Family Businesses in Mainstream Economic Literature

FBs can be analyzed through agency theory. Jensen and Meckling considered that an agency relationship, which is a contract where the “principal” engages an “agent” to perform a service on their behalf, could be applied to the problem of “separation of ownership and control” between shareholders and managers in a public ownership corporation.Footnote ¹² As these two groups have different incentives, there will always be costs associated with the desire of the principal (shareholders) to ensure that the agent (managers) makes optimal decisions in the principal’s interest. These agency costs will be: monitoring costs (to control the activities of the agent), bonding costs (guarantees that the agent will ensure that their actions will be beneficial to the principal), and the difference between the agent’s decisions and those maximizing the welfare of the principal. Jensen and Meckling consider that in the case of an owner-manager, if the fractional ownership falls, the incentive to seek out new profitable ventures will be lower and the incentive to extract rents will increase: so there will always be agency costs due to the divergence of interests between the principal (minority stockholders) and the agent (the owner-manager).Footnote ¹³ Ownership of 100 percent of the capital by the owner-manager would lead to zero agency costs in such a company. Then, in a FB, agency costs are lower because there is an alignment of the incentives of the shareholders and managers, who are the same or belong to the same family.Footnote ¹⁴

One of the limitations of agency theory is its exclusive focus on incentives. The transaction costs approach considers that human nature is based on bounded rationality and opportunism, leading to a situation where most contracts are incomplete and their implementation uncertain.Footnote ¹⁵ The firm is a “governance structure” with the lowest transaction costs—costs of planning, adapting, and monitoring the contracts—when these transactions concern specific assets and face uncertainty.Footnote ¹⁶ The transaction cost approach recognizes the role trust can play in the organization of a company and considers that a FB has lower transaction costs: due to the role of family trust, FBs offer advantages in terms of incentives and controls—managers, expecting a continuing relationship, “are less tempted to sacrifice long-run advantages for short-run gains” and are easier to monitor—as well as disadvantages, such as a high risk of conflicts, tolerance of inefficient behavior, and lack of talent in the family.Footnote ¹⁷

Family Businesses as a Mode of Coordination

These theories are too restricted to address the question of FBs. First, the transaction cost approach is close to agency theory as it considers maximizing self-interest as the only goal of the economic agent.Footnote ¹⁸ The FB is not exclusively an organization looking for the highest return for its shareholders. Analysis of the FB requires a theoretical background that insists on the relations between political, social and economic spheres. The institutionalist approach appears more appropriate for understanding FBs. For Polanyi, the economic system is embedded in the social system and man does not act to protect his self-interest but his social position.Footnote ¹⁹ Other institutionalists consider that there are deep interrelations between the political environment and the market system.Footnote ²⁰ The economic system governing transactions and disposition of goods then acquires unity through a combination of “patterns of integration.”Footnote ²¹ One is based on “reciprocity”: these are relations based on symmetry in kinship groups which allow the individual to respect a code of honor. Another is “domestic administration” where people take care of their related group (family, village, etc.). Redistribution through a center and exchange through markets are the other “forms of integration.” Kornai refers to modes of coordination of transactions, these mechanisms being related to specific rules organizing the relations between persons.Footnote ²² He distinguishes five modes of coordination: bureaucratic coordination, market coordination, self-management, ethical coordination (which may be based on reciprocity, on expecting mutual help or on one-sided altruistic behavior), and family coordination (between family members). So, the family could be considered as a “mode of coordination” alongside other mechanisms like market or bureaucracy. This means that a study of FBs in LDCs through the institutionalist theoretical framework should be especially relevant, for three reasons.

