Sources of Incompetent Management in Family Businesses

Abstract
The purpose of the present research was to identify the source of
incompetent management in family firmly firms. Complexity theory
perspective was used to inform and provide a framework for analyzing
this family business issue. The main causes of complexity in management
of family firms are failure to establish the boundary between different
subsystems such as management, ownership, companies, and family as well
as the presence of family members in the management teams, which reduces
objectivity in goals setting. Lack of business institutionalization
reduces the capacity of family business to formulate written policies,
rules, and procedures. This reduces the sensitivity of family managers
to basic elements (including legal and regulative systems) of
institutionalization. Lack of policy guidelines on employment,
recruitment, and promotion of firm managers result in allocation of top
managerial positions to family members irrespective of their
qualifications and experience. The challenge of incompetence in family
firm management can be reduced by ensuring accountability of all
managers.
Key words: family firms, firm ownership, accountability, managerial
incompetence, institutionalization.
Sources of Incompetent Management in Family Businesses
Every business enterprise, whether owned by family or non-family
shareholders, face wide range of challenges prevailing in the market.
However, family owned business face special challenges, especially those
that are related with management. Intermingling between family and
business, management structure, and ownership complicates leadership
transition, thus reducing the capacity of a family owned enterprise to
acquire competent managers. However, the impact of family on
competitiveness of family owned enterprise depends on extent to which
family members are involvement in business affairs. Ayranci (2010)
suggested that the impact of family on business can be assessed by
focusing on family experience, power in the business, and culture scale.
This implies that the degree of involvement demonstrated by family
members in their business is directly reflected in competence of that
particular business in the market. Managerial competence is the key
issue associated with the three factors (power, experience, and culture)
that are used to define the level of family involvement. Competence of
the management teams in family firms can be enhanced by maintaining
accountability at management and board of directors’ levels.
Statement of purpose
The major challenge facing family management is related to existence of
a layer of relationship between different subsystems that the business
interacts with. From the stakeholders’ perspective, failure to
understand these interconnections may reduce the effectiveness of the
family firm management. These firms are usually management by family
members from the founder to subsequent generations. This reduces the
opportunity for these business to attract experienced, talented, and
executives with specialized skills. Consequently, family firms are
ranked as the poorest management organization (as shown in Figure 1) as
a result of lack of competence in the management teams. This creates the
desire to understand the complexity surrounding management of family
firms and sources of incompetence in their management teams, which will
be considered in the present study.
Figure 1: Effectiveness in management of different types of firms
Source: Bloom, Sadun & Reenen (2011).
Research questions
The research questions used to pursue the purpose of this study include
what are the major causes of complexities in management of family firms?
What impacts does lack of institutionalization of family firms has on
competence and effectiveness of these firms? What impact does irregular
employment of managers and selection of board members have on competence
of management teams of family firms? What recommendations should the
family firms consider to reduce managerial incompetence in future?
Outline
The structure of this paper consists of six parts. The first part
provides a brief discussion of the complexity theory, which highlights
the major subsystems (such as management, ownership, family, and
companies) considered in analyzing the issue of incompetence management
in family firms.
The second part addresses the major causes of complexities in management
of family firms, which include the lack of clear boundaries between
subsystems and presence or concentration of family members in management
teams.
The third part focus on effects of lack of institutionalization of
family firms on competence and effectiveness of the management teams.
The main issues addressed in this part include the insensitivity of
family managers to formulate formal rules and procedures of governing
the firm.
The fourth part addresses the issue of irregular employment, staff
development, and promotion in relation to competence of management teams
of family firms. Some of the concepts used to drive the point include
the Carnegie and primogeniture effects.
The fifth part provides the key suggestions that help in reducing
incompetence of family firm management teams, all of which focus on
maintaining accountability at management and board of directors levels.
Lastly, the paper concludes that lack of accountability is a major
challenge in family businesses, but it can be reduced by maintaining
accountability and institutionalization of these firms.
