Adoptive Expectations: Rising Sons in Japanese Family Firms

In our paper, Adoptive Expectations: Rising Sons in Japanese Family Firms, forthcoming in the Journal of Financial Economics, we examine a 40-year postwar panel of listed companies in Japan. In developed economies, inherited control is linked to poor firm performance (Morck, Stangeland, and Yeung, 2000; Smith and Amoako-Adu, 2005; Bertrand and Schoar 2006; Perez-Gonzalez, 2006; Bennedsen, Perez-Gonzalez, and Wolfenzon, 2007). Our panel of nearly all Japanese firms listed from 1949 (when markets reopened after World War II) to 1970, and followed until 2000, reveals inherited control more common than generally thought (Chandler, 1977; Porter, 1990) and heir-run firms performing well. These results are robust, and analysis of succession events shows heir control “causing” good performance.

To explain this exceptionalism, we explore two unique practices of Japanese business families: marriages arranged to inject talent into business families and adoptions of promising adults as principal heirs. Indeed, many families employ both simultaneously. These practices motivate the introductory adage, for business families celebrate a daughter’s birth, a new space for an adopted son-in-law, with red rice (Morikawa, 1992). Star managers and elite university graduates are prime candidates; daughters’ love interests are secondary, or irrelevant (Hamabata, 1991; Chen, 2004). These practices remain common in business families in postwar Japan–roughly 10% of our successions transfer control to a son-in-law, adopted son, or adopted son-in-law–for brevity we refer to all as non-blood heirs.

Non-blood heirs might explain Japan’s exceptionalism in various ways. First, non-blood heirs might indeed be very talented, and Chief Executive Officer (CEO) talent might matter greatly to firm performance (e.g., Bertrand and Schoar, 2003; Bennedsen, Perez-Gonzalez, and Wolfenzon, 2010). If this were the only driver of high heir-run firm performance, blood heirs, whose families valued blood over yen, might generate poor firm performance, as in other developed countries, while the larger group of all heir-run firms on average might still display superior performance vis-à-vis professionally run firms.

Second, the mere existence of a non-blood heir option might alter the characteristics of observed blood heirs. Non-blood heirs might displace the least talented blood heirs, elevating the mean performance of observed blood-heir-run firms by clipping off the lower tail. Or, fearing displacement by a “better” son, blood heirs might not dare slack, allaying Carnegie’s (1899) conjecture that inherited wealth “deadens the talents and energies.” As with hostile takeovers, the threat may eclipse the incidence, elevating blood-heir firms’ performance vis-à-vis professionally managed firms.

Third, the existence of a non-blood heir option might also alter the characteristics of professional managers in family firms. The possibility of such a “job” might attract higher quality managers to family businesses in Japan than elsewhere. Or, competition for the merit-based “non-blood heir job” might incentivize professional managers, raising performance in family firms that might consider a non-blood heir.

We find non-blood heirs’ firms to be star performers, consistent with their being selected for talent. Reinforcing this, non-blood heirs are disproportionately alumni of elite merit-based admissions universities. We also find blood-heir firms performing better than non-family firms and professionally run family firms, in line with the selection and incentive effects discussed above.

The full paper is available for download here.