A renewed interest in FB studies emerged in the 1990s. This new trend in research has developed a vision of the FB as an economic organization embedded in its societal, political and cultural environment.Footnote ²³ An institutionalist view of FBs is also justified because in LDCs family businesses have been able to develop their own institutional arrangements to achieve the development of “capitalism from below.” If the market transition initiated by the Chinese government at the end of the 1970s created opportunities for these “entrepreneurs from below,” which were very often FBs, this “army of entrepreneurs,” through institutional innovations, mutual monitoring and enforcements in crosscutting networks of like-minded actors, generated a social dynamic which allowed the adoption of formal rules and better protection and enforcement of property rights.Footnote ²⁴ In Vietnam in the 1990s, companies put in place their own institutional arrangements to compensate for the inability of the state to impose the rule of law: contracting took place without formal laws, and companies—most of them FBs—used other instruments, like scrutinizing potential trading partners or trust developed through longer duration of trading.Footnote ²⁵ Moreover, an institutionalist framework to study FBs is especially relevant in LDCs where there are interrelations between social, political and economic changes. In South-East Asia, the governance of Chinese FBs is embedded in the traditional system of inter-personal relations based on trust known as guanxi.Footnote ²⁶ Chinese family structures have changed in order to make FBs more conductive to modern economic activities—the balance of power is more favorable to younger generations and women in the governance system—but the maintenance of deeply felt family obligations makes it possible to have a devoted workforce in FBs.Footnote ²⁷ Family businesses in LDCs are also indicative of interrelations between the political and the economic system. FBs as organizations, due to some special “qualities” (concentration of power, long-term view, secretive culture), can develop “privileged” relations with the political system.Footnote ²⁸ Nevertheless, it has also been proved that, in some cases, state policies have also had a deep impact on FBs: public policies supported the development of FB groups in South Korea and Malaysia but could also be considered as detrimental to their interests, for example in India after independence.Footnote ²⁹

FBS as a Mode of Coordination in Iran

Before the 1979 revolution, FBs dominated the Iranian economy. By the mid-1970s, the private sector represented 75 percent of industrial production.Footnote ³⁰ Most of the largest companies were FBs, with 85 percent of the largest privately owned firms owned by forty-five families.Footnote ³¹ Successful entrepreneurs like Mahmoud Ladjevardi (who created the Behshar Group), Mohamad Taghi Barkhordor (Pars Electric) and Mohammad Rahim Motaqi Irvani (Kafsh Melli) were then a reality. They benefited from a booming economy due to increasing oil revenues, but also demonstrated exceptional qualities in terms of leadership.Footnote ³² After the revolution, banks, insurance companies and many large manufacturing enterprises were nationalized.Footnote ³³ According to Article 44 of the 1979 Constitution, a large section of the economy had to be publicly owned.Footnote ³⁴ Since then, the private sector has only controlled around 20 percent of GDP.Footnote ³⁵ In addition, the average size of FBs has been considerably reduced. For example, in 1976, in the manufacturing sector, companies were divided in terms of size between 5,432 large companies (more than ten employees) with 98 percent of them belonging to the private sector, and 165,000 small companies (of fewer than ten employees) from the private sector.Footnote ³⁶ In 2002, in the manufacturing sector, one could find 16,305 companies of more than ten employees (most of them belonging to the public sector) and 426,117 of companies of fewer than ten employees (belonging to the private sector).Footnote ³⁷ In the private sector, the average number of working-class employees per employer declined from 16.3 in 1976 to 3.1 in 2006.Footnote ³⁸ Besides, the percentage of self-employed people in the employed population aged ten or over (who may rely on the work of unpaid family workers) increased from 31.9 percent in 1976 to 35.1 percent in 2015.Footnote ³⁹ Moreover, the nationalization process traumatized the Iranian private sector as the most successful entrepreneurs were suddenly accused of “collaboration” with the previous regime and their assets confiscated.Footnote ⁴⁰ Uncertainties in the business environment were amplified afterwards, due to the war with Iraq and economic sanctions, especially from the US.Footnote ⁴¹ Iranian FBs have also had to face the regular use of violence by quasi-public organizations to suppress competition.Footnote ⁴² These quasi-public organizations are composed of companies belonging to the bonyād and the Islamic Revolutionary Guard Corp (IRGC). The bonyād are quasi-public organizations created after the revolution: they became the owners of the companies confiscated from private businessmen. Benefiting from tax exemptions and political support, some of these organizations have become huge.Footnote ⁴³ The IRGC, the ideological army of the regime, also developed significant economic activities.Footnote ⁴⁴

