The Challenges Of The Family Firm Commerce Essay

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Before going into any details, let us understand what does the term "family firm" means? So far there is no single definition for the term as it has variety of definitions pertaining to the context. The most nearest definition pertaining to the context is that it can be defined as a firm that is controlled by one or more families involved in management or at least holding capital stakes in the organization. (Sharma,2004) It is also stated that family business research are puzzled with the definitional problem pertaining to its subject.(Winter et.al,1998)

The problems could be solved through two approaches. The conventional approach is to recognize the reasons which distinguish the family firm from a non family firm. One suggestion is to identify the number of family members affected through business decision or the number of generations which are active in the business. (Brockhaus,2004)

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The other approach to the problem seizes that there is no obvious differentiation between the family firms and non family firms and hence there is no particular definition which would be able to detain the differences between the two types of firm. (Astrachan et al,2002)Thus the supporter of the view suggests that the intensity of family involvement should be measured on continuous scale and not on binary classification of family vs. non family firms.

In-spite of all the ongoing debate, there is still a well known fact that the family participation does construct the family business different (Chua et al,2003). It usually possesses distinctive managerial quality where it combines both the family and the business assets so as to make a distinctive and attractive culture which makes them to have competitive advantage.(Denison et al,2004) Such distinctive quality varies in accordance with the level of the family involvement in the business, but the amount of variations is not unlimited. It usually has end points. At one point there would be companies which would not be eligible as family firms under any definitions while at the other end there would be companies which would be considered as family firms by all definitions. To define the family firm requires a great effort as it has been demonstrated of how difficult it is to draw lines between these two end points. Thus in the subsequent section, we would be exploring the definitional problem by attempting to draw this line. A number of multi circle model have been developed so as to define the family firm. Various multi models such as two circle, three circle and four circle models have been initiated over time and they are consecutively presented below.

Two circle model:

Sharma had carried out extensive research in the family firm field and came to the conclusion that most of the definition revolves around the act which the family firm plays in constructing resources and strategic capabilities.(Sharma,2004) He concluded that family and business are the two institutions(Lansberg,1983) where each has its own framework, regulations and characteristics. Thus individuals are provoked to fulfil the requirements of both the system where they overlap. This is more clearly depicted in the figure shown below:

Three circle model

To differentiate among the family firms and the promoters, Davis and Taiguri(1982) launched another model known as three circle model. They had quarrelled saying that this differentiation was very much necessary as it will help in precisely typifying the business side of the firm. Thus working as an employee or as a manager and being the owner of the company are two separate activities that are exhibited in different social entities.(Gersick et al,1997) This approach has been broadly acknowledged as depicting a more precise image of the family firm. (Gallo and Empresa,1997)

Four cycle model:

Hilb(2004) brought the awareness stating that the business firms needs to be contrasted more as it consists of both the administrative and decision making responsibilities of its members. In USA these responsibilities are compressed into one legal entity and thus they are conceived as a part of the same circle.(Weimer and Pape,1999). But in the case of Switzerland, both these bodies are separate entities.(Hilb,2004) The fourth circle model as shown in the figure below needs to be added to the model so as to accurately describe the family firm in these countries

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But if we consider the third world countries then both these administrative and decision making board are not only separate entities but also the membership of such bodies may not be even influenced by each other.(Weimer and Pape,1999) Hence if we see the below figure, the two circle of the four circle model named leadership and supervision would not overlap each other.

The four circle model, as shown above in the two cases, comprises of family members, the promoters, members in the family firm and the decision making boards which demonstrates the fundamental role available in the family enterprise. Klein(2002) offered definitions for all the above four roles stating that the family members are the ones which exercises important influences on the family firm. These important influences stems from the promoters, members in the family firm and the decision making boards. But this influence does not need to be adding on as the full authority of any one circle may be sufficient enough to portray the firm as a family firm. But if the influence of the family firm is less than 50 percent in all these three domains then the business is not a family firm business. (Klein,2004)

 Even many scholars have agreed that continuity should be an ideal model which the family firm should possess.(Desai,2010;Ward and Aronoff,2002) If the owner of the business wishes to remain attached to the company in the future, then only the firm would be entitled to be called as a family business. (Gallo,1997). This continuity can only be seen if in minimum two generations are actively involved in the business, thus expressing their intention to keep the firm in the family.

