How do informal institutions influence family-owned firms?

As outlined in my previous post, the prevalence, strategy and performance of family-controlled firms (FCFs) differs across countries, yet research has primarily underscored formal institutions like regulations and legal frameworks to justify these differences. In our research, we widened the scope to explore how informal systems such as social ordering systems, hierarchies and values might explain these divergences.

Using the family business legitimacy index (FBLI) as a guide, we were able to attain a fine-grained assessment of the role of informal societal systems on FCF ubiquity, strategic choices and success.

>> FCF prevalence: In countries with high FBL scores, family is considered the primary economic unit, kinship-based relations are favored and the business culture reflects traditional values. When viewed on the continuum of FBL strength, the United Arab Emirates and Bangladesh top the list while New Zealand, Denmark and Sweden rank among the lowest.

Our research finds a positive association between the prevalence of family-controlled firms and countries with high FBL scores. In these markets, decision-making follows a patriarchal structure, with the male head of the household exerting maximum formal and informal corporate control and frequently using the business as a channel to spread their family values. At the same time, they benefit from exclusive kinship-based networks closed to non-family firms, such as social capital, relational trust and feelings of interpersonal solidarity. Employees, in turn, expect job security and protection from their managers, presumptions that are far weaker or absent in weak FBL countries.

But not everything is a positive for family-owned firms: informal institutions are self-enforcing in high FBL countries, meaning that family firms enjoy these potential strategic advantages as long as they respect and operate within this traditional system.

“In countries with high FBL scores, family is considered the primary economic unit, kinship-based relations are favored and the business culture reflects traditional values.”

>> FCF strategy: In terms of their strategic choices, family-owned firms in high FBL countries are given more legitimacy and leeway to pursue unique strategies. These might include strategies to preserve family businesses and the adoption of a parental, altruistic leadership style that prioritizes socio-emotional wealth over financial gain.

At the same time, family firms in high FBL countries place a premium on family control, often leading them to avoid risks and dedicate fewer resources on diversification, innovation and internationalization compared to non-family-controlled firms. In contrast, the opposite is true in weak FBL countries, where family-owned firms are far more likely to implement globally established strategies and adopt the practices of non-FCFs as a means to attain legitimacy.

“In terms of their strategic choices, family-owned firms in high FBL countries are given more legitimacy and leeway to pursue unique strategies.”

>> FCF performance: When organizations receive positive social evaluations, they are more likely to outperform less-positively assessed rivals both in terms of both accounting profit and stock market returns.

According to our research, this is also the case of family firms in high FBL environments: both market and non-market forces such as political, community and governments endorsements enable them to outperform their non-FCF peers by providing symbolic support and access to material resources which are not available to non-family-owned businesses.

In terms of market forces, family-owned companies in high FBL-oriented countries also benefit from relational contracts with clients, financiers and employees, which all tend to prefer doing business with this type of business. At the same time, community-level social capital gives FCFs the advantage of additional sources of information, allowing them to tap new market opportunities and find new channels for business growth.

“Family-owned companies in high FBL-oriented countries also benefit from relational contracts with clients, financiers and employees, which all tend to prefer doing business with this type of business.”

Key takeaways

All in all, family businesses in high FBL-focused countries benefit from a virtuous circle that often results in higher financial performance in comparison to non-FCFs. In high FBL countries supportive of family firms, entrepreneurs are more likely to invest in family firms and family firms are more likely to achieve funding and less likely to fail. At the other end of the spectrum, the opposite is true: family-owned firms in low FBL countries are less likely to attain funding and less prevalent.

And what about the concept of informal institutions as “weak substitutes” in countries where formal systems are not as robust? Our research does not support this notion, finding that formal and informal institutions vary independently but can reinforce each other’s positive outcomes. In this regard, countries like Malaysia and Singapore – which combine both high family business legitimacy and robust formal institutions – perhaps provide the optimal scenario for family-controlled firms.

“All in all, family businesses in high FBL-focused countries benefit from a virtuous circle that often results in higher financial performance in comparison to non-FCFs.”

For leaders of family-owned firms, understanding the business impact of informal institutions in their core markets of operation is critical. While FCFs may derive strategic advantages in high FBL countries, their legitimacy in weak FBL countries could be undermined. In these contexts, FCFs might be better off following conventional corporate strategies and downplaying behaviors more typical of family-owned firms, especially those perceived negatively such as nepotism and patriarchal leadership styles. On the other hand, in countries with strong FBL scores, it is unclear whether FCF legitimacy extends to foreign family businesses, which could be a further area of research.

As engines of employment, social stability and economic development, family-owned firms are also important for policymakers. As evidenced by the family business legitimacy index, the social perception of family business varies significantly across countries, which should inform their decision when aiming to promote them.