FBs in Iran as a Mode of Coordination Related to a Low-Trust Environment

In Iran, trust inside FBs is important, because of a pronounced distrust of the external environment. This reflects a general lack of trust in formal institutions. Several interviewees referred to the lack of legal protection, “especially if you haven’t the right connections.” One referred to the erratic application of the rule of law. Others would talk of a threatening environment after the Revolution due to the development of “social corruption.” Several managers criticized the inefficiencies of commercial justice which led Iranian businessmen to prefer to work within the family because they feared that, in the event of a dispute with non-family partners, it would be impossible to resolve it in court. Interviewees shared the view that the government only “protected” “insiders.” The perception is that one cannot trust the government because it is not fair and advantages its “cronies.” Interviewees made a distinction between real “entrepreneurs” and “rent-seekers” able to obtain special advantages due to their connections with the state. Some interviewees call these rent-seekers, khoṣulati: these companies are successful only because they get special advantages from the government.Footnote ⁶⁶ According to one interviewee, “the system is not fair because these [non-productive] people would not be able to manage a grocery store or a bakery!” Managers of FBs consider that the government has created “rules of the game” which allow these khoṣulati to prosper. One interviewee said: “there is an unwritten rule in Iran: who are your friends?” For one interviewee, “the government does not want proper institutions to develop because it would lead to less rent-seeking activities for its cronies.” Another declares that he “refuses a state that gives advantages to some and deprives others.” The perception is that the government has created “rules of the game,” to use Baumol’s expression, which have favored the unproductive and well-connected.Footnote ⁶⁷

There is clearly a deficit of vertical trust in Iran since the revolution. There is both a top-down explanation for this lack of vertical trust—the unfairness of the law and order institutions—and a bottom-up explanation—high levels of economic inequalities leading to high levels of corruption and a perception of the legal system as unfair.Footnote ⁶⁸ The state being considered by some as inefficient and unfair, it is logical to avoid taxes: one FB manager said, “FBs prefers to pay khoms and zakāt because at least they can give access to Paradise … if we pay our taxes to the government, we don’t know what will happen.”Footnote ⁶⁹ FBs do not consider the state as acting in the general interest and this de-legitimization of the state can justify fiscal avoidance.Footnote ⁷⁰ This lack of vertical trust has also led to a “strategy of discretion.” One FB manager declared that some small FBs do not reveal their real addresses, do not have any signboards describing their activities and do not keep a register of their employees as they do not want to pay social contributions. This lack of vertical trust has also generated a deficit of horizontal trust. The inefficiencies of the legal system have led people to avoid working with potential partners due to potential conflicts: it is considered safer to work inside the family. That confirms the complementarity between vertical and horizontal trust.Footnote ⁷¹ Nevertheless, in some cases FBs could also develop horizontal trust in order to compensate for the lack of vertical trust. One interviewee referred to a situation where, due to the loss of a public contract for “political” reasons (the contract being allocated to a para-public company), the company nearly went bankrupt: “the employees decided to stay and to work for several months without any salary until the company was profitable again.” Another referred to an “emotional relationship” with clients, that can lead to the acceptance of payment delays and the avoidance of commercial legal proceedings. This confirms the ability, in some cases, of a private order to be a substitute for a non-functioning public order as experienced in Central and Eastern Europe.Footnote ⁷²

The interviews did not describe an absolute distrust of public institutions and of the rest of the population. Some, especially the younger entrepreneurs, considered that institutions like commercial justice were working slowly but adequately. Other interviewees rejected the view of a complete opposition between trust in the family and distrust in “external” institutions. Some referred to the fact that “there are families where there is a new dispute every day.” So the interviewees consider that it depends on the type of family involved. Besides, trust is not always absolute inside the family. One interviewee told me that nowadays, in FBs, spouses or children are worried about the individual consequences of financial difficulties of the company: “a payment default by the company could lead to a prohibition to leave the country for the shareholders and my wife is worried.” This distrust of public institutions is more common among the older generations who have experienced the trauma of the nationalization process and are accustomed to a world where social relations with relatives are the only means to survive. The younger and more individualistic generation seems less sensitive to this perception and one interviewee considered that “the young generation is more willing to start companies with friends.”

