Freakonomics: Is handing down a business good for business?

A little boy in a suit looks up at a businessman symbolizing family busines, nepotism, and family-firm succession.

Tess Vigeland: It's Freakonomics time. Every two weeks, we're talking with Stephen Dubner, co-author of the books and blog about the hidden side of everything. Hello there, Stephen.

Stephen Dubner: Hey Tess. I was wondering, have you got your resume sent off to Omaha yet?

Vigeland: Oh, I did that long ago my friend.

Dubner: Yeah, because Warren Buffett needs to have somebody run Berkshire Hathaway when he's done and I'm guessing that they'd be dying to have you in there.

Vigeland: I think they would. And now that David Sokol's out, naturally, I would be next in line.

Dubner: Naturally. Now, if for some reason Warren Buffett doesn't pick you to run Berkshire, he should have his head examined. But he could just do what a lot of CEOs do, which is just pick one of his kids, right? But Buffett's actually taken a very well-known stance against nepotism. Listen to his son Peter Buffett.

Peter Buffett: You know, my dad talks about the ovarian lottery.

Dubner: So Peter Buffett won that lottery, but he says his dad never pressured him or his siblings to go into the family business. So Peter Buffett got to focus on his music -- he's a composer -- and on philanthropy. And as he tells it, that is probably a good thing.

Buffett: The odds of having a son or daughter that are as passionate and excited and driven as a founder of a business was, or even the person that took it over, I think are incredibly small.

Vigeland: But Stephen, I think a lot of business founders don't think that way. The Buffetts are kind of a unique example. I mean, Warren Buffett has really made a point that he's not giving his kids his $47 billion fortune or the keys to the corner office.

Dubner: You're right. And you're also right in that elsewhere, in most places, the Church of Scionology as I like to call it -- which is handing out the family firm to the family scion -- it's booming. Roughly one-third of Fortune 500 companies are family controlled. But the important thing I wanted to know is this: Is handing down a business good for business? I asked Antoinette Schoar, a finance professor at MIT who's studied family-firm succession.

Antoinette Schoar: We actually see drops in performance of these firms after they are transitioning from a founder to the heir, or the heirs. We see drops between 10 and 20 percent of profitability.

Vigeland: Right. But I mean, you don't go into business to make a profit, right? No, I'm just kidding. Of course you do. But there have to be other reasons. If I spend my whole life building a business, I might actually want my son or daughter to take over. It's part of the legacy.

Dubner: Absolutely. There's a lot of reasons why people do pass firms onto the family. But there are also some not-so-obvious reasons. I talked to Vikas Mehrotra, who's a finance professor at the University of Alberta.

Vikas Mehrotra: Trust is in short supply in typically in countries where families are dominant.

Dubner: Did you catch that, Tess? In countries where family firms are dominant, trust is in short supply. Now what that means is trust is kind of short-hand for having strong institutions, for having transparent markets. When you don't have all that, you don't have as many options for passing the company along and you're more likely to protect your firm by simply handing it off to junior.

Vigeland: Whether junior wants it or not.

Dubner: Exactly. Right. Yeah.

Vigeland: But of course, hopefully, we don't see that as a problem here in the U.S.? There are a lot of options here.

Dubner: Which is why -- believe it or not -- the U.S., for all the family firms we see around us, has one of the lowest rates of scionology in the world. There's also the fact that we in the U.S. helped pioneer a management model. Here's Richard Sylla, who's a financial historian at NYU.

Richard Sylla: The first business schools were founded in the United States. I think the Wharton School at the University of Pennsylvania was founded in 1883.

Vigeland: So because we've got all these folks who have a pedigree, they've actually got an education, you don't necessarily have to be related to the founder to take over as CEO.

Dubner: That's what we believe. And slowly, it seems, the rest of the world is starting to believe in that as well. In fact, Tess, I'm wondering, have any interest in relocating perhaps to India?

Vigeland: No. OK, OK, I'll play along. Yes. Sure, why not?

Dubner: Well, if you don't want to go I'm not going to force you. I'm just saying there may be a nice little job opening there for someone like you. If Buffett doesn't hire you and bring you to Omaha, Ratan Tata, who runs the gigantic Tata Group -- this giant conglomerate which is a family firm -- is looking for a CEO to succeed himself, and he's thinking about bringing in an outsider. So you might want to brush off that resume and get it off to Mumbai.

Vigeland: All right. Well I like their cute, little cars so I'll think about it. Stephen Dubner, our Freakonomics correspondent. There's more of his work at FreakonomicsRadio.com. Thanks, it's been fun.

Dubner: Thanks for having me, Tess.

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