Are Family-Run Companies Hotbeds of Nepotism?

Last year we hired a local firm to take down a row of enormous pine trees on our property. They were all dying and in close proximity to power lines and the road we live on. Our windy season was fast approaching and they had to come down. The job involved dangerous heavy equipment, heavy risk, and heavy teamwork.

After watching the seven-person crew working for two days I was impressed with how well they worked together and had each other’s backs. Turns out they were all related. This wasn’t just a family-run business. Everyone in the business was family. And they trusted each other with their lives.

A few months back I made a trip to Sonoma Valley in California’s wine country, where it’s entirely common for wineries to be family owned and operated. Again, it’s primarily a matter of trust.

Since small businesses are usually closely held, keeping management in the family is a prerogative. If the family hires or promotes an undeserved relative who then screws up, they alone and sometimes their customers pay the price. There are usually few if any outside stakeholders involved.

That’s not the case with large family-owned corporations, especially those that are publicly traded, where nepotism can lead to lapses in corporate governance and dire consequences for investors, employees and customers.

But not all family-controlled companies are cut from the same cloth. They don’t necessarily lead to nepotism. Many are entirely run by outside executives. And they certainly have no monopoly on hiring losers to run their companies. That can happen with any board, as companies like H-P and Yahoo (NASDAQ:YHOO) know all-too well.

Besides, founding families may have more voting stock than any other single shareholder, but that doesn’t mean they have majority control. The Waltons, for example, do own more than 50% of Walmart (NYSE:WMT) stock while the Ford family has just 40% of Ford’s voting rights.

The truth is, nepotism and cronyism are two sides of the same coin. If you’re going to worry about a family-controlled board playing favorites with their offspring, you should be just as concerned about a board that was handpicked by a founding CEO rubberstamping everything he puts in front of them.

I would argue the latter situation is far more prevalent and problematic.

Quite a few prominent American companies that have stood the test of time are family-owned to some extent, although we can certainly debate whether they’re well run or not. Besides Wal-Mart and Ford there’s Cargill, Koch, Viacom, Loew’s, News Corp., Mars, Gap, General Dynamics, and Comcast, to name some of the biggest.

Cofounder Irwin Jacobs ran Qualcomm, the world’s top wireless chip company, until his son Paul took his place in 2005. By any measure, the younger Jacobs was a highly effective CEO for a decade. He stepped down last year and was replaced by then president and COO Steve Mollenkopf ... not a member of the Jacobs family.

Motorola’s another story. The electronics company, which was mostly run by the Galvin family since its founding in 1928, has not faired nearly as well, to say the least. It’s never been known as a well-run company, and that’s reflected in its poor performance relative to peers and the S&P 500.

If you go back to the heady days following the start of the new millennium, one of the three major corporate scandals resulting in bankruptcy was Adelphia Communications, which was run and defrauded by the Rigas family. Father John and son Tim are still in prison. The other two notable corporations, Enron and WorldCom, were not family-run.

Interestingly enough, about one third of the S&P 500 is said to be family controlled, more or less. Go figure.

Nepotism certainly appears to be at play in a recent story involving Korean Air. The company is part of Hanjin Group, one of South Korea’s chaebols or family-run conglomerates that were selected by the nation’s government to help rebuild the economy following the Korean War.

The “nut rage” incident occurred when Cho Hyun-ah – then EVP of the airline – was served macadamia nuts in a bag instead of on a plate. Cho, who just so happens to be the 40-year-old daughter of Hanjin Chairman Cho Yang-ho, reportedly went ballistic on the cabin crew and ordered the plane back to the gate.

She has since been stripped of her duties at the airline and indicted on aviation safety charges. Nepotism or just a really bad day? Who knows?

In my view, the only way to run a company is by pure meritocracy. If boards and CEOs would just follow that one rule, it would solve half their problems. But I’m not going to hold my breath.

Having observed the corporate world for decades, I’ve probably seen enough nepotism and cronyism to last a lifetime. But for every case of nepotism, I’ve seen nine or ten cases of dysfunctional founders, CEOs, and boards doing dumb things that have nothing to do with blood relations.