Dead Money: Inheritance Law and the Longevity of Family Firms

Dead Money:Inheritance Law andthe Longevity ofFamily FirmsMichael CarneyEric GedajlovicVanessa M. Strike

“Dead money” refers to the potential for the division, reduction, and misallocation of familyfirm assets during intergenerational wealth transfers. We consider the effects of inheritancelaw provisions on property transfers and the potential impact on family firm vitality in fourjurisdictions: Germany, France, Hong Kong SAR, and the United States. These jurisdictionshave divergent legal origins and inheritance law regimes that generate distinct patterns oftransformation and continuity in family firms. The contribution of the paper is to identifyexternal institutional factors that determine the central tendencies on family firm longevity ina literature that has hitherto focused on internal factors such as the efficacy of adoptingprofessional management and succession planning.

Introduction

How does inheritance law influence the efficiency and longevity of firms owned andcontrolled by families? It is well established that inheritance law has important conse-quences for the distribution of wealth in society (Keister, 2000), but little is known aboutits effects on family firm outcomes, where much of that wealth is concentrated. Inheri-tance laws are property rights institutions that govern the transfer of wealth betweenindividuals and from one generation to another following death (Friedman, 1966).In this literal sense, inheritance law is concerned with the money of the dead. However,the phrase “dead money” is from stockbroker idiom describing capital that is unlikelyto provide an economic return. Mark Carney, the governor of the Bank of England, haspopularized the term “dead money” in recent debates about economic stagnation inWestern economies. Carney is specifically referring to the large accumulations of cash oncorporate balance sheets (The Economist, 2012a). The concern is with large-scale capitalmisallocation since corporate cash holdings sit idle, neither invested in productiveactivities nor disbursed to shareholders for reinvestment in alternative wealth-generating

Please send correspondence to: Michael Carney, tel.: 514-848-2424; e-mail: [email protected], toEric Gedajlovic at [email protected], and to Vanessa M. Strike at [email protected].

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projects. In this paper, we focus on a quantifiably larger body of potentially dead money:inherited wealth associated with family firms and the laws governing its distributionbetween generations.

Inheritance laws pertaining to testamentary freedom, trusts (entails), and estate taxesthat can divide, reduce, and reallocate family firm assets have significant effects on firmefficiency and survival prospects. The concern is that substantial sums of wealth associ-ated with family businesses and inherited by succeeding generations will be inefficientlyallocated. More generally, family firms managed by family successors lacking either thecapability or interest in either monitoring or managing an inherited firm could result in agrowing pool of potentially dead money.

Much management research on intergenerational transfer of family firm property isconcerned with either the transition of the firm from family to professional management(Gedajlovic, Lubatkin, & Schulze, 2004; Stewart & Hitt, 2012) or with succession and theidentification of best practices that promote firm vitality and longevity, such as successionplanning (Eddleston, Kellermanns, Floyd, Crittenden, & Crittenden, 2013), successorsocialization (Steier, 2001), and family evaluation of firm assets (Zellweger, Kellermanns,Chrisman, & Chua, 2012). However, family firm survival rates into the second generationare low, estimated at less than 30% (Lee, Lim, & Lim, 2003). Furthermore, researchfocused exclusively on the experiences of surviving firms can be misleading because, byexcluding the large number of family firms that do not survive succession, it ignorescentral tendencies in the population. The left censoring in much succession research mayomit relevant factors driving longevity rates in the population. While the main body ofliterature on family firm succession and professionalization is focused on factors internalto the firm, other organizational theories suggest that survival is often explained bycontextual factors that are external to the firm (Aldrich, 1979; Hannan & Freeman, 1977).Equally, economic geographers have established that there is much geographic variationin firm growth and survival rates (Johnson & Parker, 1996), further suggesting contextualeffects.

To increase our limited understanding of the consequences that external factors haveon the family firm, we focus on legal institutional determinants on efficiency and longev-ity. To do so, we provide a comparative institutional analysis (Hamilton & Biggart, 1988)of four jurisdictions. Each jurisdiction is characterized by different configurations ofinheritance laws regarding testamentary freedom, property entailing, and inheritance tax.We show how these legal institutions interact with one another and with other social andlegal institutions governing the inheritance of property to influence country-specificpatterns of succession, professionalization, and longevity of an archetypal family firm ineach jurisdiction. We consider the extent to which founder capital remains “alive” andsubject to productive use within the family firm or, alternatively, reallocated to moreproductive use beyond the firm. Specifically, we describe the impact of inheritance law inthe multigeneration Mittelstand class of small- to medium-sized enterprises (SMEs)native to Germany (Berghoff, 2006), the absence of a comparable SME population inFrance (Landes, 1949; Pichet & Lang, 2012), the single generation ethnic-Chinese familyfirm in Hong Kong SAR (Wong, 1985), and the three-generation dynastic family firm trustprevalent in the United States (Friedman, 1964; Marcus, 1992).

With this paper, we contribute to the family firm literature by extending existing workon succession and professionalization beyond internal factors and incorporating externalinstitutional factors into accounts of family firm efficiency and longevity (Gedajlovic,Carney, Chrisman, & Kellermanns, 2012). We draw attention to the administration of thelarge volume of family wealth that is neither put into the hands of family successors norprofessional managers of family firms. Due to the availability of trust instruments, much

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inherited capital is placed in the hands of third parties such as trusts, family offices, andother types of professional intermediaries, who influence the disposal of family capitaland the extent to which it is put to valuable use. Recognizing that a wider variety of agentsis involved in the administration of the family wealth, we introduce the notion of surro-gacy. Surrogates serve as intermediaries operating between family owners and the pro-fessional managers of family firms (Marcus, 1992). This relationship creates a doubleseparation of ownership and control, and raises potential agency problems that havelargely gone unexplored in the family firm literature.

Legal Theories of Family Firm Longevity

There are three distinct bodies of legal literature that have implications for family firmlongevity. The first is a law-and-finance hypothesis suggesting that family firm controlpersists in the absence of legal protection for investors (La Porta, Lopez de Silanes, &Shleifer, 1999). The second is a commercial law hypothesis suggesting that familyreputation serves as a substitute for weak commercial law (Gilson, 2007). The third body,the least developed in the family firm literature, is concerned with inheritance law andintergenerational transfers of family wealth (Bjuggren & Sund, 2002; Ellul, Pagano, &Panunzi, 2010).

Inheritance law determines the types of legal instruments available to founders toassist in realizing transgenerational intentions. Testamentary institutions such as wills,trusts (entails), and foundations as well as state inheritance and estate taxes governinggenerational transfers provide fundamental individual and collective property rights. Thefunctioning of these property rights creates tensions between individual rights to freelydispose of property and social obligations to provide for conjugal family members, moredistant family members, and even wider society (Beckert, 2004). How societies reconcilethese tensions through particular configurations of inheritance law is widely variable andhas important normative social, political, and economic outcomes. Bertrand and Schoar(2006, p. 80) observed that “rigid inheritance rules may be constraining to family busi-nesses,” but despite its evident importance to firm cohesion and longevity, the study ofinheritance law in the literature is in its infancy (Ellul et al., 2010). While there is aconsiderable literature on the performance of second- and later-generation family firms,there is no cross-country or comparative studies of research on later-generation familyfirm performance that might begin to identify international similarities and differences.Moreover, there is very little literature on how inheritance law affects the longevity of thefamily firm.

