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Why Should Executive Posts Be Passed On Like Heirlooms?

By George Anders and Carol Hymowitz and Joann S. Lublin and Don Clark

8/2/2005 - John Ward has been studying family-controlled businesses for more than 30 years. The professor at Northwestern University's Kellogg School of Management knows plenty of patriarchs who talk of eventually turning over control to their children. But, he says, "such handoffs happen smoothly only about one-third or one-quarter of the time."

The management turmoil at News Corp. is the latest case in point. The media company's chief executive officer, 74-year-old Rupert Murdoch, had been grooming his oldest son, Lachlan, 33, for a shot at the top job. On Friday, however, Lachlan Murdoch said he was quitting the company to pursue his own career in Australia. Immediately, analysts speculated that Rupert Murdoch would now shift his attention to younger son, James, 32, who runs the News Corp.-affiliated British Sky Broadcasting Group PLC satellite-television service.

The incident raises a fundamental question: Why should executive posts at shareholder-owned companies be treated as family heirlooms?

Sometimes, the answer is obvious: because the family maintains control over the company, typically by issuing two classes of stock, with family holdings concentrated in the shares that carry more votes. That's the case at many media companies, including Viacom Inc., Cablevision Systems Corp. and Washington Post Co. Investors in these companies "have to accept that the leader and owner has the prerogative to pass the baton to whomever he wants," says Thomas Eisenmann, a Harvard Business School professor.

At many other companies, though, the ruling family doesn't exercise legal control. Mr. Murdoch owns roughly 30% of News Corp., for example. The Amos family controls only about 11% of the voting shares at insurer Aflac Inc., where two family members have served as CEO and a third is climbing the management ladder. And the Jacobs family owns less than 3% of the stock at high-tech powerhouse Qualcomm Inc., where Paul Jacobs just succeeded father Irwin as CEO.

In these cases, Prof. Eisenmann says, "you have to scratch your head and wonder if, given the choice of all the people on the planet, the founder's offspring is really the right person to run the place."

Advocates of such moves say that family insiders gain deep, informal business expertise from an early age, simply by watching their parents in action. Sons and daughters also yearn to show that they can do at least as well as their forebears. That can make family members prime candidates to take command when the top job opens up.

Yet these moves are facing more scrutiny in an era of increased concern about corporate governance, where investors and independent directors are nervous about the appearance of nepotism. "The bar has been significantly raised by governance reforms and the idea that there's a stewardship for public capital," says Charles Elson, a corporate-governance specialist at the University of Delaware's business school. To win top jobs, family members "will have to make a much more compelling case that they are right for the position," he says.

Consider what happened at San Diego-based Qualcomm, which makes chips for cellphones. The board's governance committee began considering a succession plan for Irwin Jacobs, now 71, three years ago. Marc Stern, the independent director who was chairman of the committee, said directors discussed nepotism issues "with everyone ad nauseum."

Over time, though, Mr. Stern said, Paul Jacobs emerged as the best choice to succeed his father. Directors preferred an inside candidate, partly because they feared appointing an outsider would cause a number of valued managers to leave the company. The younger Mr. Jacobs, 42, had worked for the company full time since 1990, running the company's handset unit and then helping sell that business so that Qualcomm could focus on chips and patent licensing.

In the end, Mr. Stern said, the board chose the younger Mr. Jacobs more in spite of his name than because of it. "In reality, Paul actually had to be better than if his name was Paul Jones," he said.

Directors at Barnes & Noble Inc. used similar criteria in choosing Stephen Riggio in 2002 to succeed his brother Leonard as chief executive of the bookseller. Stephen Riggio had worked in the original Barnes & Noble outlet as a teenager and later held marketing, merchandising and sales posts. Together, the Riggio brothers own roughly one-quarter of Barnes & Noble shares. Longtime director Michael N. Rosen, a partner at Bryan Cave LLP, said stock ownership "was not an issue" in the selection. "The board looked at his credentials and his wide range of roles inside the company and decided that he was highly qualified for the job," Mr. Rosen said.

Some institutional investors welcome multigenerational family leadership as a sign that the company's leaders want to build long-term value. But other holders worry that it may be hard to discipline or oust a problematic manager if he or she is part of a family that calls the shots, either because of sizable stock ownership or operating leadership.

When such well-connected executives perform poorly, "it's hard to agitate for change," observes Ann Yerger, executive director of the Council of Institutional Investors, a Washington group that represents about 150 pension funds. "It's difficult [for a board] to fire a family member."

Indeed, some recent studies suggest that shareholders lose, more often than not, when the CEO's job is treated as a family sinecure. Raffi Amit, a family business specialist at the University of Pennsylvania's Wharton School, recently completed a study of 508 large companies' performance from 1994 to 2000, chiefly publicly traded but also including some closely held ones. He analyzed the performance of family-controlled businesses and concluded: "When the second generation takes over, they destroy value."

For evidence of how well -- or poorly -- family leadership can work, the cable-television industry provides examples at both extremes.

