Family firms and COVID-19 – Mahvesh Mahmud


80 percent of Pakistan’s industrial base are family businesses. This is a misunderstood economic phenomenon which needs to be first understood in detail in order to draw out important lessons from it to create a positive impetus for overcoming the economic challenges posed by the COVID-19 crisis.

For economists, the theoretical debate on family firms (FFs), like the fable of the elephant and the blind men, remains rich in its parts, but poor in its whole. Recent research has explored various facets of family firms, but failure to reach a consensus on what defines family business and how to theorise the complex family-business dyad, has precluded the development of an integrated policy on the topic and hence the concept is often not discussed in mainstream debate. Only recently in a PIDE seminar related to the Competition Commission of Pakistan (CCP), a family business owner highlighted how his business could benefit from CCP and contribute positively towards the economy, but this too was not wholly accepted nor addressed by the participants. I would attribute it to lack of understanding of the basics of the concept which are explained below.

In economics, family firms are differentiated from non-family firms vis-a-vis two lenses of analyses: one is the agency theory perspective and the other is the resource based view. Agency theory highlights problems that stem from separating ownership from control in organisations. The concept of agency costs includes all actions of an agent that breach the interests of a principal and all contracts, efforts, incentives and policies, used by the principal to align the interests and actions of agent with their own. Applying this concept to family firms, it was largely believed that when ownership and management would reside within a family, agency costs would be negligible.

This assumption was challenged by various researchers who, by drawing on economic theories and data collected from 1,376 family firms, showed how family ownership may not be the kind of governance panacea that agency theory assumes it to be and that agency problems may be more pronounced in family firms due to altruism (familial bonds and preferences) than in non-family firms. Owners needed to manage agency problems caused by asymmetric altruism and self-control through monetary incentives to improve family firm performance. Similarly, another study found that principal-agent family bonds may increase agency costs but that these costs [could] be curtailed by use of appropriate monitoring mechanisms [or incentives] within the family business. These problems were to be seldom controlled through incentives since they found that family members were already owners of the firm and altruism caused agency costs such as; free riding, parental bias towards offspring’s performance, and privileged consumption of perks. It was also found that altruism could facilitate birth and market entry of family firms, however, the post-market entry phase was riddled with agency problems that threatened the firm’s ability to compete by engendering strategic inertia, a misalignment of incentives and ineffective governance.

Endorsing the positive aspects of altruism, some researchers found that the overall agency problem in family firms was less serious than that in non-family firms because of family involvement. It was found while exploring nuances of altruism that parental altruism’s influence on agency relations in family firms was contingent upon whether or not the firm’s ownership was controlled by the founder, by siblings, or by an extended family and that a family firm’s ability to capture agency benefits of altruism was dependent on controlling the owner’s ability to manage self-control. Researchers felt that taking a resource based view perspective, showed that in “scarce environments “to ensure viability of family firms, altruism may lead to owner managers’ willingness to suffer lower compensation to decrease overheads for the firm and counter intense competition in the business environment. Altruism could be used to reduce agency costs in family firms provided it was reciprocal and symmetrical (that is both family owner and family manager are altruistic toward each other and symmetrical). But they also showed that altruism could lead to an increase in agency costs as family firms grew in size and age. These agency problems were found to manifest themselves in the form of moral hazard among immediate family members and adverse selection among quasi-family members.

A solution to reducing agency problems was to treat family managers as agents. Those family firms where owners monitored and provided incentives to family managers, reduced agency costs and improved family firms’ performance was realised. These were some of the issues related to family firms from an agency theory perspective, debate on which seems far from over as policymakers continue to demonstrate how altruism and agency problems are related, and how agency costs can be monitored and mitigated. Agency theory is also silent on strategic choices that family firms make, a gap filled by the Resource Based View (RBV) perspective of family firms which argues that a firm’s valuable, rare, inimitable resources could lead to its sustainable competitive advantage. It showed that family firms had a unique bundle of idiosyncratic resources rooted in the interaction among the systems between family, its individual members and the business. This they termed as “familiness” which is unique to family firms and a concept that allowed researchers to understand family-based competitive advantages and the impetus for the strategic vision and goals sought by family firms. Starting with family firms with consolidated family ownership and multiple generations of family management to those firms having controlling family ownership and strategic management input only at the board level the familiness perspective lent a systemic, holistic spectrum of family business organisation for researchers to utilise. The Resource Based View perspective identified five resources (familiness) of family firms that provided advantages over non-family firms. These resources were human capital, social capital, patient capital, survivability capital, and governance structure. The authors showed that the most important resource to a family firm is its human capital. Relying on human capital (e.g., knowledge) provides opportunities for these firms because intangible resources are the most likely to lead to a competitive advantage. However, that reliability on human capital may be limiting for family firms due to inaccessibility of substantial human capital outside the family and therefore requires family firms to evaluate, acquire, and shed resources effectively. While some policymakers have focused purely on pursuing wealth maximisation objectives, an alternative view is pursuing wealth maximisation as their dominant objective and place importance on noneconomic goals or constraints, such as maintaining family harmony or job creation for family members. In such pursuit of non-economic goals, there may be an influence of key decision makers on rent-seeking behaviour of the family firms, affecting its economic performance.

In the COVID-19 environment, Pakistan needs to dispel with the resource based view and the agency theory views of family businesses. They need to see firms in the institutional perspective. The two different levels of institutional environments that affect firms: the broad environment and the immediate one (please see Figure 1). At the level of the broad institutional environment there are general, shared understandings among firms; established norms, rules, routines and favoured firm characteristics or authorities (government, regulatory etc), sanctioning regulations. Firms experiencing pressures in this environment tend to conform to the environment by becoming useful to other successful firms or organisations perceived to be successful, in the hope of being judged as professionally appropriate and legitimate.

At the level of the immediate environment, norms, rules and routines are more specific for each firm, affecting its tasks and day to day operations. It can be argued that for family firms this is the level defined by family involvement in business where members of the family (e.g., owner-founder, owner-manager, family manager, kin etc) are part of this environment establishing norms which are rooted in long-held, institutionalised familial values, defining the unique set of organizational practices which may have led/or lead to the family firm’s success/legitimacy in the broad environment over time.

The immediate environmental pressures affecting a FF would reign supreme only in cases where the broader environment is less institutionalised than the immediate environment (e.g., in cases where the market in which the firm is operating is emergent, or fewer competitors are prevalent, or where there are few or no regulatory authorities or government sanctions, whereby rules and norms are still being established). In such an instance, familial values could provide the family firm an organisational guide map for maintaining legitimacy. If the reverse was true, where broader environmental pressures were stronger (e.g., in the presence of strong competition demanding conformance to norms, or authorities sanctioning practices) then the family firm’s legitimacy would depend more on conformance to the broader environmental pressures than to the immediate ones.

The concept of “institutional environment” provides important insights concerning the family firm organization/environment interface amidst COVID-19 as it explicitly attends to the importance of broadly-based expectations in a wider setting that contains prescriptions affecting legitimacy of family firms. This is where family firms will become more dominant and exact influence in affecting jobs and overall well being of the economy. Family firms are going to create firm-level innovation tailored to counter COVID-19 and structure the economy around it. There will be companies who will now become COVID-19 savvy and reshape the economy in institutionalising protective measures around work and workplaces.