Thursday, August 03, 2006
How Costly is Nepotism?
in a sample of 5,000 Danish firms from 1994 to 2002, firm performance (measured by the ratio of operating income to assets) improved only after a nonrelative took over. The ratio of operating income to assets averaged 3.3 percent in their sample—for a firm with a million dollars in assets, that puts annual operating income at $33,000. Company performance improved 1.3 percentage points ($13,000 in annual income per million in assets) after the succession of outside-the-family CEOs. And it declined 0.1 percentage points ($1,000 in annual income per million in assets) when scion CEOs were chosen.
The authors argue that these effects are causal. They show that having a first-born son increases the probability of passing the company to a family member (companies pass within families 40 percent of the time if the first born child is a son, but only 30 percent of the time if the first born child is a daughter). They use this to instrument for the decision to appoint a family member CEO and find:
Firms in which the CEO dad had a male firstborn, a factor that by itself should have no effect on the firm's subsequent operating performance, experience a $10,000 larger deterioration in income per million dollars in assets after a succession.
These are some interesting findings that suggest both that people who complain about nepotism may be justified in their criticism and that families are willing to pay a significant price to keep companies "within the family."
Of course, in light of the paper discussed in the previous post, having a first born son may not be as random as once believed. As such, the IV estimation strategy they employ may be invalid if the parental characteristics that affect the probability of having a first born son correlate with the unobserved determinants of firm performance.
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