Theoretical concept: Complexity theory
There are many theories (including system theory, resource-based theory,
stewardship theory, and agency theory) used to analyze the complexities
surrounding the management of family businesses. However, the complexity
theory perspective is the most useful theory in enhancing the
understanding factors that create ineffectiveness and incompetence in
management of family business. The complexity theory examines complex
systems by analyzing the larger systems and smaller system existing
inside them (Pearson, 2013). The theory is based on the assumptions that
changes that occur within the system bring about changes in its
environment and complex system can organize itself after disturbance or
after chaos. In relation to the management of family businesses, the
complexity theory can be used to analyze the patience and time required
by humans to analyze systems prior to suggesting solutions, style of
leadership (such as participatory) adopted by enterprise managers,
controlling, and commanding approach. Failure of most family business
to enhance distributed intelligence by maintains a central leadership
and speeding up the process of creating new social capital and human
capital affects the competitiveness of family business management
(Dusek, 2012). The challenge of incompetence in management of family
business can, thus be understood by analyzing the interaction between
different subsystem that include family, management, companies, and
ownership (Klein, 2010).
Sources of complexity in family business management
The primary challenges that prevail in family business result from
issues related with management and ownership. The analysis of managerial
complexity surrounding family business is well explained by addressing
the number and heterogeneity of different elements of complexity. The
number of executives, on one hand, reduces management effectiveness and
the overall organizational competence. For instant, family business have
tendency of putting in place a large executive board that creates
managerial challenges such as slow decision making, ineffective
communication, and coordination. Heterogeneity, on the other hand,
refers to diversity of qualifications held by members of management
teams where family business may lack the appropriate combination of
occupational skills and experience to address emerging challenges. This
reduces competitiveness of the organizational management team and
capacity of their business to compete with other players in the market.
Klein (2010) identified that the main difference between family-owned
business and other corporations in terms of management result from the
existence or absence of differences in experience, levels of education,
and national mentality. Family businesses that employ their own members
to manage the business may lack these values.
The differences in interests existing among the stakeholders of family
businesses increase managerial complexity by interfering with the goal
setting process as well as subjective relevance (Klein, 2010). Family
businesses are often management by family members who may include
parents, their children, and other members if extended family. These
groups of people may have varying interests in the family enterprise and
their presence in the management teams further complicates the processes
of decision making and goal setting. Under the ownership subsystem, the
management of a business in which the stakeholders have the same portion
of shares is less complex compared to a business with majority and
minority shareholders. However, this form of complexity results from
inability of family members to create the boundary between the firm and
the family subsystems. A research conducted by Achleitner, Braun,
Schraml & Welter (2009) indicated that assumptions of both agency and
stewardship theories about family businesses are overly simplistic. This
is because human motivation and attitudes are antecedents of intentions,
which form the basis of human behavior. Under the complexity theory, the
presence of inherent factors of human motivation and attitude in family
business reduce the capacity of business managers to be cognizant of
changes taking place in their environment. This form of managerial
challenge affects all evolutionary stages of business development
including product lifecycle, dividend policy, strategy planning,
ownership structure, professionalism, governance, growth, and
capitalization (Dusek, 2012).
The impact of lack of family business institutionalization on management
efficiency
The top management teams in family organization mainly focus on higher
levels of commitment and perceived long-term orientation. However, these
factors may not be sufficient to bring about and maintain organizational
institutionalization because family firms are affected by other factors
(such characteristics of the owner family), which affect adaptability
and institutionalization (Ayranci, 2010). In contrast, an
institutionalized firm adopts an orderly, integrated, and stable
procedures and process while un-institutionalized firm retains unstable,
narrow, and loose technical business processes. This implies that the
process of institutionalization should address issues of formal norms,
formal structure, and development of objective procedures, legalization,
and administrative rituals. Research shows that family harmony promotes
transparency, objectivity, professionalism, formalization, and fairness,
which are important dimensions of firm institutionalization (Alpay,
Bodur, Yilmaz, Cetinkaya & Arikan, 2008). In addition, a democratic
decision making process promotes adaptability of the firm, thus
enhancing its capacity to cope with emerging challenges in the market.
These are the key indicators of an effective management team that can
promote growth and ensure a sustainable performance in short-run and in
the long-run.
Insensitivity to basic principles and elements of firm
institutionalization is common in family businesses. A research based on
descriptive statics revealed that the top management executives of
family businesses are do not show any positive sense towards any of the
key pillars of firm institutionalization (Ayranci, 2010). This research
showed that family business managers are not positive about the
establishment of business constitution, written procedures, integration
of non-family executives in the management structure, and a sustainable
board of directors. This is based on perception that focusing on the
basic elements of institutionalization reduces the significance of
fundamental factors (such as dimensions of succession, financial, and
management) of the relationship between the family and firm subsystems.