Introduction:

Even though the family firms varies in size, age and industry but the vast amount of roles played by these individuals are common to all. This distinctive managerial quality is a basis of competitive advantage, but it can also be weakness to the firm (Dyer, 2003). Thus family and company are separate institutions with visibly different purpose:

"The primary objective of a family is the happiness of its members, and the primary, albeit not single, objective of an enterprise is to create wealth. In fact, the for-profit organization is practically the only societal institution that carries this responsibility - and it is evident that the rules for creating happiness are not the same as the rules for creating wealth."(Gallo and Amat,2003)

These diverse rules direct to what can be called the basic quandary of the family business:

As both the family and the business have their own wants and target: each one has its own existence and philosophy. Thus it would be helpful to recognize that the convention of effectual business can be conflicting. The families are driven by fairness, comprehensiveness and kind feelings while business are driven by critical investigation, leadership and without any discrimination. (Kenyon-Rouvinez and Ward,2005)

This difference is mainly because of the goals of both family and businesses are different. Hence the goals are not realizable simultaneously. This resulting problem is called a dilemma which would be discussed in details below:

The success of the firm mainly depends on how fruitfully it balances the conflicting demands of family and business.(Scherer et.al,2005) For example the family teams can build up special faith and competence and exhibit explicit commitment to honesty and repute(Chitoor and Das,2007) while at the same time the family firms can face a heightened risk of partiality and disagreement. Thus it is from this dilemma from where both the weakness and strength of the family firm develops. Muhlebach(2006) had concluded her analysis of family firms saying that there are two sides to the story, one having some advantages and some disadvantages.

This irony can be more precisely be understood if it is illustrated on four cycle model where the demands of the business cycle such as supervision, ownership and management may be different from the demands of the family. There might be an instance where the three business cycle model may clash with each other. Thus these three different cycles would try to pull away from the family circle in a slightly different direction. These conflicting demands are shown in the figure shown below:

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During the period of generational change family firm dilemma becomes an important issue as it leads to many of the dilemmas that the family enterprise may face.(Gersick et al,1997). There is a big questionnaire during the period of family members getting older as whether both the family and firm will stay together in the next generation. And if it remains together then it should be decided as how the management should be passed on.

This all development leads to succession (Aronoff et al,2003) where it consists of large amount of processes within the company. Normally the succession in leadership should be the primary objective followed by succession in ownership. These all processes should take place within the family and the business arenas at the same time. But usually there are some family members who are not skilled or all set to acquire the control of the company. At times the entrepreneurs hold-up the succession development until he feels that he is out of action. Even at times there would be enthusiastic and capable successor and the incumbent may have gone ahead with the course of action in due time but it turns out to be very complicated to get through the changeover phase even after the baton has been passed. Thus "succession is the ultimate test of a family business."(Gersick et al,1997)

During the generational transform one would normally see that there might be significant transformation within the business which normally overlaps with the family. This becomes a difficult issue in succession planning. Even the researchers too have believed that the generational transfer should be closely associated with diversity and growth so as to have unbiased progress of successful family firm.(Klein,2003) But if the promoter is happy with an established business then he may avoid others from making the required transformation.

The trickiest part of succession is that it acts as an enzyme. Not only in business circles but also in family firms one can see that there could be conflicting interests especially among the promoters and the managers.(Klein,2004) The main factor which differentiates the family firm from other business is that the demands of the family firm and the demands of the three business circles have variances among each other.(Miller,2006) Each of these variances generates its own set of dilemmas. These dilemmas would be subsequently analysed.

Family vs. Administartion

The demands of the family vary from the demands of the management, thus contributing productive ground for quandary. The most famous example is commonly named as "founder's shadow." Both the traits of the leader and the culture of the firm have the strong linkage. (Coutu et al,2004)This linkage becomes predominantly strong when the leader is the same as the founder.

Thus the trait of the founder plays a vital role in starting the business and thenceforth.(Fueglistaller et al,2004) The worth on which the founder has built the firm establishes its culture and competitiveness. For the family business to have a source of competitive advantage they need to have managerial awareness of their distinct culture.(Scherer et al,2005) The family business to have constant success in the coming generations needs to have the continuity of the promoter's values.(Denison et al, 2004) This whole aspect is known as founder's shadow and it has been found to stay in power past the first and second generations of a family business.(Sonfield and Lussier,2004) Thus from the management point of view it is vital to safeguard the founders shadow.

But on the other hand the persistent influence of the occupant might create a hitch for the family. For example the entrepreneur may be forced to continue for the sake of continuing. This would create problems to entrepreneur as he may ignore health problems and would also prevent him from accepting the age limitations.(Shefsky,1994) Even the offspring of the promoter who is the successor of the family might have problem in generating self respect and self-rule.(Russell et. al, 2002) In extreme case these business may become an illness affecting the family. These are all the cases in which the concept of keeping it going means keeping the family sick. (Kaye, 2005)

Even though the founder and the successor may not be strongly afflicted by such problems but still it is very hard to sustain healthy communication in times of succession. In fact the key issue for the increase of social disagreement among the families which guides the business to the second generation is mainly due to the generational shadow of the founder(Davis and Harveston,1999)

Family vs. Ownership:

Both the family and the ownership are always found to be at odds with each other when it comes to estate planning. They often exhibit contradictory demands. The research conducted by Ward(1997) for the effectiveness of the family business over time have found that the firms which had been there for a long time were distinguished by the convergence of the ownership and administration in the grip of few family members or even just one person. This research was extremely astonishing as usually the families grow over generations. Then a question arises in the mind that is the convergence mainly due to the intentional decisions or was it due to the conditions observed in certain cases such as the promoter having only one child. But it apparently reduces the possibility of disagreement between the siblings or cousins over the business. The findings led Gallo and Amat (2004) to suggest that the ownership convergence sustains the business and promotes its long life.

