The Age of the Scion: A new generation of leaders takes its place at family-run corporations worldwide. Will the kids be alright?
FORTUNE
Monday, April 2, 2001
By Nicholas Stein
Like many proud entrepreneurs, Qualcomm's founder and CEO, Irwin Jacobs, loves to talk about his company, which he built from a single office above a San Diego pizzeria into a multibillion-dollar telecommunications empire. And like many proud fathers, Jacobs loves to talk about his children even more. His elder son, Paul, is leading Qualcomm's foray into wireless Internet technology. His younger son, Jeff, was recently charged with heading the company's venture capital arm. But ask whether he hopes one of them will succeed him as CEO, and the 67-year-old Jacobs clams up. Though the Jacobs family controls two seats on Qualcomm's board and holds the largest minority stake (4%) of its stock, Jacobs refuses to call Qualcomm a family-controlled company. "I hope that it continues to provide a very exciting opportunity for lots of talented people," he says diplomatically, "both within the Jacobs family and outside of it."
Jacobs' reticence is understandable. He is simply reacting to a widely held belief in corporate America that families and business don't belong together. Though the country once crowned the Kennedys, and elected one political scion over another in last year's presidential race, it has long viewed family-controlled corporations as somehow un-American. Critics of such family ties claim that the U.S. became an economic superpower by discarding the shackles of feudalism and embracing a corporate culture that selects leaders for their talent--not their lineage. They charge that families are too willing to sacrifice economic growth to protect their interests, providing unqualified relatives with executive positions and destroying shareholder value in the process. "Wall Street is skeptical of family-run businesses in general," says a prominent stock analyst. "Sometimes the strategy that might maximize shareholder value may not be in line with the objectives of the family."
If the critics are right, the global economy will soon be in a world of trouble. That's because this, indisputably, is the Age of the Scion. Thousands of post-World War II entrepreneurs who created much of the world's current wealth are reaching an age at which they are beginning to contemplate passing their businesses on to the next generation. A 1997 study conducted by Arthur Andersen and Mass Mutual found that, in the U.S. alone, 43% of the family-controlled businesses surveyed expected to change leadership by the end of 2002. Some economists predict the largest intergenerational transfer of wealth in history.
But are family values and shareholder value really so incompatible? Contrary to the prevailing view on Wall Street, a growing cadre of researchers and academics has found that family-controlled companies actually outperform their nonfamily counterparts. In addition, they play a far more significant role in the global economy than you might suspect. According to the Family Firm Institute, family-controlled companies account for 78% of the U.S.'s job creation, 60% of its employment, and 50% of its gross domestic product. Outside the U.S., the percentages are even higher. And family businesses are not just closely held private firms and mom-and-pop variety stores: They encompass about a third of the FORTUNE 500.
As they take their place in the new global economic order, scions will need to resolve this fundamental challenge: How can they address Wall Street's suspicions while simultaneously accepting their birthright? "There is an unhealthy bias in the institutional world about family-managed companies, an inherent belief that they are unfair and underperforming because they are family. That just doesn't hold up if you look at the performance of these companies," says John Davis, a senior lecturer at Harvard Business School. "There is a great deal of pressure today on publicly traded family companies to demonstrate the need--and the value--for having a family successor."
Every Sunday from October to January, millions of Americans turn on a football game and crack open a beer. If the beer is a Budweiser--and as the country's top-selling brew, it probably is--it was produced by Anheuser-Busch, whose 36-year-old vice president, August Busch IV, may soon take over from his father as the fifth-generation Busch to lead the company. If the football game is on Fox, it is owned by News Corp., the media conglomerate controlled by 70-year-old Australian mogul Rupert Murdoch, who is grooming his sons, Lachlan, 29, and James, 28, to take over the business. (Daughter Elizabeth, 32, appears for now to have bowed out of the succession sweepstakes.)
Across the globe, many large, influential corporations are preparing the next generation of leaders to take over the family business. Last year Jeffrey Koo Jr. became president of Taiwan's Chinatrust Commercial Bank, leading to speculation that he may soon succeed his 67-year-old father as chairman of the country's largest private-sector bank, the flagship property of the Koos' sprawling financial empire. "I never expected to go into the family business," says Koo Jr., a jovial 37-year-old who planned instead to pursue a career as a professional golfer. But his father persuaded him to get his MBA so that he would know how to take care of his winnings. "He's very good at persuading me to do things," laughs Koo Jr., who ended up "falling in love" with business. After a stint at Morgan Stanley and a year at a Japanese bank, Koo returned to Taiwan and joined the family firm.