Lack of formal managerial structures in family businesses increase the
freedom of family members to intervene in different aspects of business,
which threatens business security and going concern. This occurs because
un-institutionalized firm does not have sufficient capacity to establish
sustainable relationship between different subsystems such as family,
management, companies, and ownership (Klein, 2010).
The presence of a chief executive is crucial in the process of
institutionalizing the firm. The absence of well established
institutions (such as legal and regulative systems), managers of family
business are tempted to engage in self interest, deception, and
opportunistic behaviors. However, these types of behavior are rare when
the family business is still under the management the founder chief
executive (Ayranci, 2010). This implies that the removal or withdrawal
of the founder chief executive subjects the business to unexpected risks
that are caused by lack of established institutional frameworks that
should have been formed at early stages of the business growth. This may
result from three different factors. First, a descendant executive who
also a member of the family may lack the necessary incentive,
motivation, sense of stewardship, and commitment to maintain the
competitive advantage of the family business in absence of controls that
would have been established by written rules and procedures. Secondly,
selection of the firm executives on the basis of family ties results in
managers with limited expertise, thus reduce the competence of the
entire management team. Third, lack institutionalization of family firms
creates the difficulty of passing on managerial skills, social capital,
knowledge and this reduces the sustainability of managerial competence
over time (Liu, Yang & Zhang, 2010). In overall, the selection of top
executive on the basis of family relations affects the competence of
family-owned business management, especially in absence of well
established institutional frameworks.
Impact of irregular employment on management incompetence in family
businesses
Majority of the family businesses are successful during the first years
their existence, but their growth rate reduces with time. This is
because founders of family business are hardworking and driven, but
often fail to establish formal management structures qualified body of
managers, and a decentralized decision making process to take care of
challenges that may occur when the business requires the contribution of
employees who are not members of the family (Stoilkvska, 2010). This
reduces competence of business managers for family business that retain
the management positions exclusively for their members. Although some of
the family members may be well educated, lack of expertise and
specialized skills may be a limiting factor. This means that a growing
organization should contrast the present and optimal responsibilities
and roles of all the senior managers to maintain the competence of their
management teams. This is a rare exercise in family-owned businesses.
Most of the challenges related with recruitment of unqualified and
inexperienced members of staff are inherently caused by lack firm
institutionalization. The majority of firm business fails to put in
place employment policies that can guide them in recruiting competent
employees. These businesses often adopt the open door employment
policies for family members. This creates a wrong perception that family
business is a safety net for members who fail outside the business
(Stoilkvska, 2010). In addition lack of established employment and
compensation policies results in payments that are not commensurate with
performance. Some family businesses adopt the equal pay for all family
employees and this reduces the motivational effect associated with
employee compensation. Consequently, the competent employees are
expected to take responsibility of their less than competent family
members in business. This have a negative effect on business culture
because family values (taking care of younger siblings) are incorporated
into business, thus eliminating the boundary between family and business
subsystems. The majority of the family firms family succession of the
top management positions, especially the chief executive officers
(Bloom, Sadun & Reenen, 2011). This reduces selection and the pool from
which managerial talents can be drawn. The extreme effect is
misappropriation of business resources for personal and family needs
since professionalism no-longer exists.
Carnegie effect is highly prevalent in family businesses given that the
majority of young family members expect to inherit family investment.
The Carnegie effect is mostly seen in economies that are dominated by
family businesses and affect labor supply for unearned income. Erlend,
Halvorsen & Thoresen (2013) defined Carnegie effect as the notion that
inherited property has negative effects and harms its recipients’
incentive to work. The generational transfer of property and wealth
accumulation are some of the key issues that affect the capacity of
family businesses to attract and retain qualified members of staff who
are not family members. This affects the overall elasticity of labor
supply in the individual firms and the entire economy. This is based on
the assumption that the younger family members who have the guarantee
that they will either get jobs or share of family investment may fail to
work hard to acquire technical and managerial skills. Consequently,
their engagement in managerial roles in the family business reduces the
effectiveness of the firm management team and the overall organizational
performance.