Family Firm Asset Divisibility and HeritabilityWe identify three dimensions of inheritance law: testamentary freedom, trusts and

entails, and estate/inheritance tax. We consider how these dimensions affect the cohesionand longevity of the family business sector by examining the transaction costs theoryconcept of asset specificity because the structure of the firm’s assets determine both theirdivisibility and heritability (Gedajlovic & Carney, 2010). An estate consisting entirely offinancial assets is fungible as the assets are both divisible and heritable. In turn, physicalassets such as land, buildings, and machinery are heritable but less divisible without a lossof productive value. For instance, frequently divided land holdings can lose value dueto diseconomies of scale. Intangible assets such as reputation, social capital, and tacit

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knowledge are indivisible and imperfectly heritable. An entrepreneur’s reputation forprobity, for example, cannot be shared out and may not be fully heritable by all membersof the succeeding generation.

Testamentary Freedom. Testamentary freedom refers to the extent to which individualsare free to dispose of their wealth. The permissiveness of inheritance laws vary signifi-cantly around the world. Generally speaking, testamentary freedom is greater in countrieswith English common law origins than in countries with civil law origins (Ellul et al.,2010). The social tension with regard to testamentary freedom is between the testator’sindividual rights on the one hand and social justice norms of the claims of spouses andrelatives on the deceased’s property on the other. The economic advantage of unlimitedtestamentary freedom is to provide entrepreneurs with incentives for thrift, saving, andenterprise, but these incentives may not apply with the same force to inheritors (Morck,Strangeland, & Yeung, 2000). When entrepreneurs are free to settle their inheritance on asingle individual, they provide a cohesive body of capital to stabilize and finance the firm.Inheritances perpetuate economic inequality, however, and testamentary freedom canresult in significant concentration of wealth, reduce innovation, and limit the equality ofopportunity (Keister, 2000). Restrictions on testamentary freedom usually take the formof compulsory shared or equal inheritance among children, consistent with norms ofsocial justice. Extreme partitioning of estates can destabilize the firm and may havenegative effects on the level of economic growth. For example, Ellul et al. found thatrestrictions on testamentary freedom are associated with lower investment in family firmsbut do not affect investment in nonfamily firms and that these negative effects only occurin family firms that have experienced a succession.

Entails. An entail is a restriction on testamentary freedom that removes property from themarket process so as to avoid its division. In effect, it places the “dead hand” of its founderover property: the inheritor of the entailed property may enjoy the fruits (usufruct) of thatproperty, such as through rent, but the property may not be sold, diminished, mortgaged,or otherwise encumbered. The inheritor must pass on the undivided property to thefollowing generation. From a property rights perspective, entailing is a legal institutionthat provides the testator with the right to control the cohesiveness of wealth in futuregenerations by restricting the property rights of inheritors. In other words, entails upholdthe property rights of the dead over those of the living (Friedman, 1966). The economicadvantage of entailed estates is to assure the cohesiveness of the property; for example, aspendthrift inheritor may not sell the property and consume the proceeds. The economicdisadvantage is that it deprives the living owners of access to credit because entailedproperty cannot be encumbered as collateral. This may lead to a scarcity of investmentcapital. Entailing also creates negative incentives for inheritors and can generate a “rottenkid” syndrome (Schulze, Lubatkin, & Dino, 2003). John Stewart Mill (1891, p. 576)declared that the “heir of entail, being assured of succeeding to the family property,however undeserving of it, and being aware of this from his earliest years, has much morethan the ordinary chance of growing up idle, dissipated, and profligate.”

However, the primary concern with entailing is the effect on political liberty. Entailingprovides for the concentration of wealth in the hands of powerful families and is histori-cally associated with the monopolization of politics by a landed elite aristocracy oroligarchy. One of the first acts of the French Revolution was to abolish entails to curtailthe power of the aristocratic ancien régime. Entails also fell out of use in Britain duringthe nineteenth century under pressure from economic liberals who believed entailedproperty restricted industrialization by locking up wealth in immobile agricultural assets.


In the United States, the drafters of the Constitution pressed individual states to abolishentailing. However, entail-like instruments have reappeared in U.S. inheritance law in theform of dynastic (Friedman, 1964) and perpetual trusts (Dukeminier & Krier, 2003).

The major difference between an entail and a trust is that capital in the latter maybe reallocated since the trust establishes a fiduciary relationship that vests legal title tothe trustee with the power to make contracts or encumber assets. How effectively atrustee actually does this will depend on the specific rules governing the administrationof trusts. Efforts to resolve the tensions between the property rights of the living and thedead are reflected in laws that forbid perpetual trusts and stipulate a specified numberof years during which the trust may operate before becoming the absolute property ofthe inheritor.

Death (Estate and Inheritance) Taxes. Estate taxes are levied upon the value of the totalestate of the testator. Inheritance taxes are levied upon the individual recipients of inheri-tances. Estate taxes tend to reduce the value of an estate while inheritance taxes can bevaried to accommodate the financial position of inheritors. Opponents claim that deathtaxes reduce the stock of capital available for investment, which impedes economicdevelopment. Death taxes may also reduce the incentives for saving and increase incen-tives to intensify consumption near end of life, thereby institutionalizing weak incentivesfor the accumulation of property. On the other hand, advocates of death taxes base theirarguments on the principle of the equality of opportunity, concerns over the undemocraticconsequences of the concentration of wealth, and the social desirability of progressivetaxation.

Collectively, the specific configuration of inheritance laws will influence the extent towhich capital accumulated in a single generation retains its viability either through itsefficient use within the family firm or reallocated to more productive uses beyond the firm.We offer two propositions concerning the relationship between inheritance law provisionsand the durability of the family firm’s assets.

First, the restrictions on testamentary freedom that compel testators to divide estatesequally between family members will typically destabilize a family firm’s capital basebecause inheritors have clear title to the capital, and they are free to take it out of thecompany if they so choose. Legal provisions for compulsory equal inheritance automati-cally and progressively divide control of the capital into many separate hands, whichdamages unified control. Similarly, the imposition of estate or inheritance taxes can erode,sometimes severely, the firm’s asset base if assets must be sold to meet the tax provisions.In combination, restrictions on testamentary freedom and heavy death taxes will tend todestabilize the firm’s capital base. Accordingly, we propose that:

Proposition 1: Other things being equal, family firm longevity will be reduced whereinheritance law reduces and divides family firm assets.

