Sunday, June 27, 2010

Family creates value

The idea of writing this blog came to my mind when I was in Ahmadabad for my summer internship.Apart from the Gujarati splendor what I witnessed was a quite different type of business lingo. The bosses and the sirs were replaced by bhaiyaa, bhai or even pappa. Even though the firm that I worked for happened to be a B-School but things were no different over there either. In fact this lingo was more common when the discussion was among the higher-ups in the firm.So what was so different about the businesses in Ahmadabad or rather the Gujarati style of functioning? It was the style or type of ownership. They were the Family owned businesses (FoB).

But why should that be the point of discussion. After all, family owned businesses are not new in India. They are not the exception rather they are the rule.According to a 2006 study, nearly sixty percent of India's 500 largest companies were affiliated with family business groups. In 2006, of the companies on the BSE Sensitive Index (Sensex), representing the top thirty companies and accounting for nearly a fifth of the BSE's total market capitalization, nearly a third were family owned and controlled.When the complete set of listed and non-listed Indian companies is considered, the percentage of family ownership jumps to seventy percent.Corporate groups like the Tatas,the Birlas, and the Ambanis are some of the notable examples.

In this blog,I would like to discuss what makes the family ownership so successful?
  • First of all they posses flexibility in decision making that can result in higher returns.
  • A FoB has ownership concentration which results in unification of management and ownership. This reduces agency costs (costs that arise because of core problems such as conflicts of interest between shareholders and management) significantly.
  • A FoB is more likely to manage its business and profits for the long term so that it can be passed on from generation to generation.
  • The owners of a FoB are more likely to create "employment stability and loyalty" as they have a lifelong association with the firm.
  • With lower transaction cost and information asymmetry, a FoB is more likely to succeed in environments characterised by weak legal protection as they can provide bonds of trust that can substitute the protection provided by the legal system e.g. Italy has a GDP per capita rivaling that of Great Britain,despite having insufficient legal system.
  • A FoB can be a good breeding ground for the future generation of the family because of the support, platform as well as tutelage that they receive and also from the traditional knowledge being passed on from one generation to another.
  • Presence of family members at key positions in the firm (a characteristic of typical Gujarati firm where the finance is handled entirely by family members) can help avoid large scale corruption.
  • FoBs are more likely to take calculated risks rather than gamble recklessly on shareholders' investments.
  • In a poorly developed external financing environment, family affiliation can be a great source of strength.
South Korea's economy centered upon family-owned enterprises known as chaebols has been quite successful especially from the 1960s to 90s. But their example brings forward an important point that culture can have a major bearing on the outcome. Family ownership is consistent with the strong family-and paternal hierarchy-oriented Confucian heritage of South Korea. Even in India, the Marwaris have been much more successful than their peers as FoB is consistent with their approach. So even in an era of Corporate Governance,we can say that FoB can create value for its shareholders, if equipped with adequate expertise, skills and legal support. After all its all about "Owning Up".
Hopefully I may have added some value to the family of bloggers. Waiting for your comments.


  1. If this was the case, it wouldn't have been true only for India.

    Probably Indian Capital Markets are not that well developed that people can invest in a better way.

  2. @Prat, I agree that the existing setup helps the FoB to become more successful.But whether its India or US, agency costs are a reality as they emanate from greed which is too humane to be completely removed out of the system but the better regulations (US) have the final say.Anyways my idea behind writing this blog/article was to highlight the advantages of FoB per se rather than vis-a-vis professionally run firms.
    Thanks for your insights.