A prominent failure occurred at Adelphia Communications Corp., controlled by the Rigas family until it collapsed in 2002. Founder John Rigas and his son Timothy, the company's chief financial officer, were convicted on fraud and conspiracy counts in July 2004. Their trial was filled with evidence of family members using company cash for such things as golf-club memberships and massages.

By contrast, Comcast Corp. has grown into the largest U.S. cable operator, and gets high marks for its management. The Roberts family effectively controls the company through supervoting shares, and founder Ralph Roberts, 85, ceded most authority in the early 1990s to his son Brian, 46, who is now CEO. The two men get along well and have offices next to each other at Comcast's Philadelphia headquarters.

In other cases, patriarchs don't seem inclined to move on. Viacom Chairman Sumner Redstone, at age 82, has yet to show any interest in relinquishing his duties. His son, Brent, used to serve on the media conglomerate's board but left several years ago and is now a lawyer in Colorado with no ties to Viacom.

Mr. Redstone's daughter, Shari, is a Viacom director and in June was named nonexecutive vice chairman of the company. But Mr. Redstone, who controls 71% of Viacom's voting shares, has said he doesn't expect his daughter to have an operational role at the company, because he believes in professional management. Viacom is preparing to split into two publicly traded companies, headed by the top executives of its operating units.

In the 1990s, the Greenberg family appeared to be a dynasty in the making at American International Group Inc. The father, Maurice, was chairman and CEO of the big insurer, while his two sons, Jeffrey and Evan, held top management posts. But both sons left to run other insurance companies, with insiders saying that the younger Greenbergs chafed at their father's strong-willed ways and felt they weren't getting a chance to take full command at AIG.

Maurice Greenberg stepped aside as AIG's chairman earlier this year, at age 79, in the face of regulatory pressure and an investigation of AIG's accounting.

"The most important thing is whether the senior generation is willing to let go," says Prof. Ward of the Kellogg School. "They should be talking about this at age 55 or 60. If they're over 65 and haven't set a firm retirement date, it's probably not going to happen. Then the next generation feels second-guessed -- as if the original entrepreneur is going around behind their backs, picking up information or giving guidance."

When family handoffs of authority do go well, younger members often say they had to endure some extended quarrels and turf battles before fully coming into their own. Sometimes those are deliberate rites of passage; other times they simply reflect the inevitable clashes of two strong-willed people.

In his memoir, "Father, Son & Company," Thomas Watson Jr., the legendary former CEO of International Business Machines Corp., recalled a stormy apprenticeship as a young man to his father, who had founded the company. Only during World War II, when he interrupted his IBM training to become a military pilot for a few years, did the younger Mr. Watson feel he could find his own identity.

Even today, "there's pressure on me to show I can do it myself, and not because of my family," says Paul S. Amos II, executive vice president for U.S. operations at Aflac. The company was founded in 1955 by Mr. Amos's grandfather; his father, Daniel P. Amos, is the company's CEO.

"We think alike and sometimes finish each other's sentences," says Daniel Amos. "We can't stop talking about business when we're home, and our wives get angry for doing that." Even so, the younger Mr. Amos, who spends a lot of time in the field away from headquarters, says, "I'm not sure this would work if we were right next door to each other all the time."

In some cases, founding families have reinjected themselves into day-to-day leadership after a period of relying on outside managers. At Ford Motor Co., nonfamily executives led the company for the 1980s and 1990s. But in October 2001 the board ousted CEO Jacques Nasser and installed William Clay Ford Jr., a great-grandson of company founder Henry Ford, as the new chief executive. Since 2001, Mr. Ford has led a turnaround effort that includes job cuts and plant closures. Profits rebounded in 2003 and 2004, but have weakened this year.

Likewise, in Europe, 42-year-old François-Henri Pinault took over in March as CEO of retail conglomerate PPRSA, which was founded by his father. The younger Mr. Pinault -- whose family owns 42% of PPR -- succeeded a longtime nonfamily boss, Serge Weinberg.

Still, there are examples of European companies trying to shed their family roots. Last year, Leonardo Del Vecchio, who founded eyewear maker Luxottica and owns 69% of it, passed over his son, Claudio Del Vecchio, a seasoned manager who runs the Brooks Brothers division in the U.S., and chose an outsider to be the company's chief executive.

Meanwhile, at Toyota Motor Corp., Japan's biggest car maker, the role of the founding Toyoda family is an increasingly delicate issue; Japan's corporate world is also moving away from such traditional practices as family-run businesses. The founding Toyoda family is estimated to own less than 3% of the company, but family members are in several key posts, including Akio Toyoda, 48, the grandson of the founder. In June, he was promoted to senior managing director, a move many interpret as an attempt to groom him for the eventual presidency of the parent company, the most senior position within the Toyota group. Chairman Hiroshi Okuda recently told reporters that the Toyoda clan was like the cherished "flag and centripetal force" around which employees could rally. He added, "We need a unifying force."

-- Peter Grant, Joe Flint, Alessandra Galloni, Joseph B. White, Jeffrey A. Trachtenberg, Joe Hagan and Jathon Sapsford contributed to this article.