In addition, inheritance law provides incentives and restrictions that either inhibit orfacilitate the transfer and reallocation of capital. For example, high death taxes createincentives for owners to freeze or permanently entomb capital in foundations and trustinstruments that escape tax liability. This creates ownership without control in that theinheritor technically owns but cannot touch the assets in trust, which restricts the inheri-tor’s ability to redirect the underlying assets to new activities. In contrast, transferabilityof property can enhance its efficiency since unimpeded transfer allows assets to betransferred from low to higher value use, which is more likely to occur in the context ofthe competitive market. Inheritance law instruments, such as an entail or perpetual trust,

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permanently suspend the alienability of individual property; more generally, any restric-tions on the inheritance and division of an estate take the asset off the market because itis allocated according to legal rule rather than market forces. For example, the entailmentof the property when combined with primogeniture (settling an estate on the eldest son)takes the property out of market allocation since the inheritor is not selected for merit orability, but by legal provision.

Proposition 2: Other things being equal, the value of family firm assets will bereduced when inheritance law restricts the transferability of individual property; thisoccurs when inherited assets are “taken off the market” and excluded from competitiveallocation.

What is understudied in the literature on family firms is how these dimensions of inheri-tance law interact with one another to impact firm vitality and longevity. Other legalinstitutions, such as investor protection (La Porta et al., 1999) and commercial (Gilson,2007) laws, are also likely to influence the viability of specific corporate forms. Customand social norms can influence individual preferences for intergenerational intent, as well,while inheritance laws may either inhibit or facilitate those preferences. To illustrate,norms of primogeniture are common in Europe, but inheritance law expressly forbids thepractice in many countries. In this respect, comparative institutional analysis can shedlight on organizational outcomes by situating understandings of firm/institutional rela-tionships in a wider historical context (Hamilton & Biggart, 1988). We proceed by relatinglegal inheritance regimes to outcomes in four jurisdictions, two with civil code origins(Germany and France) and two with English common law origins (Hong Kong and theUnited States), to illustrate significantly different patterns of family firm longevity.

Germany’s Long-Lived MittelstandA distinguishing feature of the German economy is the Mittelstand, a large population

of medium-sized, multigenerational family firms. Mittelstand means “the middle rank”and connotes a “desirable social class, neither urban working poor nor wealthy landedestate owners living off rents but a person of solid and legitimate wealth” (Berghoff, 2006,p. 264). Historically, Mittelstand firms can be located in a technological tradition that maybe traced back to the “family-like structures” of medieval craft guilds (Kieser, 1989). Intheir contemporary form, Mittelstand are characterized by strong emotional investmentby owners and staff, and an emphasis on continuity, paternalism, and independence(Berghoff). Mittelstand owners exhibit strong intergenerational intent whose “raisond’être is not maximizing short-term profits but securing the company’s existence for thenext generations and that goal is to build up a lasting private empire for their families”(Berghoff, p. 273). The vast majority are found in business-to-business markets and arelocated in rural areas. They are largely self-financing or rely on local bank financing andare deeply embedded in their local communities (Pichet & Lang, 2012).

Mittelstand also include the “hidden champions” (Simon, 1996), which are “pocket-size multinationals” with revenues of less than €800 million. These firms are focused onniche markets, possess unique organizational cultures, and cultivate close relationshipswith suppliers and customers. Both top and middle management are typically recruitedinternally from the more long-serving members of staff. Some 95% of these hiddenchampions are family firms. Demographic conditions in the twentieth and early twenty-first centuries have posed a severe challenge to the multigenerational intent of Mittelstandowners. Traditionally, German inheritance law assumed male leadership of the firm at


succession, but two world wars resulted in a deficit of males. Additionally, Germany’sbirth rate has fallen dramatically since the 1970s, thereby endangering Mittelstandowners’ ability to find male family successors (Linnemann, 2007). The Mittelstand havemet this challenge by installing spouses and female children as successors (Berghoff,2006). Linnemann found that 44% of Mittelstand firms are succeeded by conjugal familymembers and collectively have adopted a variety of succession solutions. Many firms areoften partially sold to employees (through means of a management and employee buy-in)or sold outright to other families, mostly living within the same community. Very fewcease operations due to poor economic performance, and even fewer choose a publiclisting by anonymous arm’s-length shareholders. Consequently, most Mittelstand remainessentially family-controlled entities.

German Inheritance LawHow does German inheritance law contribute to the adaptability and persistence of

midsize Mittelstand firms? The main provisions for property and inheritance are embod-ied in Germany’s Civil Code, which was systemized between 1874 and 1890 followingthe reunification of German states in 1871. Jurists responsible for codification were awareof the economic and social effects of both the U.S. Constitution and the French CivilCode, and they were concerned with the heavy emphasis accorded to individual rights.German jurists “perceived the growth of unfettered individualism associated with theliberal economy as a menace to society’s moral foundations in the family” (Beckert, 2004,p. 150). The inheritance provisions of the German Civil Code reflect the thinking of moralphilosopher Georg Hegel, who saw the family as a legal person and the ultimate repositoryof property rights:

The family as a legal person . . . must be represented by the husband as its head. Heis primarily responsible for caring for the family’s needs as well as the control andadministration of the family’s resources. These are common property, so that nomember of the family has particular property, although each has a right to what is heldin common. (Hegel, 1991/1821, p. 60)

Testamentary Freedom. Consistent with the collective orientation in German society,both the property rights and the testamentary freedom of individuals is dramaticallycurtailed. As described by Beckert (2004, p. 53), “In death the person exits the familygroup, though no real transfer of property takes place as a result. Instead, the survivingfamily members enter into the rights of the deceased.” The family is rigidly defined in thecivil code in categories based on bloodline and legal (marriage) relationships. To upholdsocial justice and to ameliorate the effect of individualistic property distribution, Germanjurists sought to limit the individual arbitrariness of the last will and testament throughprovisions for a large compulsory portion of the deceased’s property to be inherited by alllegitimate heirs, including direct descendants, surviving spouse, and parents (Beckert).Fifty percent of the deceased’s property is automatically allocated to a surviving spouseand legitimate children.

Entails. While trusts are a fundamental element of inheritance in common law jurisdic-tions, they play virtually no role in German civil law. Nevertheless, German inheritancelaw retained entails until the mid-twentieth century. Entailing with norms of primogeni-ture is found in the German law of Fideikommisse, which grew rapidly in the nineteenthcentury and went hand-in-hand with rapid industrialization. Inheritance of an entailed

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estate by the oldest son was viewed with equanimity by the state, and the law was finallyabolished in 1945. Because the Fideikommisse bestowed full inheritance upon the oldestson, it was in an apparent contradiction with civil code provisions for inclusive inheritanceby all conjugal family members. The reconciliation of this contradiction could be foundin the general laws governing the establishment of Fideikommisse; specifically, entailscould only be placed on land “and capital wealth of considerable size,” where size isdetermined by the state (Beckert, p. 135). This distinction is important because it providesa legal basis for the establishment of Germany’s dual industrial structure. Specifically, thecapital of very large family-owned firms, such as Bosch, Bertelsmann, ThyssenKrupp, andSiemens, can be entailed in the oldest son, who may enjoy the fruits of that capital but maynot otherwise dispose of it. This effectively makes the firm a perpetual trust and facilitatesits transition to professional management. In contrast, firms of medium and small size(i.e., Mittelstand) may not entail capital properties and are governed by the provisions ofthe civil code, which we suggest induces continuing family ownership and participationin the family firm.

