The Costs of Family Succession in Firms

25 October 2006 at 10:22 am Peter G. Klein Leave a comment

| Peter Klein |

Interesting new paper shows that keeping senior management positions within the family reduces firm performance:

Inside the Family Firm: The Role of Families in Succession Decisions and Performance, by Morten Bennedsen, Kasper M. Nielsen, Francisco Pérez-González, Daniel Wolfenzon

This paper uses a unique dataset from Denmark to investigate the impact of family characteristics in corporate decision making and the consequences of these decisions on firm performance. We focus on the decision to appoint either a family or external chief executive officer (CEO). The paper uses variation in CEO succession decisions that result from the gender of a departing CEO’s firstborn child. This is a plausible instrumental variable (IV), as male first-child firms are more likely to pass on control to a family CEO than are female first-child firms, but the gender of the first child is unlikely to affect firms’ outcomes. We find that family successions have a large negative causal impact on firm performance: operating profitability on assets falls by at least four percentage points around CEO transitions. . . . Overall, our empirical results demonstrate that professional, non-family CEOs provide extremely valuable services to the organizations they head.

The instrumental-variables technique reminds me of another paper on the value of top management that exploits a different source of exogenous variation in succession patterns: death. Rachel Hayes and Scott Schaefer’s “How Much Are Differences in Managerial Ability Worth?” (Journal of Accounting and Economics 27, 1997, 125-148) compares the returns to firms losing their CEOs to a rival firm — suggesting that the CEO was of above-average ability — to the returns to firms whose CEO dies unexpectedly. Firms in the former category experience negative abnormal returns upon the departure announcement, while firms in the latter category experience positive abnormal returns upon announcement of the CEO’s (eternal) departure. Hayes and Schaefer use the results to estimate an economic value of having a better-than-average CEO.

Thanks to Steve Dubner for the pointer to the first paper.