Column 10 - Are Japanese Family Firms Successful?

In this column, I will examine the question of whether Japanese family firms are successful based on "Adoptive Expectations: Rising Son Tournaments in Japanese Family Firms," a research paper presented before a RIETI study group on corporate governance in March 2008.

In many countries, family firms are a dominant form of organization. To begin with, let us clarify the definition of a family firm. Preceding studies have shown that a firm's founding family, even without holding large shares, can maintain its influence within the organization by having a family member appointed as a board member. Following the literature, a firm is defined as a "family firm" if the founding family is listed among the top ten shareholders and/or serves as a CEO/Chairman. Prominent examples of family firms include Hilton and Wal-Mart in the United States, and Toyota, Suzuki, Kikkoman, and Takeda Pharmaceuticals in Japan. Family firms have the following advantages. First, there is no separation between ownership and control because the controlling owners are often managers. Second, the controlling family tends to make investment decisions based on a long-term perspective. Disadvantages include the inability to select the best qualified successor to run the family business. This is due to the fact that the controlling family has a smaller pool of heir choices that are limited to from their family members. Also, intergenerational transmission of managerial talent is often not perfect. Family firms that fall into this trap are bound to be short lived.

Family firms face a dilemma: adhering to family control poses the risk of less competent management, while hiring professional managers is associated with the agency problems.

Earlier studies on family firms have shown a general tendency for founder-managed family firms to demonstrate higher performance than nonfamily firms, while heir-managed family firms underperform nonfamily firms. However, Japanese family firms are unique in that they customarily bring in male heirs from outside the founding family (hereinafter referred to as "non-blood heirs") either by adoption or marriage. Examples of such families include the Iwasaki family (Mitsubishi group) and the Toyoda family (Toyota group).

Adoption and marriage are beneficial to the family business for the following reasons. First, the founding family has a good chance to cherry-pick a talented person from a larger pool of human resources (or the labor market). In which case, the founding family is not constrained by the genes. Second, the adoption and marriage can be considered as a high power incentive contract that would bind the interests of the heir to those of the founding family. Adoption and marriage are long term contracts which lock in the relationship of the "new son" to the adopting family for his life time. In addition, this contract implies that if the "new son" performs, he and his future heirs would inherit the founding family's wealth. Therefore, he is likely to have strong incentives to maximize the firm's value. This contract might be more powerful in terms of incentive binding than the stock option contract used in U.S. firms because the "new son" can enjoy various private benefits of control that are not available to professional managers. Examples of such private benefits are the ability to use the founding family name to obtain privileges from inside and outside the firm and the capability to hire his children in the firm.

Would such a customary practice provide a solution to the above-mentioned dilemma faced by family firms? In "Adoptive Expectations: Rising Son Tournaments in Japanese Family Firms," this study examines this question using listed companies from postwar Japan. Specifically, the analysis covers the non-financial firms that went public on the Tokyo, Nagoya, Fukuoka, and Osaka stock exchange between 1949 and 1970. This paper examines performance of these firms from 1962 until 2000 or the time of delisting, whichever occurred first. The sample includes 50,674 sets of data from 1,355 firms out of the 1,435 total new listings that occurred between 1949 and 1970.

We find that heir-managed family firms have been outperforming nonfamily firms, which is contradictory to the general tendency found in the analysis of family firms in other developed countries. A comparison within Japan's heir-managed family firms also shows that non-blood, heir-managed family firms have been outperforming descendant-managed family firms. Incidentally, nonfamily firms belonging to a keiretsu corporate group are ranked lowest, both in terms of performance and firm value, among various other types of firms that include founder-managed family firms; descendant-managed family firms; non-blood, heir-managed family firms; professional-managed family firms; and, non-keiretsu-affiliated, nonfamily firms.

Next, we compare the profile of chief executive officers (CEOs) by the type of firm they manage.

With regard to family firms, it is presumed that non-blood heirs are more competent than descendant heirs. Using educational background as an indicator of competence, we examined CEOs in terms of whether or not they attended an elite university, and the highest education level attained. Our results indicated that non-blood heir CEOs have higher educational backgrounds relative to descendant CEOs, and in many cases descendant CEOs have higher educational backgrounds than founder CEOs. In terms of the length of tenure as CEO, non-blood heirs stay on as CEO for roughly 20 years on average, almost the same as the tenure of descendant heirs but substantially longer than the six-year average for professional managers.

In summary, this study shows that in contrast other countries, family firms in Japan display superior performance than nonfamily firms. This is probably due to the unique succession practice of bringing in competent heirs from outside the founding family whenever the family did not have one. Adoptions and marriages not only overcome the problem of intergenerational transmission of managerial skills but also mitigate the problems of alignment of incentives between managers and shareholders.