Death Taxes. The longevity of Germany’s Mittlestand is largely explained by the opera-tion of death taxes on individuals. First, Germany levies no estate tax so there are noincentives to sell the firm’s assets to pay for a deceased owner’s tax bill, which is commonin jurisdictions that levy an estate tax (Bjuggren & Sund, 2001). Second, Germany appliesan inheritance tax on individuals. However, the inheritance tax regime has historicallyeither exempted outright or applied relatively low rates to conjugal family members. Thus,family heirs have little incentive to sell their shares in the family firm to meet their owninheritance tax requirements. Third, these incentives have been reinforced over the yearsby deferring inheritance taxes on wealth that is tied up in a family-owned business. Forexample, a program established in 2009 offers shareholder heirs of Mittelstand up to 100%exemption if they commit to maintain a firm’s activities for 5 years and make no majorredundancies (Pichet & Lang, 2012). Such tax deferral measures effectively make a familyfirm a type of trust that provides strong incentives to maintain the business as a goingconcern. Moreover, a family firm’s intangible assets, such as reputation, social capital, andtacit knowledge are inevitably bundled together with tangible assets. However, the intan-gible assets are sticky to family members and will lose value if they are sold to nonfamilyowners (Gedajlovic & Carney, 2010). Hence, German inheritance taxes help maintainfamily ownership and so preserve the underlying value of the bundled assets furnishingfurther incentive to maintain the business in family control. In this sense, the German familyfirm is a “store of value,” and family beneficiaries will have an interest in maintaining theongoing value in the form of an inherited and undivided firm.

Thus, with regard to our first proposition, although inheritance law divides familyassets among siblings and spouses, there are few incentives to break up the firm and dividethe proceeds among individual inheritors. Since individual descendants cannot be disin-herited, and because the aggregate wealth of the family members is typically best pre-served by maintaining the business as a going concern (i.e., individuals lose value if thefirm were divided or sold), there are strong incentives for all inheriting family members toshare an interest in the continued viability of the firm and to avoid potentially divisiveconflicts. With the progression through the generations, however, the legal rights of moredistant blood relatives become diminished. Mittelstand firms may therefore be required toretain surplus capital to prune ownership by offering to purchase the acquired rights ofsuch family members. However, the retention of such reserves reduces the pool of capitalavailable for reinvestment and may inhibit the growth of the enterprise, which is consid-ered a weakness of Mittelstand firms (Homburg, 1999).


Moreover, consistent with our second proposition, the abolition of entails keepsfamily assets “on the market” and offers a benchmark for the efficiency of the firm’sperformance. That is, family members could collectively agree to sell the firm if aprospective buyer offered a price sufficient enough to induce a sale. Concluding,Berghoff (2006, p. 276) argued that “social approval and political support for the model”accounts for the remarkable staying power of the Mittelstand. This is consistent withproposition 1: estate taxes do not reduce the value of the family firm’s assets and arelikely to increase the firm’s lifespan. In sum, inherited capital retained in Mittelstandenterprises has a low probability of becoming dead money following intergenerationaltransmission. Indeed, the incentives to maintain the business as a going concern withinthe family and embedded in a local community will increase the probability that capitalis preserved and regenerated following inheritance.

“Why Doesn’t France Have a Mittelstand?”This question posed in an Economist article (The Economist, 2012b) draws attention

to weaknesses in France’s medium-sized enterprise sector. The article faults postwarFrench industrial policy that favored the development of large-scale, state-supportedenterprise while neglecting SMEs. Pichet and Lang (2012, p. 48) stated that “there is aconsensus today amongst economists and politicians regarding the comparative deficiencyof medium-size companies in France.” France has only half as many medium-sizedenterprises as Germany, and the average French firm has just 14 employees while theaverage German firm has 41 (The Economist, 2012c). Landes (1949) ascribed weaknessesin France’s SME sector to problems of control by conservative families and proposed thatFrance’s slow industrialization in the nineteenth century was due to the prevalence ofrisk-averse independent family businesses that assiduously shunned external financing.Landes also drew attention to the low status and prestige accorded to entrepreneurs and thepreference of their children to pursue careers in more prestigious professions, such as lawand medicine. He observed that the “inheritance of ownership is something very rarelyfound in France; the designation ‘& Son’, so common in England is almost unknownin France” (Landes, p. 56). According to Fukuyama (1995), French family firms wereunable to reap scale economies because they were unwilling to dilute control. Hedescribed a U-shaped distribution of firms in France, with a large population of very smallfamily firms at one end, a population of large firms that were the product of stateintervention at the other, and a “missing middle” (Fukuyama, p. 56) of intermediate-sizedorganizations.

French Inheritance LawHow does inheritance law explain the evident weaknesses of France’s midsize family

firm sector? Its foundations are contained in the country’s Civil Code, which was devel-oped during the turmoil of the French Revolution, beginning in 1790 and ending withits enactment in 1804 by Napoleon Bonaparte. The revolution established new inheri-tance principles based upon individual equality, liberty, and political goals designed tostrengthen the democratic foundations of the Republic through a balanced distributionof property. Prominent French social philosophers such as Montesquieu and Rousseauargued that equality was a precondition for personal liberty, and their influence providedthe philosophical logic for the principle of individual equality that became “a quasi-sacrednormative reference point for shaping inheritance law” (Beckert, 2004, p. 209). In this

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view, freedom is conceived as independence from the whims and dominion of others,including parents’ ability to determine one’s life chances. A persistent tension between asocial preference for equality and individual freedom to dispose of property has charac-terized inheritance law discourse since the introduction of the Civil Code (Beckert). In thedebate, the negative economic consequences arising from the fragmentation of familyestates is well recognized and frequently articulated, but the implementation of equalitybetween heirs provided reformers with an overriding imperative.

Testamentary Freedom. To achieve the goal of the equality, French inheritance lawrestricts testamentary freedom, like Germany’s, by establishing a réserve, an obligatoryportion of the value of an estate that must be divided equally among heirs. Unlike Germanlaw, French law embodies the concept of the individual estate and seeks to estimate itsvalue at the death of the individual. Considering each inherited portion of a partiallyindivisible estate as separate effectuates high estate and inheritance tax burdens, whichalters incentives with regard to the going-concern value of the properties. Inheritance lawhas been somewhat liberalized over the course of the twentieth century with provisionsfor réserve légales, a rule that allows grandparents to bequeath wealth to grandchildrenproviding children renounce their inheritance rights, and attribution préférentielles, a rulethat allows the transfer of an indivisible property, such as a family business, to one partyproviding the inheritor compensates the other legitimate heirs. However, the dominanttendency of French inheritance law is to restrict testamentary freedom and to institution-alize divided inheritances, which we suggest will typically undermine intergenerationalstrategies intended to extend the life of the family firm.