In Japan, Akio Toyoda is considered a likely successor to his father, Shoichiro, as president of the world's most valuable car company (Toyota). If he succeeds, he will join fellow auto scion William Ford Jr., who in 1999 became the first family member in 20 years to assume the chairmanship of the company that bears his great-grandfather's name. Richard Li, the 34-year-old son of Hong Kong tycoon Li Ka Shing, recently grabbed headlines with the spectacular rise--and precipitous fall--of Pacific Century CyberWorks, his broadband Internet business. In Canada, billionaire Kenneth Thomson just nominated his son David to succeed him as chairman of Thomson Corp., a global provider of legal and financial information. And fellow Canadian Pierre Karl Peladeau now holds the reins of Quebecor, the world's largest printer, following the death in 1997 of his father, Pierre.
Yet as they prepare for the transfer of power from one generation to the next, family-controlled firms are at their most vulnerable. It is the failure to manage the succession process that most often causes families to lose control of their companies. Eighty percent of all family businesses don't make it to the second generation, and only 13% make it to the third, says John Ward, a professor at Northwestern's Kellogg School. Some go bankrupt under the new leadership. Some are forced to sell to a competitor. Others simply shut their doors forever.
The failure to move from the first generation to the second has a lot to do with the characteristics of the classic entrepreneur, says Joachim Schwass, a professor of family business at Switzerland's IMD business school. "They are not willing to let go of control and not sufficiently aware of what they need to do to prepare the next generation." As a result, says Schwass, the second generation "often ends up frustrated, disgusted, and very ill prepared."
There can be a lot of tension between the first and second generations, frequently over whether the children even want to go into the firm, adds Ron Chernow, who has written books about the Rockefeller, Morgan, and Warburg dynasties. "Going into the firm not only means having to sustain a level of performance that will be difficult, but doing it at exactly the moment in your life that you'd like to opt for independence."
Rather than face the prospect of watching his life's work destroyed by a succession battle among his three children, IKEA founder Ingvar Kamprad split the company in three, restricting his children's ability to fundamentally change his vision. Italy's Zegna family had a less drastic idea. They called in each of their children, asked them to outline a new vision for the upscale men's clothing company, and then implemented it as a joint venture between the older and younger generations. "The older generation often believes that because the success of their business is a direct result of what they have done, they don't need to change any aspect of it," says IMD's Schwass. "But the companies that are successful change their strategy after each generation. Bringing in the new generation and saying, 'Son, do as I did,' will not work."
In 1998, soon after Jeffrey Koo Jr. returned to Taiwan, he started broadband Internet service provider GigaMedia with the help of an investment from Microsoft. "The Internet was a shock to my father," says Koo Jr. "He had always been my teacher, but after Microsoft invested he came to me and said, 'Teach me about this Internet.' GigaMedia changed our relationship."
Since taking over as president of Chinatrust, Koo Jr. has transformed the company from an old-economy stalwart into one of Asia's most Internet-savvy banks. He has also advocated more transparency, bringing in Moody's and S&P ratings and holding regular meetings with analysts. "At first it was a shock," he says. "Asian banks are supposed to be conservative and secretive. But I told them if they want to become international, they have to be well known by investors."
The only difference between a nuclear reactor and a nuclear explosion is the way you contain the explosion," says Joseph Astrachan, a professor at Kennesaw State in Georgia. "If a family business is managed well, it has tremendous power. But if managed poorly, it can turn explosive." Family-run corporations bring to the business all the dynamics inherent within the family, adds Ross Nager, executive director of the Arthur Andersen Center for Family Business. "There's a love and a trust and a respect that can be very powerful when they are brought into a business environment," he says. "The flip side, though, is that what's brought into the business are the tensions, jealousies, and personal problems."
Family businesses that successfully navigate the choppy waters of succession and interpersonal conflict find themselves in an advantageous position relative to their nonfamily counterparts, says Daniel McConaughy, director of the Family Business Center at California State University at Northridge. In a study published last year, McConaughy compared the financial performance of 219 founding-family-controlled corporations over a two-year period with matched pairs of nonfamily companies. "The results," writes McConaughy, "suggest that firms controlled by the founding family have greater value, are operated more efficiently, and carry less debt than other firms."
Indeed, after studying the findings of similar research conducted in 1988 by the Wharton School on behalf of Pittsburgh's Pitcairn Group trust company, Pitcairn Chairman Dirk Junge launched the Family Heritage Investment Strategy, a mutual fund that invests solely in family-controlled public corporations (see box). "The family-controlled companies had higher returns on assets, higher returns on equity, and higher growth rates of earnings," says Junge. "They were also substantially less leveraged, meaning they had a much better fundamental understanding of their businesses than their nonfamily-controlled competitors."
