Family Firm Productivity and How To Improve It

By James J. Chrisman

A family firm is defined by a family’s involvement in the ownership and management of it and a vision of how the firm will benefit the family, potentially across generations. Although they have not always received the attention they are due, family firms are among the most important and interesting organizational forms in the world. The vast majority of companies in the United States are family owned, and in Mississippi, they account for as many as 98 percent of business organizations. Furthermore, a substantial proportion of businesses listed on the S&P 500 and S&P 1500 can be considered family firms. In other Western countries, the representation of family businesses among both small and large entities is even higher than in the United States. In the rest of the world, they are the dominant organizational form, period.

Recognizing the relevance and impact of family firms, the management faculty at Mississippi State University created the Center of Family Enterprise Research in 2006. It is the only research center in the College of Business approved by the Board of Trustees of Mississippi State Institutions of Higher Learning.

The mission of MSU’s Center of Family Enterprise Research is to conduct and promote original research on family business; to provide educational and research opportunities for graduate students, primarily at the doctoral level, and to disseminate the results of research to family businesses in Mississippi in order to improve their management and performance. Mississippi State University is ranked among the top universities in the world in family business research and has one of the strongest doctoral programs in this field.

Over the course of its existence, the Center’s faculty members have noticed that family firms face a number of unique paradoxes owing to the involvement of family members in the firm’s ownership and management. For example, these companies appear to benefit from a desire to keep ownership and management control in the hands of family members, potentially across generations, but are reluctant to plan for succession. Another paradox is that while the involvement of family members can generate competitive advantages in terms of their skills and commitment to the firm, it also makes it more difficult to expand the company’s skill base through the employment of individuals from outside the family. In a recent study, we investigated this issue.1

Broadly speaking, we researched the relative labor productivity of family and nonfamily firms. In addition, we studied how and if family firms could improve their productivity relative to that of nonfamily firms.2 To answer these questions, we based the study on three key ideas. First is that when the interests of owners and employees are aligned, both are more likely to achieve their objectives because they will be more inclined to cooperate.

The second idea is that the productivity of the labor force is dependent upon the ability of the individuals in the labor force, as well as their effort. Higher-ability workers will tend to be more productive than lowerability workers, if they put out the same level of effort. This is generally known, but what is not as well recognized is that higher-ability workers will usually put out more effort than lower-ability workers. The reason is that the pay-offs from greater effort are larger for the former versus the latter. If their remuneration or other benefits are tied to their productivity, they will profit more from their effort as well.

Third, firms that are able to provide inducements that are particularly attractive to individuals with higher ability will benefit more than firms that provide inducements that are equally attractive to higher- and lowerability workers because they will end up with more higher-ability employees.

In this study, we proposed that firms that offer incentive compensation will usually experience higher labor productivity than firms that do not. This relationship is well-established and understood. We also proposed that owing to their unique goals and attributes, family firms will generally have lower productivity than nonfamily firms. Family owners, wanting to keep ownership and management control in the family, often deny opportunities to buy into the firm and/or achieve positions of leadership to nonfamily employees. Furthermore, family firms usually pay less than nonfamily firms. It is the individuals with higher ability who are most concerned with those issues because they are more likely to believe such opportunities are within their reach.

On the other hand, family firms are known to offer greater security and a paternalistic atmosphere to their employees. Such inducements are attractive but will not help in putting together a high quality organization because they do not induce higher-ability individuals to seek employment in family firms. In fact, the combination of lower opportunities and secure work environment virtually assures that on average, the employees, particularly those at the managerial level, will be of inferior quality to those found in nonfamily firms.

Finally, we proposed that gains in labor productivity for family firms that provide incentive compensation (compared to those that do not) will be greater than the gains for non-family firms that provide incentive compensation. We argue that this is because incentive compensation not only rewards higher productivity but also signals to potential recruits that productivity will be rewarded. The upshot is that the firm will attract, hire and retain more higher-ability employees. Because family firms tend to favor family employees, this signal is more important for them than it is for non-family firms that do not have a similar bias toward a particular type of employee.

We used a sample of approximately 108,000 small and medium size family firms and 108,000 matched non-family firms drawn from the U.S. Census Survey of Small Business Owners. We found that the productivity of the companies that used incentive compensation was 9.3 percent higher than that of companies that did not. Among family firms the difference was 11.3 percent. We also found that the productivity of firms without incentive compensation plans was 4.2 percent for non-family entities than for family firms. However, among companies that used incentive compensation, the productivity gap between non-family and family firms was only 0.5 percent. Furthermore, we found that labor productivity was significantly and positively related to the use of incentive compensation by family firms.

Interestingly, we found that providing higher pay and/or benefits that serve as pay-equivalents (retirement programs, health insurance and paid holidays) also had positive effects on the relative productivity gains of family firms. The reason is that individuals usually associate higher paying jobs with greater demands for ability and effort, thus discouraging to some extent workers who are less competent and/or industrious. However, the effects were not as strong as they were for incentive compensation, which fits with our contention that the more discriminating the inducements are – i.e., more accessible to higher-ability workers and less accessible to lower-ability workers – the greater their value to firms, and family firms in particular.

For family business owners and managers, the implication is that the more powerful the signal that ability and effort will be commensurately rewarded, the more attractive a company will be to quality candidates. This will lead to higher labor productivity, which should translate to higher profits for the family and higher compensation for the employees – a win-win situation. To get the kinds of employees desired, it is important to signal what the culture and values of the organization are, what is expected of potential employees and what is in it for them. Family owners and managers need to follow through on their explicit and implicit promises as well as monitor the behavior of employees to ensure that they follow through on theirs. Interestingly, the presence of an equitable and efficient system of monitoring and rewarding employee behavior may be another potentially effective signaling device to attract high-ability workers. But that is another story.

1 See Chrisman, J.J., Devaraj, S. and Patel, P.C. (2017). The impact of incentive compensation on labor productivity in family and non-family firms. Family Business Review, 30, 119-136.

2 We focus on labor productivity (sales per employee) rather than profits or cash flow because it is less subject to manipulation or expropriation by owners and managers of a firm, family or otherwise.

Dr. James J. Chrisman is a Professor of Management and the Director of the Center of Family Enterprise Research in Mississippi State’s College of Business. He also holds a joint appointment as a Senior Research Fellow at the University of Alberta’s Centre of Entrepreneurship and Family Enterprise and is a Fellow of the U.S. Association for Small Business and Entrepreneurship. He received his PhD in strategic management from the University of Georgia, an MBA from Bradley University and a BBA in finance from Western Illinois University.