Entails. One of the first acts of the French Revolution was to abolish entailing, aninstitution that was fundamental to the existence of the aristocracy of the ancient régimeand which the revolution sought to overthrow. Subsequently, the state has been suspiciousof entailing trust-like instruments, and their uses have been heavily restricted. The Frenchequivalent of the English common law trust is the fiducie, but it is used solely forcommercial transactions (Sitkoff, 2013). The fiducie offers no fiscal advantages in inheri-tance law and is not used for generational wealth transfer. In particular, it cannot overrulethe rights of protected heirs in French inheritance law. In the absence of trust instruments,French families have a system of holding companies, often consisting of multiple layersor pyramids to separate the ownership of cash flows from the original company as a meansof shielding wealth from divisive inheritance rules.

Death Taxes. Perhaps the defining feature of French inheritance law is a heavy burdenimposed by inheritance and estate taxes that reduce the value of estates.1 French lawassesses both estate and inheritance taxes, which at the beginning of the twentieth centurycould amount to some 80% of the aggregate inheritance. First, to meet heavy estate taxburdens may require sale of the firm’s assets, which is likely to undermine the firm’ssurvival prospects. Second, unlike Germany where inheritance taxes are both low and canbe deferred, inheritance taxes are higher and cannot be deferred, further reinforcing thepossibility of assets sales. Moreover, inheritance law evaluates estates at their full assetvalue, not at their net value; outstanding mortgages, for example, could not be deducted.This provision discourages the use of debt, often leading to the severe undercapitalization

1. Owners can avoid inheritance and estate taxes by transferring property prior to their death. However, giventhe deeply embedded social preference for equal inheritance, fragmenting tendencies still prevail.


of family businesses (Landes, 1949). The result is that founders’ capital is heavily reducedby taxation, and the residual is divided among multiple heirs with differing aptitudes andmotivations for managing a family enterprise.

Consistent with proposition 1, restrictions on testamentary freedom and death taxessignificantly reduce the asset base of founder-created firms; both factors serve to divideand reduce family firm assets. While restrictions on entails and trust facilitate the reallo-cation of capital, the effect of restrictions on testamentary freedom and death taxes is toreduce the vitality and survival tendencies of family firms and, at least in part, explainswhy France does not possess medium-sized firm sectors comparable to the Mittelstand.

The Single-Generation Ethnic Chinese Family FirmThe consensus of the ethnic Chinese family firm literature is that they rise and fall

very quickly, generally within a single generation (Redding, 1990; Tam, 1990; Wong,1985; Zheng, 2010). Public family firms in Hong Kong lose an average of 56% of theirmarket value within 5 years of the passing of ownership and control to successors; thisvalue is never recovered in a subsequent time period (Fan, Jian, & Yeh, 2008). Chinesefamily firms are also subject to centrifugal forces that lead to their “perennial fissioning”(Tam). These forces arise from the deeply ingrained normative preference for equalinheritance among sons (Zheng). Furthermore, Redding (p. 216) noted that such firms inHong Kong adopt simple, highly centralized organizational structures in which “complexintegration is avoided . . . organizations subdivide when they are large into more or lessseparate units each with its own products and markets.” This results in a tendency forfounder-managed firms that relinquish control to enter a phase of gradual segmentation(Wong).

Despite the rapid fragmentation of the founders’ capital base, Hong Kong has avery large population of small- to medium-sized family firms that is constantly self-regenerating. While their founders exercise nearly absolute authority in utilizing the firm’scapital, Wong (1985) suggested that founders do not perceive the capital as their ownpersonal property, but rather see themselves as the trustee of an estate that belongs to malechildren, and “a good trustee must create an endowment to the family estates to ensure thatthere are valuable assets to transmit to future generations” (Wong, p. 64). Despite thefragmentation of family capital, Hong Kong has historically generated impressiveentrepreneurship and new-firm founding rates (Yu, 1998). Social values describedas “entrepreneurial familism” (Wong) are characterized as a major driver of economicdevelopment (Whyte, 1996). Greenhalgh (1989, p. 90) claimed that family entrepreneur-ship in the Chinese family “offers its core economic actors, traditionally adult males, apackage of individual incentives and group insurance against failure that encourages theemergence of highly motivated, risk-taking entrepreneurs.”

Hong Kong Inheritance LawHow have family firms in Hong Kong come to exhibit entrepreneurial dynamism and

a short average lifespan? We suggest that the interaction of inheritance law and deeplyembedded normative preferences for the division of estates among males facilitates thephenomenon of entrepreneurial familism.

Testamentary Freedom. Hong Kong law and the foundations of its inheritance law arebased on English common law, which has not changed with the return of sovereignty to

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China. Inheritance law is adopted from the English Wills Act of 1837, which wasenacted in Hong Kong in 1844 (Evans, 1980). The application of English common lawby colonial jurists often accommodated local cultural norms and religious preferences(Chung, 2003). In Hong Kong, inheritance law evolved to incorporate elements ofChinese customary law and in particular to recognize the deeply held normative pref-erence for dividing estates equally amongst male children (Tan, 1999). The result of thiscombination of English and Chinese law is that individuals enjoy almost absolute tes-tamentary freedom, with no restrictions on individuals to whom an estate may devolveprovided there are no children, and have tended to divide their estates according to thewidely held customary Chinese norm of equal inheritance among male descendants(Zheng, 2010).

Entails. While English common law facilitated customary preference for equal inheri-tance, the application of common law heavily restricted Chinese customary preferencesfor the creation of trusts. Historically, Chinese customary law provided for the creationof perpetual lineage estates, called “tongs,” which are the functional equivalent ofEuropean feudal entails or modern perpetual trusts (Chung, 2010). Tongs represent acustomary method for accumulating and retaining wealth in the form of a religiousendowment in the name of a deceased ancestor. Because customary Chinese businessactivity is embedded in a network of kinship, ethnicity, and personal relationships, tongsfrequently intertwined familial and business capital. Tongs were traditionally employedas a complex corporate ownership structure for collective family shareholding of pro-perty and business investment as well as serving spiritual ends (Chung, 2003). Whilecolonial jurists accommodated preferences for equal inheritance among males they wereless inclined to accommodate preferences for creating religious trusts. Chinese tongsrepresented a legal ambiguity for the colonial authorities in Hong Kong because theyviolated the English common law “rule against perpetuities,” a rule that forbids anyvesting of property beyond the period of the life of persons living at the time of thedisposition. Consequently, tongs were prohibited for the purposes of accumulatingfamily capital in English colonial jurisdictions with large Chinese populations (Chung,2003). While the prohibition of tongs denied the Chinese population of its customarymethod for intergenerational transmission of collective wealth, it did ensure that thecapital would remain outside the “dead hand” of the perpetual trust and preserves itsavailability for reallocation. Moreover, Hong Kong residents have traditionally madelittle use of Western-style trusts, which have important tax deferral and avoidance quali-ties. Due to the complete absence of death taxes (see below), Western-style trusts haveno such tax advantages in Hong Kong.