Nevertheless, quasi-general distrust in public institutions and low “generalized trust” have created a “low trust” environment where FBs can survive. According to agency and transaction cost theories, FBs, with their trust-based relations, have the ability to succeed in such an environment.Footnote ⁷³ But post-revolution, public institutions were not only perceived as inefficient, but also as unfair—benefiting the insiders—and even threatening, due to the trauma of nationalization and the use of violence by new “quasi-public” competitors. The Iranian case confirms that the “perceived” lack of fairness of public institutions usually leads to a deep distrust of public institutions and low general trust.Footnote ⁷⁴ One can see that, in Iran, the FB is not only a governance structure adapted to a low-trust environment. In Iran, the unfairness of the “rules of the game” made the survival of FBs based on pure economic rationality highly problematic and the FB, as a mode of coordination based on family solidarity, had the necessary resilience to survive.

FBS in Iran as a Mode of Coordination Protecting “Modernity”

After the revolution, the state put in place a new “moral order” based on Islamic law which led to discrimination against women. In such an environment characterized by a threatening political order, the FB could be considered as a refuge. More specifically, the FB could, in some cases, give support to women against discrimination. One female owner-director said that she created a FB because she needed moral support, as the sector in which she wanted to start a company was known for gender discrimination. Another noted that due to inheritance laws, female entrepreneurs did not usually have enough assets to provide collateral and could not get financing from the banks, and so had to rely on the family to start their businesses.Footnote ⁷⁵ The FBs also used commercial law to defend women’s rights. According to the interviewees, most Iranian managers who created FBs gave shares of the company to their wives, opposing the Islamic inheritance law in Iran which states that a woman accounts for half a man. More generally, interviewees gave a positive appreciation of women in the workplace. “Women are more loyal in business. They give greater attention to detail.” “They are more efficient and courageous than men.” “I have always preferred to work with women than men: men often talk too much; women are more concentrated on their task.” Most acknowledged that there are few women who run FBs. But several directors gave me examples of women who were highly successful in managing FBs. Most of the directors told me that they would not have any problem with their daughter succeeding them (if she was qualified). This does not mean that there are no obstacles to the presence of women in management positions in FBs. One of the women interviewed referred to the huge “government pressure” exerted on women who work. Another remarked that the difficulties she had to get access to bank credit when she created her company had more to do with society’s reluctance to let women manage companies than with official banking policies. The FB can also be considered as a refuge for the whole family, especially for children, as the new Islamic moral order put pressure on them: one interviewee said that “The father had to create a FB to protect the family from the state.” Besides, very often, the objective of providing jobs for children was put forward as a reason for creating a FB, which reflects a lack of trust in the efficiency of the labor market. Anecdotal evidence shows that FBs also provided a safe harbor for people who, due to their political views, were barred from employment in the public sector. Some research partly relates the creation of a large number of very small companies (mostly FBs) in Iran after the revolution to a strategy by the middle-class elite, forced out of the public sector, to make a living and stay out of reach of the government.Footnote ⁷⁶

