The Family Firm Mixed Gamble – When Nepotism Makes Business Sense

Short-term gain versus long-term performance is a trade-off faced by many firms, whether run by executives with a work-only link to the institution or those from the founding family and therefore with a greater sentimental attachment to their business legacy. Times of crisis tend to open the eyes of all executives, making them more likely to recruit talent from outside their favoured circle in order to help their firm emerge from difficulty. When the economic waters are quieter, firms are more likely to resort to their tried-and-tested ways, including the profile of those they wish to promote or recruit. In the latter scenario, family firms are more likely to display nepotism, but with the risk of lower financial performance that such an HR strategy implies. But what if conditions existed where such a policy could actually make business sense beyond simply keeping a firm within the family?

Generating socioemotional wealth

The corporate strategy behind nepotism centres upon gains of a less immediately financial nature (“socioemotional wealth”), namely the retention of family control, the establishment and maintenance of emotional ties between co-workers, and the opportunity to pass on a business to the next generation. Such a strategy has the perks of ensuring smooth links between colleagues, the relatively easy transferral of tacit knowledge, and a high level of commitment from firm members who, due to the extra personal affinity they have for the firm, are more likely to give that extra 10% to make things work for the family good.
On the flipside, conflicts of interest can take place between family members who are also colleagues, and the financial performance of a firm will sometimes take a back seat as family firm members are more interested in matters of personal reputation and the state of the legacy that they hope to inherit rather than the state of its balance sheet in the present. In short, family firm members are confronted with a financial and reputational gamble that requires them to make a judgement call in terms of their priorities. Identifying the right institutional and economic context in which to take the more nepotistic route can make all the difference, meaning that executives find themselves in the position of taking a “mixed gamble” – a calculated one but the results of which are not always certain if the conditions are not right.

Testing the economic waters

Whilst “reciprocal nepotism” nurtures interdependence and interaction between family members, in turn creating trust and bolstering a company, it is important to understand within what industries and institutional environments it is wisest to apply such a practice. The uncertainty (or otherwise) of the economic climate also plays a key role. Research reveals that family firms have much less to offer within industries such as groceries and commodities, where the sophisticated business priorities so important to family firms such as tacit knowledge and reputation are less prevalent and where product differentiation is of lower strategic importance. The likes of the luxury or wine sectors present the opposite profile and therefore more conducive conditions for family firms.
On a broader, country-wide scale, when the business climate is less secure and institutional presence is generally low, the value of workforce loyalty and the overall financial performance of a family firm is thought to be boosted as bringing in non-family members from the outside may upset the corporate apple cart.

Aligning HR practices

Depending upon the overall business conditions, what family firms need to do to raise their financial performance levels whilst continuing to recruit from within the family is to show more flexibility and innovativeness on an HR level. This applies in particular to such crucial factors as regulatory pressure, in-firm training and mentoring, performance-related pay schemes, job security, and job flexibility. Theoretical research into these factors concludes that when business conditions are more uncertain, family firms are more likely to be able to deliver in these areas, thereby improving their own performance at the same time.
For the time being, family firms are in reality more rigid in their ways of working, so room for improvement remains. That said, by adjusting their HR practices with greater frequency to business environment contingencies, family firms have their best ever chance of being able to balance the needs of the ever-prevailing family with financial gain. A preferential treatment strategy emerges as not so irrational a way of doing business after all, provided that the right conditions are in place and have been properly identified by senior executives before they take the nepotistic plunge.

This article draws inspiration from the paper Is nepotism so bad for family firms? A socioemotional wealth approach, written by Shainaz Firfiray, Cristina Cruz, Ionela Neacsu, and Luis R. Gomez-Mejia and published in Human Resource Management Review 28 (2018).

Ionela Neacsu is an assistant professor of Strategy and Innovation at Rennes School of Business, France. Her research interests include Strategy, Entrepreneurship, Corporate Governance, Executive Compensation, and Family Firms.