Death Taxes. Hong Kong applies neither estate nor inheritance taxes. While there aremodest taxes on inter vivo transfers of immovable property and Hong Kong stock, thereis an exemption on transfers arising on death. So while an estate can be heavily divided atinheritance (unless the family produces a single son), estates are not reduced by tax;compare this with France, where estates are both divided and heavily taxed. Consequently,consistent with proposition 1, the entire portion of a founder’s estate is available forreallocation. Consistent with both propositions 1 and 2, the prohibition on traditionaltrusts combined with the absence of inheritance taxes and the customary practice of equalinheritance among male children ensures that capital stays unlocked and on the marketfor reinvestment in new enterprise. We reason that this specific conjunction of inheritancelaws is an important driver of Hong Kong’s prevailing pattern of single-generationfamily firms.


The Three-Generation Dynastic U.S. Family FirmThe law and finance hypothesis predicts that since United States-based family firm

owners can be confident that their property rights are protected by law, conditions arepropitious for a rapid transition to widely held ownership and professional management(Burkart, Panunzi, & Shleifer, 2003). The efficiency of handing over control to profes-sional managers in the United States has been well established (Perez-Gonzalez, 2006;Villalonga & Amit, 2006). Moreover, the family firm life cycle hypothesis suggests thatfamily firms will evolve toward being widely held firms where there is an active marketfor corporate control, since the market provides greater opportunity for a family to sell itscontrolling stakes at a premium (Franks, Mayer, Volpin, & Wagner, 2012). Each of theseperspectives suggest that a publicly listed family firm will tend to be short lived in theUnited States because there are both incentives and mechanisms to enable their transitionto widely held corporate ownership and professional management.

However, another body of literature points to lingering and substantial multigenera-tional family ownership in managerially controlled firms in the form of shares controlledby third parties such as trusts, endowments, and foundations, often described as the“establishment” or “old money” families (Palmer & Barber, 2001). Hence, althoughthe management is extensively professionalized, U.S. publicly listed firms retain familyinvolvement through board participation or controlling equity interests (Anderson &Reeb, 2004) that is often exercised through the agency of the trustee.

Friedman (1964) distinguished between the caretaker trust, a short-term instrumentfor the maintenance of widows and orphans, and the three-generation dynastic trust, whichrequires the delegation of substantial discretion to a trustee. The establishment of a trusteecreates a surrogate to manage dynastic trusts in an agency relationship interveningbetween the settlor of the trust, family beneficiaries, and the professional managers of theoriginal family firm (Marcus, 1980) in an organizational arrangement we describeas the double separation of ownership and control, which we return to in the discussionsection of this paper.

American Inheritance LawMuch inheritance law in the United States is the jurisdiction of the states. Federal

influence is, however, strongly felt through taxes levied on estates and incomes derivingfrom inheritances. The evolution of the law arises from a tension between the two levelsof government and in part reflects a state’s interests in retaining trust in capital ratherthan contributing to federal revenues through death taxes (Hirsch, 2009) or through trustcapital transfers to states with more liberal trust laws. Competition among states toretain capital can produce a nationwide diffusion of similar statutes. Thus, although thereare interstate variations in rules, it is possible to speak of U.S. inheritance law in moregeneral terms due to similarities between states that eventually emerge through regulatorycompetition (Hirsch).

Testamentary Freedom. U.S. law evolved from English common law and providesalmost unlimited testamentary freedom, with the only compulsory component concerningprovisions for a surviving spouse. Commenting on the U.S. law’s current state, Hirsch(2009, p. 239) suggested that the scope for freedom of testation “is as broad as it has everhas been” and “without parallel elsewhere in the Western world.”

Death Taxes. Reflecting its common law heritage and founding constitutional concernfor individual liberties, U.S. inheritance law has changed little over the centuries in its

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emphasis upon institutionalizing individual rights (Beckert, 2004). The most notabledepartures from this continuity are developments concerning estate taxes and the rise ofthe trust as a legal instrument of inheritance strategies. The reference points for thedebates on estate tax center on proponents’ commitment to the principles of the merito-cratic society, equality of opportunity, and associated concerns over the consequences ofconcentrated wealth. In contrast, opponents view estate tax as an unjustified interferencein private property and a source of economic inefficiency by reducing the stock of capitalavailable for investment. An estate tax was first introduced in 1916 with the express goalof reducing the oligarchic concentration of wealth, with further impetus given under theNew Deal logic of redistribution (Beckert). But opponents have persisted in seeking toreduce and abolish the estate tax, which they succeeded in doing when then-PresidentGeorge H. Bush eradicated the tax in 2000 on the grounds that it did not raise significantrevenue, but with a provision for its reintroduction in 2010 (Graetz & Shapiro, 2011).

Entails. Wealthy testators have found ways to avoid or postpone estate taxes, largelythrough the creation of trusts. The use of trusts as a mechanism for preserving familywealth increased continuously throughout the nineteenth and twentieth centuries(Friedman, 1964; Marcus, 1992). Because a trust upholds the individual rights of itssettlor, it necessarily restricts the testamentary freedom of the beneficiaries, who mayenjoy the fruits of the trust but may not dispose of the underlying assets. In this sense,beneficiaries have ownership without control of the underlying assets. To strike a com-promise between the testamentary freedom of inheritors versus the dead hand of the trustsettlor, legislators have historically favored the use of the common law “rule againstperpetuities,” the rule that eventually grants beneficiaries full control rights. In the UnitedStates, this compromise was undone in 1986 when Congress introduced the generation-skipping transfer tax, designed to close the tax postponement loophole available in thedynastic trust. Individual states responded by abolishing the rule against perpetuities andallowing for the creation of perpetual trusts (Dukeminier & Krier, 2003), which permitsestate taxes to be permanently postponed. Perpetual trusts represent a throwback to feudalentailing in that the settlors of a trust possess the power to mandate specific uses of wealthin perpetuity, a legal provision in which “the US stands out as a country peculiarlydeferential to the wishes of the dead” (Hirsch, 2009, p. 240).

With respect to proposition 1, the interaction of testamentary freedom, death taxes,and trusts in the United States tends neither to excessively reduce nor divide family firmassets. This is because testamentary freedom and the capacity to avoid estate tax throughthe creation of trusts allow for the stabilization of the firm’s capital base. The impact ofinheritance law on family firm longevity dynamics in the United States are primarilygoverned by proposition 2. In theory, trustees may reallocate capital from lower- tohigher-value activities, but trustees are perhaps better known for their conservatism andrisk aversion with respect to assets placed under their trusteeship.

Having been institutionalized as instruments of family wealth transfer, the lawsgoverning the administration of trusts became a primary element of inheritance law. Thelegal standard applied to trusts that was widely adopted during the nineteenth century wasthe requirement that trustees exercise the highly conservative fiduciary investment stan-dard of the “prudent person.” This standard prohibits speculative investment and empha-sizes the safety of capital. The rule was liberalized in the twentieth century to a “prudentinvestor,” which reflects advances in financial portfolio theory and essentially requires thattrustees diversify the trust’s assets (Dukeminier & Krier, 2003). Nevertheless, trustsremain oriented toward cautious investment. Accounting and legal fees can significantlyreduce the overall return on trust investments, and these fees tend to expand with the


multiplication of beneficiaries as trusts are progressively divided over the generations.Moreover, underperforming trustees are not easily replaced; this requires recourse to thecourts. Locking family wealth into a trust, therefore, heavily regulates its allocation andestablishes a central tendency to favor wealth preservation over wealth generation, whichbroadly corresponds to our conception of “dead money.”

