Why and when Family Firms Are Doing the Right Thing when Hiring a Family Manager with Low Skills in Economic Tasks

Jenny Kragl (EBS University of Business and Law)
Alberto Palermo (Institute for Labour Law and Industrial Relations)
Guoqian Xi (Shanghai University of Finance and Economics)
Joern H. Block (University of Trier)

Abstract: Prior economic research is very critical about family CEOs and family management. Nepotism, altruism, lower managerial abilities, and a small pool of qualified family candidates are cited as reasons that speak against family management. Still, the empirical reality is different. A surprisingly large share of firms is run by family managers. Our study provides a rational economic explanation for this paradox, linked to the multitasking problem in managing family firms. We compare the performance of family and non-family managers in a moral-hazard model with imperfect performance measures, where managerial tasks are related to the economic and non-economic goals of the business-owning family. While incentive pay is more effective for nonfamily managers, the associated effort distortion towards economic outcomes is less pronounced for family managers. When economic and non-economic tasks are strong substitutes, the family hires a non-family manager at the expense of its non-economic goals. However, the more complementary the tasks, the more aligned the performance measure with the family's goals, and the less severe the moral-hazard conflict, the more likely a family manager is optimal. We find that family managers can be preferred even if they have lower ability than non-family managers on average. Our study contributes to the literature about family management and agency costs in family firms and has practical implications for family businesses deciding between hiring managers in or outside the family.

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