This ability of the FB to defend a modern social order is, in fact, related to its adaptation to new societal dynamics. First, Iranian FBs were able to change in order to give a central role to competency as a core value. All interviewees stressed the importance of expertise in their company. One even said that “My family name can open doors, but ultimately it will be my expertise which will make a difference.” Several times, interviewees reported that they have fired incompetent relatives. In another case, one refused to hire his father because he knew he was not fit for the job. An interviewee said that he preferred his financial director to succeed him because his son was not prepared. Others consider that “nepotism is more prevalent in the public sector than in the private sector.” This does not mean that nepotism has completely disappeared from Iranian FBs—some interviewees referred to cases they knew where an incompetent son had put the FB in trouble—but emphasis on expertise is now prevalent. Reflecting these changes, an interviewee said that “processes like reporting and performance measurement are more important than relations.” Expertise has superseded all other values: “I don’t care if my successor is a man or a woman, young or aged, all I care about is for my successor to have the ability to manage the company.” “We say to our employees that they have to prove their religiosity in their behavior, which implies … providing the best products for the population.” This has also led to more participative management: “if I grant more importance to others’ ideas, my company is more efficient.”

Furthermore, FBs had to adapt to the deep internal changes in the family power structure. The traditional Iranian family based on a patriarchal model is no longer the norm in Iran. There is a consensus in the panel that “the young are more educated now.” The development of information technology has led to a certain loss in the authority of the fathers in FBs because “fathers do not understand anything in e-commerce.” This has changed the organization of FBs: there is now greater communication between the father and his children. Some managers have changed their own behavior. One said that the traditional model of a bāzārī FB where there is unconditional acceptance of the father’s authority and where “the children first learn to do the cleaning in the company” had to change. “I prefer to take my son by the hand to go along the way with him,” said another. Very often, fathers would recognize the importance of considering their children’s preferences: in several cases, they insisted that their children were working in the FB because they wanted to (or that they would decide in the future to work in the FB if they liked it). Nevertheless, this increasing assertiveness of children has led to some conflicts. In some cases, the father still wants to impose a hierarchical mode of management and that creates tensions with the children. Several managers even considered that “culturally, Iranians just don’t know how to work as a team, even in the family.” In several cases, the father-manager had distributed shares to his family for fiscal reasons. The children (and wives) then went to court to defend their rights as shareholders. According to some interviewees, children want to have responsibilities very early, whereas before the revolution, children would listen to their fathers and would accept lesser responsibilities at the beginning. Several managers also emphasized that their children were not prepared to succeed them because they did not want to work too hard. One said that “we were the generation which would eat the skin of watermelons. Today the opposite is true as the parents eat the skin and leave the best part to their children.” The increasing assertiveness of children in FBs does not mean that their organization has been completely transformed. There is respect for the “father” in every FB. Several FB directors declared that they learnt a lot from their fathers. And in most companies the father commands the company from the top. But blind acceptance of the father’s authority is no longer the norm in Iran.

All these changes in FBs took place with family solidarity preserved. One FB head referred to one of their values, respect for elders, and said that they were employing very old relatives. All these transformations show the ability of the Iranian FB to be a key intermediary between social and economic changes. One could consider that these new societal dynamics associated with a higher average level of education had a deep impact on FB values and organizations. But these changes, like the emphasis on competency, may also be a sign of economic pressures due to competition.Footnote ⁷⁷ Again, the Iranian FB cannot only be considered as a governance system. It is a mode of coordination which has been very effective in defending a modern view of society in opposition to the Islamic moral order legalized after the revolution.

FB as a Mode of Coordination Protecting Property Rights

It is also possible that this distrust of formal institutions is not due to the explicit inefficiencies of institutions but to a perception by some FBs of these official institutions as threats. For one interviewee, “nationalization has been more destructive for the Iranian economy than the war with Iraq.” There is a fear in the Iranian private sector that private companies could once again be exposed to this risk of expropriation.Footnote ⁷⁸ Such a fear is amplified by a sense of fragility as the public sector controls 80 percent of the economy and most private companies are very small. A FB manager said: “In Iran, the relation between the government and the private sector is a relation between a master and his slave.” Moreover, the perception has developed that the “rules of the game” do not protect the private sector. This refers to an economic system where predatory behavior from para-public companies can put private business at risk.Footnote ⁷⁹ These perceptions have led some of the Iranian businessmen interviewed to consider the favorable situation of the private sector in Iran before the revolution as a “lost paradise.” They consider that before the revolution, there was a “real” private sector and that is no longer the case: “Before the revolution, we had Ladjevardi, Barkhordar or Hojabr Yazdani … Their name was their honor. [Today] family businesses don’t have such a reputation. Now, they have destroyed all these families.”Footnote ⁸⁰