How were family firms able to outperform their nonfamily rivals? By taking advantage of the streamlined management and ownership inherent in their corporate structures. Professional managers rarely have as big a stake in the companies they direct. That's why they often fall prey to the pressures of Wall Street analysts. "You see lots of companies managing their stock price when they should be managing the company," says Chernow. The CEOs of family firms, by contrast, tend to have a longer-term outlook, pursuing strategies that may hurt their short-term earnings but ultimately lead to superior growth.
In Europe the traditional view of ownership and entrepreneurship is even more long term than in the U.S. "Most entrepreneurs have a vision of building a business that lasts for several generations," says Schwass. There is even a society, Les Henokiens (after the ancient biblical figure Enoch), for companies that have remained under the control of the founding family for at least 200 years. Members meet often to discuss strategies and even swap scions with each other so that they can get work experience outside their own business. "What drives European family business is a deeply ingrained desire for control," says Schwass. "If there is a tradeoff between growth and control, many family businesses will forgo growth opportunities rather than ceding control to outside shareholders."
Of course, that is the very charge institutional investors and disgruntled shareholders levy against family companies: that they are insulated by their relatively secure position and slow to pursue growth opportunities or replace ineffectual managers. "When you buy shares in a family-controlled company, you have to be very naive to believe that the owners are looking out for the shareholders' interests," says shareholder activist William Steiner. Steiner points to a long list of family-controlled companies--including Chiquita and Hasbro--whose stocks "have gone nowhere" in years. "Don't talk to me about the long term," he complains. "In the long term I'll be dead."
Institutional investors have not always been so mistrustful of family-controlled corporations. The large democratic corporation now valued by Wall Street--run by professional managers and owned by a diffuse group of individual shareholders--was once viewed as less than ideal. Instead of acting in the best interests of the company's owners, Adolph Berle and Gardiner Means wrote in their 1932 book, The Modern Corporation and Private Property, professional managers act in their own self-interest. And because the SEC forbade shareholders from communicating with one another, it was extremely difficult for them to remove ineffective management.
When the SEC overhauled its proxy rules in 1992, allowing free communication among shareholders, it forced management to become more accountable. Large institutional investors, which collectively hold more than 50% of all securities, were the main beneficiaries of the new rules. Now they could band together at their whim to remove managers who didn't share their vision for how the company should be run. But one group of companies remained out of reach: those in which the family controlled enough of the voting shares to keep institutional investors on the periphery.
In Built to Last, their seminal examination of the qualities that make companies great, authors James Collins and Jerry Porras singled out 18 "visionary corporations." Tellingly, nine of these corporate exemplars began as family businesses, and eight--Ford, Johnson & Johnson, Marriott, Motorola, Nordstrom, Philip Morris, Wal-Mart, and Walt Disney--are still controlled by their founding families. Critics point to Rite Aid (whose founding family resigned after acknowledging SEC filing improprieties) or W.R. Grace (which paid millions in settlements after the Environmental Protection Agency found it responsible for dumping toxic chemicals) for examples of families that abused their control at the expense of their shareholders. But those cases are clearly exceptions. "A family's connection to a business," says Harvard's Davis, "is more likely to lead to very human workplace practices and greater concern for quality than will other ownership forms."
As we enter the Age of the Scion, global economic conditions are making it tough for publicly held family firms to maintain their independence. In an era of consolidation, firms feel they have to keep growing, which puts pressure on them to exchange their control for capital. And Wall Street's distaste for many of these companies keeps their stock prices depressed, making acquisitions difficult--and increasing the risk of their getting gobbled up by rivals. Some, like Ford, have set up two classes of shares to try to protect the family's voting interests--a tactic despised by institutional investors because it limits even further their power to affect change.
But the greatest challenge family-controlled corporations face is from the scions themselves. Unlike preceding generations, many current scions have been to the best business schools and have worked at the best firms, making them far more sympathetic to Wall Street's negative view of the family firm. The new generation stands awkwardly with one foot in their families' storied past and the other in Wall Street's institutionalized future. Chinatrust's Jeffrey Koo Jr. says he hopes to find "a great professional leader who cares about the business and has passion for it." India's Kumar Mangalam Birla, 34, the fifth-generation CEO of his family's industrial conglomerate, insists, as Qualcomm's Irwin Jacobs does, that his company is not a family business at all. If the next generation of scions can perform as well as their forebears, then family values may one day be as popular on Wall Street as they are in, say, Congress.
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This is Part I of FORTUNE's next-generation leaders survey. Look for the second installment, with our exclusive list of 25 global leaders under 40, in our May 14 issue.
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