Roger Trapp: The dangers of keeping it in the family when choosing management personnel

'Blood is thicker than water' is rarely the best policy

By common agreement, next week's Budget will be something of a damp squib. With its significance downplayed by the decision to postpone until next year the spending review expected for this year and the Chancellor apparently having his mind on other things, observers are not expecting anything to make Gordon Brown's 10th Budget memorable.

However, a report just out might find favour with a Chancellor known for his fondness for improving productivity and protecting tax revenues. Research carried out by the Centre for Economic Performance at the London School of Economics and McKinsey & Co, the management consultancy much favoured in government circles, suggests that the productivity gap between Britain and the rest of the world is to a large extent down to the high proportion of family businesses in the UK and the fact that many of them are badly run.

Family firms have tended to be celebrated for the stability and the longer-term view they bring to business. But the researchers - who analysed data from 730 medium-sized manufacturing companies in the UK, the US, France and Germany - point out that there is a downside in that they can be refuge for people whose only qualification for the job is that they are the child of the founder.

Firms that are family-owned but not managed by family members are usually well-managed, says the report. It suggests that this is because family shareholders, who typically have large stakes in the business, carefully monitor the managers they employ to run the business on their behalf. An example cited is Wal-Mart, which is still largely owned by the Walton family but which has had a non-family professional chief executive since the retirement of the founder, Sam Walton.

On the other hand, family management tends to be less successful. This is for two main reasons. First, selecting the chief executive from among the small group of potential family members severely restricts the available pool of managerial ability. This may not be a problem for a small firm, but for a large business employing 500 or more people, the chief executive needs to have the sort of ability that the family may not be able to provide. Second, letting family managers know that they will get to manage the business later in life can lead to what has been termed the "Carnegie effect", in which family members work less hard at school and early in their careers because they do not need to worry about getting a job.

When the chief executive is selected through primogeniture - choosing the eldest son - the management practices "tend to be extremely bad", observes the report. "With primogeniture, both the lack of selection and the negative Carnegie effect become much more severe since the CEO position is determined from birth".

Obviously, there are family firms all over the world - though, perhaps surprisingly, they account for only 10 per cent of the total in the US, compared with about 30 per cent in each of the UK, France and Germany. So, why is there such a problem in the UK?

The researchers suggest that in both the UK and France (which is closest in poor productivity performance to the UK) there are strong feudal traditions making it acceptable to pass on the running of family firms. Moreover, the UK - uniquely in the sample - has a 100 per cent inheritance tax exemption for family firms. This not only makes it possible for family ownership to remain concentrated, it also provides an incentive to do this by enabling family members to avoid substantial tax bills.

The report's proposal is that inheritance tax relief in these situations be capped at £1m (thereby continuing to protect the vast majority of family firms). This, say the authors, would not only produce a small boost to the Exchequer of about £250m a year, but would also improve productivity in the UK economy.

It all looks very appealing, not least, one expects, to Mr Brown. But, while the tax position clearly encourages continued family ownership, it is not obvious that taking away this incentive will necessarily encourage professional management. It is one thing to say that there is no reason why the Government should effectively be subsidising bad management through its tax policy, but quite another to claim that taking away this subsidy will do more than remove a distortion or inequality.

The real message is there in black and white for those who want to see it. Namely, that unless a successor to the founder has a real talent for business they should continue to own the business but employ an accountable professional to run it.