Discussion

Our comparative institutional analysis has broadly surveyed the contrasting relation-ships between inheritance law and family firm vitality and longevity in four distinctjurisdictions. Due to space constraints, a comparative analysis must limit the depth ofinstitutional detail that can be illustrated and explicated in any particular context. Table 1summarizes the main differences between inheritance law regimes and their divergentoutcomes for family firms, and gives a clear sense of the external influences onintergenerational outcomes. In Germany, profound skepticism of economic liberalism andindividualism led to the institutionalization of limits on testamentary freedom. The effectof German Civil Code inheritance provisions enables the family unit to become joint heirsto estates. These provisions and a negligible inheritance tax assessed upon conjugal familymembers who commit to maintaining employment in a going-concern firm preserve theunity of the capital base and foster the persistence of adaptive, multigenerational smallto medium-sized family-controlled firms. While these firms often encounter difficultyraising external finance, which can inhibit their growth, the inheritance law regimecontributes to the development of a sustainable system of internal financing. Germaninheritance law institutionalizes “a sense of the family” (Beckert, 2004) and familyowners of Mittelstand are able to draw upon this widely available social capital to preservea living knowledge of craft technology. The longevity and cohesion of the family firmlikely assists in the accumulation and preservation of tacit and intangible knowledge, andprovides a continuing base of competitive advantage in the modern era.

Table 1

Inheritance Law and Family Firm Outcomes in Four Jurisdictions

Jurisdiction Germany France Hong Kong SAR United States

Legal origins German civil code French civil code English common law English common lawTestamentary freedom Restrictive Restrictive Unrestrictive UnrestrictiveEntailed trusts Limited Prohibited Prohibited Perpetual trusts

permittedEstate tax burden Low High None IntermediateHistorical sociocultural

inheritance preferenceMale primogeniture Male primogeniture Equal inheritance

among malesMixed

Family firm longevityoutcomes

Large long-lived SMEsector (Mittelstand)

Underdeveloped SMEsector

Single-generationfamily firm andspontaneouslyregenerated SMEsector

Family firmtransformation intoprofessionalmanagement andasset stewardship inconservative trusts

SME, small- to medium-sized enterprise.

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In comparison, the social and political history of France since the revolution hasemphasized the equality of individuals before the law. The French Civil Code restrictstestamentary freedom and requires significant mandatory shares of an estate be subject tothe principle of equal inheritance. A residual anxiety about the reappearance of oligarchicfamilies in politics led to the abolition of entailing, strict limits on trusts, and a highlyprogressive estate and inheritance tax regime. Moreover, inheritance taxes heavily divideand reduce the value of estates available to succeeding generations. It is difficult to sustainthe vitality and longevity of family firms in this inheritance environment, and the absenceof a dynamic family firm sector in France is frequently observed in contemporary indus-trial policy discourse.

By contrast, Hong Kong inheritance law permits unlimited testamentary freedom and,when combined with social values that favor partible inheritance, the rapid fragmentationof the family firm follows. Common law rules against perpetuity deny the populationaccess to their preferred instrument for entailing property in multigenerational trusts(tongs), which serves to unlock capital from the dead hands of ancestors. The absence ofestate and inheritance taxes also preserves unlocked capital for reallocation. In Redding’s(1990, p. 134) memorable phrase, “potential dynasties are constantly dissolving,” butfamily firms are also continually revitalizing through a process described as entrepre-neurial familism.

In the United States, strong investor protection and liquid capital markets allow familyfirms to make the transition toward professional management at a time of the founder’schoosing. Consistent with prevailing social values, inheritance law institutionalizes indi-vidual rights and provides for almost unrestricted testamentary freedom. While the found-ers of the republic abolished entailing, testamentary freedom is widely used to recreateentail-like instruments in the form of dynastic and perpetual trusts. Although estates aresubject to taxation, the evolution of trust law enables founders to postpone taxes andappoint trustees, or surrogates, to oversee continuing control in the enterprises theyfounded while allowing inheritors to slowly reduce their involvement in the managementof the firm. The effect of long-term trusteeship is to preserve the cohesion of capital forseveral generations, but capital is managed with a bias toward wealth preservation overwealth generation.

The contribution of our comparative institutional analysis is to identify specificinstitutions of inheritance and to consider their interaction with one another, while situ-ating these institutions within the broader environment of a jurisdiction’s prevailingpolitical and social values. In doing so, we show that factors external to family firmscombine with one another in different ways to produce highly divergent outcomes withrespect to professionalization, the probability of successful intrafamily succession, thetemporal cohesion of a family firm’s capital base, and the probability of a firm’sintergenerational longevity. While we have only scratched the surface, the implications forthe future study of succession and professionalization in family firms suggests that moreattention must be given to the consequences of legal institutions and social norms regard-ing inherited wealth. The broad strokes we have used in describing these interactionsnecessarily leave out much essential detail. For example, we have not considered thecomplexities arising from intestacy and the legal institutions that govern the disposal ofproperty of individuals who did not make a legally valid testament. The significanceof intestacy laws lays in the state’s assumption of what the testator presumably wouldhave stipulated had she left a will and acted in a reasonable and socially appropriatemanner (Beckert, 2004). Moreover, we have only made passing reference to the evolutionof family trusts in Germany, France, and Hong Kong. However, we offer a brief discus-sion of trusts in the U.S. inheritance traditions that suggests further examination of the role


of founder succession and wealth-preservation strategies in different jurisdictions will bea fruitful avenue for future research.

The Role of Surrogates in the Governance of Inherited Family Firm AssetsMuch of the literature on transgenerational succession is focused on efficiency issues

and the performance of family successors, who typically underperform founders due tofactors such as inferior ability, emotional attachment, and risk or loss aversion. However,much of this literature overlooks the possibility that founders are likely to be influencedby the laws governing their property rights and the incentives they face in the disposal oftheir personal wealth. In North America, inheritance law provides both incentives andmeans to place wealth beyond the founding firm and into the hands of corporate thirdparties in the form of trustees and other types of agent. How these agents generate,preserve, or destroy wealth, relative to family successor or professionally managed firm,is rarely considered.