The control of the firm demands more than its convergence in the hands of as few inheritors as possible. Thus the firm's capital must also be protected from cash outflows.(Scherer et.al,2005) In many countries, concentrating the assets of the company in only one inheritor mandates rewards for the unrestricted inherited recipient. This is because most of the family owned businesses re-invest most of their income from the business back into the business(Kenyon and Ward,2005), thus finances for this compensation often streams from that firm. (Scherer et.al,2005) In order to stop the outflow of the liquidity from the compensation payments, one needs to do estate planning. If we consider from the owners viewpoint then it would be advantageous to stop other inheritors from being remunerated so as to limit their compensation as much as possible.

On the other hand most of the families would reject this concept stating it to be unfair. Though dividing the whole thing down to the last penny and that too equally may seem pointless and impracticable to many parents, but still most make every effort to treat their children equally.(Ayres,2002) Such an impartial treatment is unable to get along with the "dynastic" estate planning and as a result may come at the cost of firm's ownership dimension. (Davis and Klein,2005)

At times there are conflicting demands concerning about the timing of the rights transfer between the family subsystems and the firm. The excessive strain on family business can be inheritance tax. For example in Germany, the tax charged on the shares gained through inheritance may pressurize the capital base of the firm.( Scherer et.al,2005) It has been already suggested above that the profits earned by the firm would be reinvested back to the business. Thus heirs normally have to rely on firm's funds in order to pay off the inheritance tax. The most successful way of diminishing the impact of tax would be to transfer the assets during the promoter's lifetime. (Ward,2004)

On the contrary the entrepreneur would regularly seek to protect his wealth(Fueglistaller et.al,2004) so as that he and his wife can have a secure source of post retirement income.(Aronoff et.al,2003) But normally the entrepreneur usually reinvests their incomes back in their business. Hence in order to sustain reliable income, the entrepreneur normally transfers the ownership title to his inheritor as late as possible. Thus if the entrepreneur and his wife maintains their lifestyle based on their company assets then it would be very tough to pass on the business to their successor.(Sorenson,2000) In order to avoid such family dilemma, the entrepreneur needs to have proper timely financial planning.

Family vs. Supervision

Good corporate governance is also one of the factors which lead to dilemmas as it has been found that it often works at odds with the wishes of the family. It has already been disputed that the versatile needs of the firms which are rooted in diverse cultural and historical settings cannot be adapted by single corporate governance arrangement.(Corbetta and Salvato,2004)

Irrespective of the firm having any corporate governance configuration, the basic problem associated with the family firms is that the decision-making board are subjugated by the family Chief Executive Officer in-spite of it having a little influence in reality (Blumentritt,2006). Thus when CEO leaves the firm, then supervision becomes an essentially an important issue. There can be a case when the CEO who is about to depart makes the room for his relative to succeed him as head of the company.(Ward,1997) If we consider from the family point of view then the above case is most preferred as there are many reasons why they prefer family members than the outsiders in the business. The most logical reason is that when the businesses are founded by an entrepreneur it is rarely thought of as a family business. it is considered to be an entrepreneur' desire for independence and for that he gets the support from his family and employees.  But there comes a time where the same entrepreneur desires to leave the business as an inheritance for their children. (Ward,1997)

In addition an entrepreneur grows older as time passes and hence his responsibility in the family changes. Thus an entrepreneur who grows older feels the need to belong to multigenerational family systems as it helps them to uphold the importance and significance of their lives.(King and Wynne,2004) Thus family business provides a perfect platform for the inheritance of an entrepreneur. But this is only possible if the family members are actively working in the business as this would help an entrepreneur to be attached with the younger family members. However an entrepreneur favours relative as his successor irrespective of other factors. (King and Wynne,2004)

At some instances we can see that the entrepreneur just closes their eyes when they see some flaws of their much-loved son or daughter.(Vries, 2002) But still some researcher believe that hiring relative is neither good nor bad for the company(Vinton,1998) but if the relative is less qualified than what they should be, then it poses one of the greatest dangers for the company.(Gallo and Amat,2003) Such type of partiality is not good for the family enterprise but still the entrepreneur often lean towards such type of behaviour. Thus the company would suffer from such type of family members as they lack the entrepreneurial activities for which they are put into action.(Karofsky,1997) This type of selection would lead to poor selection of labour market which in turn would weaken the merit based promotion activities. Such type of partiality is not only an administrative failure but corporate governance failure.(Lubatkin et. al, 2005)

Conclusion

From the above section we can conclude that the requirement of the family circle is different from the requirements of the other business associated circle. Thus this resulting problem is not only confined to two circle model but it is spilled over to other circles. The different types of role dilemmas such as founder's shadow, estate planning and partiality by choosing an incompetent CEO has led to different types of problem in succession. The role dilemmas are not the lone ones which the firm encounters during succession but they face other dilemmas too. The next part would investigate about the internal dilemma which the firm faces.