involvement is high, the founder’s offspring may offer more benefits in terms of post-succession profitability. The same goes for firms that are members of business group networks.

But for those in high-tech or with dominant foreign institutional ownership, a veteran executive or outside professional may be a more suitable choice.

Ultimately, having a deep understanding of the firm’s environment is the golden rule for succession planning in emerging economies.

  • Author Profile

    Chung Chi-Nien is associate professor in the Department of Strategy and Policy at NUS Business School. His research interests include family firms, succession and corporate governance.

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