Non-family CEOs:
theory and practice

Professor John Van Reenen, Director, Centre of Economic Performance, London School of Economics, UK

At the FBN 23rd International Summit in London in 2012, one of the hot topics was non-family CEOs. Professor John Van Reenen presented data that shows that, on average, family-owned firms with an outside CEO have a higher management score than firms with a family CEO. But for firms that might be considering an outside CEO, five practical watch-outs were highlighted by family leaders and other participants at the Summit.

In his Summit speech, Professor Van Reenen described his research into management quality in firms with various types of ownership. Broadly, the best-run firms are those that have either private equity or dispersed ownership. Government-run firms are among the worst. The data suggests that family-owned firms with an outside CEO have a pretty good management score. But family-owned firms that are run by a family member (particularly the eldest son) have a lower score – on average.

Professor Van Reenen suggests three issues with automatic family succession as CEO, such as father to eldest son. Firstly, narrowing the CEO selection to a family member reduces the pool of talent. Secondly, if the eldest son knows that he is going to become the CEO whether he merits the role or not, there is no incentive for him to work hard or prepare himself thoroughly. Thirdly, talented non-family managers will want to leave the firm because they stand more chance of getting the top job in another firm that has a more open promotion process.

According to Professor Van Reenen, his research findings demonstrate that passing on the running of the business to the eldest son may not be the soundest business move. His recommendation is that family owners should at least consider the alternative of bringing in some professional outside management. He notes that in Germany, although the ‘Mittelstand’ of medium-sized firms is dominated by family ownership, they tend to hire in professional managers to run their firms.

But when it comes to practice, here are some practical watch-outs that need to be considered:

#1: Principal-Agent conflict
One of the potential issues of separating management from ownership is that the senior management may increasingly divert money into high salaries for themselves rather than paying out profits to shareholders. Professor Van Reenen recognises the danger that senior management may try to “line their pockets at the expense of shareholders”.

The existence of potential conflict between those who manage (the ‘agents’) and those who own (the ‘principals’) is not, in itself, a reason to avoid non-family CEOs. But it is a reason to be watchful.

Non-family CEOs may bring all sorts of positive qualities and competencies to their roles. But if they are mainly concerned about their own rewards, and if they are not effectively monitored by family owners, then they are far from a miracle cure for all problems.

#2: Personal qualities
During break-out sessions at the Summit, a family leader described the ideal non-family CEO as needing a ‘mix of ego and humbleness’. The person must have enough ego to be a leader. Yet the person must also have enough humbleness to accept that family owners have the last word. It’s not easy to find such a person, particularly when ‘humbleness’ can only really be tested when the person is in a position of power. Even experienced families can find that they have made a wrong choice. They then have to accept that they made a mistake (difficult in a psychological sense) and fire the person of whom they had high hopes (awkward and possibly agonising).

#3: Commitment to family ownership
Another family leader explained how a non-family CEO had been appointed because of his excellent experience and credentials. However, over some years, it became clear that the CEO’s ambition was to list the company on the stock market. This would allow faster growth and greater prestige for the CEO – but it would also bring the family’s control to an end.

The CEO was a domineering character and he had a powerful negotiating position: ‘if you don’t back me in my ambition for this company, then I’ll resign, and you know that I’m the one who is really driving growth and increasing value’.

The CEO was resisted by some of the family owners and the non-family chairman of the supervisory board, who still believed in family ownership. The chairman actively looked for a member of the family who could be trained up as an executive, so that there would be a counterweight to the domineering CEO. It took several years but a suitable candidate was found and internally promoted.

The family were now in a position to say: ‘if you want to resign, go ahead, we know that there is another well-qualified manager who can both do a great job for us AND who is committed to family ownership – because he is a family member.’

The outcome, several years on, is that the business remains firmly in family hands. The family member is on the executive board though he is not CEO. But for as long as he’s on the executive board, any non-family person who serves as CEO is much less able to push for a public listing.

#4: Time preference
Another watch-out is that some executives achieve success in public companies by focusing entirely on ‘hitting the numbers’ every quarter. But this approach may not suit the longer-term thinking of many family businesses. In fact, a manager who is all about short-termism is likely to damage a business that prizes reputation, trust and consistency.

#5: Family harmony
There are particular considerations for families that are moving to a non-family CEO for the first time. Consider the case of Next Generation (NxG) members in a family business that has traditionally been led by the most competent member of the family. The NxG spent years in learning the craft skills that the specialised business requires. They gave up their other career ambitions in order to progress from the bottom of the organisation. They spent the best years of their lives in gaining a real ‘feel’ for the business.

Then, quite suddenly, the family decided that it was preferable to have a non-family senior management team, with the family taking on a role of ‘governance’ rather than ‘management’. The NxG’s long-held expectation of succeeding to top positions crumbled and collapsed.

It’s easy to see that this situation could be deeply traumatic for individuals in the NxG – whatever the long-term benefits of non-family CEOs ‘on average’.

There is always going to be a point of departure from a business that is owned and run by the family, to a business that is run by non-family managers. To navigate this point of departure successfully, there needs to be a great deal of social leadership. Somehow the family has to be aligned around the new direction and the need to make individual sacrifices for the common good.