Similar to the Carnegie effect, primogeniture also affects the
managerial competence of family firms in the negative way. Primogeniture
is based on the assumption that the incentive of non-family members of
management teams to work hard in anticipation for promotion is reduced
by expectation that the top positions are reserved for family members
(Bloom, Sadun & Reenen, 2011). This has a depressing impact on talented
managers whose contribution towards the realization of organizational
goals may fail to be recognized for because of the presence of other
managers with family ties. The primogeniture effect is difficult to
avoid at times because it is either determined by law, custom, or right
for children to inherit family property and in their absence, the
property is passed on to collateral relatives. This further reduces the
hope for future promotion or recognition of non-family managers for
higher managerial roles. Consequently, family businesses continue losing
the benefits of presence of talented managers and ends-up with
incompetent family members holding the top positions.
The long-term benefits anticipated by the majority of family members
compared to short-term gains expected by non-family investors affects
the division of control and ownership, which ultimately destroys the
competence of the organizational management. According to Lane,
Astrachan, Keyt & McMillan (2008) most of the family owned corporations
based in central Europe, Latin America, and Asia fail to establish a
clear separation between ownership and control. Consequently, ownership
and control is concentrated in the families of the founding executives.
This is because the founding executives had the long-term perspectives
of benefiting their present and future generations. In addition, the
stock listed family businesses retain control by reserve special classes
of shares that should not be available to non-members with the objective
of maintaining the voting power. Moreover, the family members, who are
also the shareholders, play the major role in managerial positions.
These results in a class of shareholders who hold control rights that
are in excess of their rights to cash flow (Lane et al., 2009). The
family concentrated control acts as a non-entry barrier for talented
executives who may be non-family, thus reduces the opportunity for the
family firm to enhance the competence of its management.
Recommendations for future reforms in family business management teams
The present research shows that the strong influence of family members
on board of directors and management is the major cause of lack of
objectivity and managerial competence in family businesses. To this end
there are three recommendations that can help in reforming the issue and
ensure that family businesses maintain competitive managers to help the
firms in dealing with emerging market challenges. First, family
businesses should establish accountable of the firm management teams and
the boards of directors for incorporated firms. Although the strong
sense of unity and identity held by family businesses enable them to
pursue long-term objectives in business, there are negative factors
(such as nepotism, curtailing growth, and resistance to change) that may
reduce their competence in the long-run (Lane et al., 2009).
Accountability in the board of directors can be put in place by
formulating polices that reduce interference of the family members in
business operations, ensuring that board members have sufficient
diversity of skills, and business competencies.
Secondly, listed family businesses should facilitate complete
institutionalization that will allow both the minority and the majority
stakeholders to have their rights in the firm. The institutionalization
measures should focus on enhancing the capacity the minority to take
part in the decision making processes and goal setting for the firm.
This will allow the family business to integrate the ideas of business
experts and talented individuals in business operations, thus enhancing
the competence of the management teams. This can be accomplished through
formal agreement on issues pertaining to succession, selection of the
board members, and dispute resolutions mechanisms.
Third, family owned boards should ensure accountability of the
management teams by holding all managers accountable for their actions.
This can be achieved by maintaining a clear separation between the
sub-systems (family, ownership, companies in the market, and management)
related with family business. This implies that the family owned boards
should engage in the decision making process and avoid rubber stamping
decisions made by managers on the basis that they are the firm owners.
Conclusion
Lack of competence in management of family firms can be reduced by
enhanced accountability at management and board of directors’ levels.
The complexity theory provides the most suitable framework for analysis
of the managerial challenge that reduces the level of competence in
management of family firms. The main source of complexity in management
of family firms is the inability of stakeholders to establish boundaries
between different subsystems such as family, management, companies, and
ownership. In addition, the of family values in business results in the
integration of individual interests in decision making processes, thus
reducing the objectivity of goal setting in family firms. These
challenges are caused by lack of institutionalization of family firms,
which hinders the process of establishing written rules and process that
will guide the management in making important decisions pertaining to
firm growth, recruitment, promotion, and staff development.
Consequently, the firm ends-up with irregular recruitment that brings
incompetent managers on board.
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