In an overlooked body of work on the early twentieth century development of U.S.trusts, Marcus (1980, 1983, 1992) identifies the role of the legal surrogate in the financialaffairs of wealthy “old money” business families. Surrogates are fiduciary agents fromoutside the family who are introduced, typically by the firm’s founder, into the intimatemanagement of family beneficiaries’ hereditary entitlements while overseeing the activitiesof professional managers in the founder’s core businesses. The idea of surrogacy is alsofound in the small literature about adoption and marriage as mechanisms for introducingtalented outsiders into the management of the firm’s affairs in the absence of qualifiedfamily members (e.g., Mehrotra, Morck, Shim, & Wiwattanakantang, 2011). However,Marcus’s focus is the more prevalent practice of incorporating rational-legal authority, inthe guise of fiduciary agents, as a surrogate for the founding patriarch as the primary sourceof financial authority within the family. This is an underresearched phenomenon incontemporary family business research since much recent work has focused upon altruistic(Schulze et al., 2003) and social and emotional attachments of family members to theirbusiness assets (Gómez-Mejía, Makri, & Kintana, 2010). However, Marcus’s recognitionof the role played by the rational-legal authority represented by a trustee in sustainingfamily capital stands in stark contrast to the altruistic and emotional narrative. Marcus(1980, p. 860) argues that “family/business formations have achieved durability in abureaucratized society by assimilating, rather than resisting, characteristics of formalorganization which are usually assumed to be antithetical to kin-based groups.” Thefounder’s insertion of an impartial arbiter of financial and business affairs within the familyas part of a transgenerational wealth strategy anticipates emotional complications with arational corporate mechanism that carries the full legitimacy of the law.

The legal instrument documented by Marcus that undergirds the durability of a familyfirm’s capital base is the dynastic trust, which enables its founder to perpetuate a set ofcontrolling interests in the firm by appointing a trustee to administer family capital whiledecoupling personalized and emotional family interests from interfering in the firm’sactivities. Dynastic trusts typically enjoyed a life span of three generations, allowing forthe gradual and mostly harmonious dilution of multigenerational family ownership overapproximately 90 years. In an effort to compensate for the conservative financial biasof the dynastic trust (Friedman, 1964), the founders of large fortunes have sought todevise novel instruments that loosen the strict fiduciary responsibility of trusteeshipthrough legal entities such as private trusts or family holding companies (Hughes, 2013),single and multifamily offices (Wessel, Decker, Lange, & Hack, 2013), and familyadvisories (Strike, 2012). Continuing developments in trust, estate, and securities laws

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have subsequently widened the range and scope of these novel forms of surrogacy asinstruments of founders’ transgenerational succession strategies. However, the agentswho manage these wealth management devices are subject to less binding standards offiduciary conduct (Boxx, 2012).

By placing family assets in the hands of quasi-trust instruments, founders furtherseparate beneficiary ownership and control by inserting a second agent between thebeneficiaries and professional managers of the firm’s assets. In so doing, foundersestablish a double agency relationship (Arthurs, Hoskisson, Busenitz, & Johnson, 2008;Child & Rodrigues, 2003) in which agents monitor other agents in a vertical sequenceof double separation of ownership and control. The promised advantage of doubleagency is based on the general idea of employing an incentivized and expert monitor,such as pension funds and institutional investors, to oversee the actions of professionalmanagers on behalf of minority investors (Black, 1992). However, subsequent analysisof double agency relations have increasingly documented the tendency for third-partyagents, such as auditors, attorneys, and securities analysts, to become complicit andacquiesce with managerial agents in expropriating owners’ wealth rather than protectingtheir interests (Coffee, 2006; Woidtke, 2002). Legal scholars have only recently begunto document the scope of double agency problems, such as self-dealing and conflict ofinterest, in novel corporate arrangements increasingly used to manage the family wealth(Boxx, 2012).

While the use of legal surrogates is proliferating around the world (Wessel et al.,2013), with few exceptions (e.g., Decker & Lange, 2013) the management and familybusiness literature is silent on their potential for double agency costs. Instead the lit-erature emphasizes issues such as knowledge sharing, managing family emotional con-flict, and generating trust relationships between family and professional advisors (Kaye& Hamilton, 2004; Reay, Pearson, & Gibb-Dyer, 2013). The family advisory literatureemphasizes a strong mutual concern for confidentiality (Strike, 2012), which can rendersurrogate behavior and performance nontransparent and may heighten the risks ofdouble agency structures. Moreover, once established, legal surrogates take on a lifeof their own to become an autonomous form of corporate organization. As Marcus(1983, p. 226) notes, eventually the most durable parts of the founding family firmbecome “the fiduciary managed organization of patrimonial capital.” The growing popu-larity of legal surrogates in the administration of family wealth in different jurisdictionsaround the world call for more rigorous analysis of their agency costs and benefits thatis hitherto lacking.

Despite the potential for double-agency problems, legal surrogates can also bring acalculative and formal-rational authority to the management of family capital. The limitedacademic literature suggests that trusted advisors and family offices can play an importantrole in reallocating capital from low- to higher-value activities by performing venturecapital and private banking functions. In a rare study of the family office phenomenon,Dunn (1980) chronicles the activities of the Weyerhauser single-family office, which overa 50-year period exercised control over a family fortune arising from the S&P 500 lumberand paper company. In addition to managing a number of beneficiary trusts, Dunn detailshow the family office used family capital to bail out troubled Weyerhauser subsidiaries;held and managed its extensive patents, property titles, and land leases; provided privatebanking service to family members for entrepreneurial ventures; and led efforts to diver-sify the fortune into high-tech industries.

Thus, while the contemporary literature holds that family firms are risk and lossaverse with respect to diversification and new ventures (Chrisman & Patel, 2012;Gómez-Mejía et al., 2010), the proliferation of legal surrogates as guardians of family


wealth suggests that the locus of control for business families’ risk management decisionsare increasingly located not at the level of the family firm, but are instead sequestered inthe less visible activities of the family office or private trust. Consequently, the dynamicreallocation of family firm capital may be located upstream from the core family businessand underestimated by studies that focus upon the firm level of analysis. Whether theseagents breathe new life into potentially dead money by launching new entrepreneurialventures or exploit their opaque positions for self-dealing purposes is far from clear.

Conclusion

We have established that a confluence of inheritance law and deeply embeddedpolitical and social values interact to produce an institutional matrix of factors external tothe firm that in different jurisdictions produce diverse central tendencies with respectto family firm efficiency and longevity over the generations. Unravelling and delineatingthe causal relationships among these diverse factors remains a significant challenge forfuture research.

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Michael Carney is Professor of Management at the John Molson School of Business, Concordia University,Montréal, Québec, Canada.

Eric Gedajlovic is Beedie Professor of Strategy and Entrepreneurship at the Beedie School of Business, SimonFraser University, Vancouver, British Columbia, Canada.

Vanessa M. Strike is the CIBC Professor in Applied Family Business Studies in the Organizational Behaviourand Human Resources Division at the Sauder School of Business, University of British Columbia; and theScientific Director of the Erasmus Centre for Family Business in the Department of Strategic Management &Entrepreneurship at the Rotterdam School of Management, Erasmus University. She may be reached at:[email protected].

We would like to thank Jim Chrisman and two anonymous reviewers for their comments and suggestionsin helping us develop the paper. Michael Carney acknowledges the support from the Social Sciences andHumanities Research Council of Canada.

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Dead Money: Inheritance Law and the Longevity of Family Firms

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