In Iran, due to the trauma of nationalization and a general perception of the “unfairness of the system,” the risk of nationalization is seen as real and it is difficult for the authorities to issue a “credible commitment.” These concerns have been amplified with the existence of competing political orders since the revolution. The new para-public economic entities belonging to the Foundation and the IRGC are only accountable to the Supreme Leader. These para-entities are independent from the Iranian state and government. In this context, the “violent” and sometimes “predatory” behavior of these para-public entities has given them the ability to easily buy out profitable public or private companies or “eliminate” them if they are serious competitors.Footnote ⁸¹ These para-public entities could for example buy a large number of public companies in total opacity during the different periods of privatization at the beginning of the 1990s and in the mid-2000s. This environment has led to a huge uncertainty in the Iranian private sector about the protection of property rights. One interviewee even said: “The reality is that our government does not want a powerful private sector … As soon as a private company gets bigger, the government takes over ownership”. Iranian history since the revolution demonstrates that it is difficult for a government to issue a “credible commitment”—defined by Williamson as a situation that, once the private investments have been made, there will not be an expropriation—when numerous economic actors have lived through the era of confiscation.Footnote ⁸² That was the case for example during the reform process in Hungary, where the majority of the people working in the private sector or their parents had lived through the era of confiscation in the 1940s.Footnote ⁸³

Coherent with such a vision, the Iranian state is now considered by some as dangerous. FBs have the ability to deal with these institutional constraints, especially the necessity to be secretive. As most of the FBs are very small, it is possible for them to have few tangible assets. This makes them very flexible and able to quickly transfer money abroad or reinvest in another activity. This flexibility allows them to be ready for short-term opportunities. One interviewee said: “The whole concept in Iran is how to make easy money in a very short time … because people feel insecure and the state is the cause of insecurity.” This flexible capital can be easily mobilized for speculative activities. Another FB manager said: “Why should one take the risk of producing under the threat of expropriation? People prefer to build shopping centers and housing.” This policy of maintaining a high level of liquidity of assets has been the usual strategy of FBs in LDCs where there are weak property rights.Footnote ⁸⁴ Moreover, trust inside the company affords the ability to be very reactive and flexible in such a risky environment.Footnote ⁸⁵ The owner of one FB had to leave Iran just after the revolution. So, the interviewee started to manage the company in Iran and kept the owner informed about its activities. The FB, with its code of ethical conduct, could manage to adapt to such situations. This fear of government expropriation has also led FBs to adopt a policy of dissimulating any information on the financial situation of the company. One FB manager declared that “people create FBs because they don’t want to reveal their secrets.” Another associated the “usual practice in FBs of accounting dissimulation” with “a judicial system which is terrible at protecting property rights … They still want to protect private property in the sixth development plan when it was already an objective after the revolution.”Footnote ⁸⁶ Moreover, several interviewees said they had created several companies, related or not to their main area of activity: this could be due to a desire to avoid too much concentration of capital in order to protect their wealth against the risk of expropriation.Footnote ⁸⁷ This strategy of Iranian FBs confirms an environment characterized by the fear of the state as a “predator”: in such an environment, there is a preference for assets which are mobile and hard to appropriate, because of their dispersion and the difficulty of measuring them.Footnote ⁸⁸

Again, the ability of FBs to resist the predatory economic order in post-revolutionary Iran reflects qualities which are not only those of a governance structure. The FB, confronted with the violence of para-public groups and the government’s inability to make “credible commitments” in terms of property rights protection, has had to rely on family trust-based relationships. This gives the FB the ability to develop the flexible strategies that have allowed its survival so far.