In East Asian Business, Blood Thicker Than Water – A Commentary by Zhiwu Chen

"In East Asian Business, Blood Thicker Than Water"
By Professor Zhiwu Chen
Published in the Global Times (China) July 13, 2009
Read the article in its original context on the Global Times website. 

We’re all familiar with the scene from movies. A father takes his son up to the top of the company HQ and, looking down on the busy workers, tells him, "One day, my son, all this will be yours." In developed countries, however, handing down businesses has become rarer, with owners preferring to take their companies public and employ professional managers. In China, however, even very large companies are often passed on to the next generation. Why is there such a difference?

Some 2,000 years ago, Confucianism defined family and blood relationships as the utmost guarantee of economic security and social welfare. With business networks restricted to clan ties, there was no demand for wider trade, and markets were not able to develop. Under the influence of Confucianism, the Chinese stress the importance of family, and business owners only want their children to succeed them, regardless of their aptitude. They fear that handing over the reins to others will risk their children being cut out from the business and its profits.

In the West, the church served as a community of trust based on religious belief and voluntary alliance. Thus, Westerners were able to establish networks outside of family ties as long as there was clear regulation of conduct, and a reward and punishment system. The 16th century saw the emergence of profit-oriented stock companies. Over the centuries, Western society has developed proper norms to regulate the agent-principal structure. Thanks to a legal system capable of handling business agents, Bill Gates does not have to bind his daughter’s future with Microsoft.

Though the offspring or relatives of the family business owners are reliable, they are limited in number and capacity. On the other hand, employing professional managers draws from a much wider range of skilled individuals. However, the trade-off is the lack of trust. It is very difficult for the manager to always give top priority to the interests of the principal.

Which arrangement is better depends on the credit and legal environment of the society. If the laws are less reliable, the trust will be lower and the agent problem will be more serious. In this case, family successors will be better, even though few companies can prosper this way.

On the contrary, if the legal and credit environment is better, it will be more feasible to regulate agent conduct through contract arrangement and better for professional managers to take care of the company.

Japan has developed a special succession model for family members. If the founder or the head finds his son incapable of or unwilling to take over the family business, he will select the most capable young man in his firm and marry him to his daughter. After a year of marriage, the son-in-law will become his "foster son" through a formal adoption ceremony and take the founder’s surname. Then the foster son will become the head of the family.

For instance, Japan’s Mitsui Group, founded in 1673, has been a pillar of the modern Japanese economy. Several "sons-in-law" contributed to the group’s vitality over the past three centuries. In another case, the founder of Toyota, Sakichi Toyoda, didn’t choose his own son as the successor of the company, but his son-in-law.

The Japanese model has three major advantages. First, the traditional concept of family is extended and continues to be powerful. Finding a foster son to take care of the family business binds him into the family, and reduces the chance of betrayal. Second, the successor is more capable. Third, the biological children will be motivated to work hard.

However, no model can guarantee the longevity of family business. The succession of family business is so difficult that most fail to pass three generations. The benefit of this is that it forces each generation to work harder, and reduces concentration of wealth. We should praise Bill Gates, Warren Buffett and other great entrepreneurs who have donated almost all their money. They are leaving the next generation the precious motivation to start their own business.

The author is a professor of finance at the Yale School of Management. This article was translated by Qian Ye.