family owned vs. professionally managed

In this blog post, Abhisek Misra, a Legal Associate at Quislex Legal Services Pvt. Ltd. and pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, compares and contrasts between family owned and professionally managed law firms.

Gone are the days when sole proprietorship and association were the most ideal type of business wherein people used to contribute and get benefits out of the business for themselves.

Laws in the present era has emerged as the most flourishing and prospering form of business. Therefore, to keep up, and being no exception to the trending strategies, law firms had emerged in every nook and corner of the globe. A law firm is a business organization shaped by at least two attorneys to take part in the act of law. The essential administration rendered by a law firm is to counsel clients (natural or artificial persons) about their legitimate rights and obligations, and to speak to them in civil or criminal cases, business exchanges, and different matters in which lawful guidance and other help are looked for.

India has the world’s second biggest legal profession with more than 600,000 attorneys. The prevalent service providers are stand-alone legal counselors, small firms or family based firms. A large portion of the organizations are included in the issues of local law and dominant part work under nation’s antagonistic case framework. The conception of legal services as a ‘noble profession’ rather than services resulted in formulation of stringent and restrictive regulatory machinery is prevalent. These regulations have been defended on the grounds of ‘public policy’ and ‘dignity of profession. The judiciary has fortified these standards or principles, which can be reflected in the expressions of Justice Krishna Iyer, when he noted, “Law is not a trade, not briefs, not merchandise, and so the heaven of commercial competition should not vulgarize the legal profession.” However, in due course of time, courts have perceived ‘Legal Service’ as a “service” rendered to the consumers and have considered that legal counselors are responsible to the customers in the instances of inadequacy of administrations. “In the case of Srinath V. Union of India (AIR 1996 Mad 427) Madras High Court held that, in view of Sec. 3 of Consumer Protection Act, 1986 consumer redressal forums have jurisdiction to deal with claims against advocates. Section 2 (U) of competition Act, 2002 defines the term ‘Service’ along the lines of consumer protection Act, 1986”. Therefore, it might be presumed that legal profession is becoming a subject of exchange related laws where consumerism and market strengths ought to be given satisfactory scope.

The corporate law firm sector of India is fairly young and includes a blend of sole proprietorships and firms of hundreds of lawyers and dozens of associates. Thus with the changing socio-economic conditions in developing countries like India, it is extremely essential to understand the impact of the two kinds of firms.

It has been quite evident that the level of fairness, impartiality and justice, i.e. equity held by the management of a firm has a great influence on the firm’s efficiency, profitability and structure of the capital and revenue which leads to growth in its value. Family traits, for instance, paternalism, altruism give a boost to create an atmosphere of love and commitment towards the business of the firm. The long-term nature of family relationship is meritorious in monitoring and disciplining the managers of a company. Research has shown that many organizations and firms tried to adopt these family traits in an effort to compete more effectively and give a boost to the performance and working of the firm. If we see further, the influence of the family is yet another corporate governance mechanism as it involves replacing monitory examining i.e. direct monitoring by appointing the executives to run the firm. Therefore, the family headship enables the owners of the firm or the organization to exercise and practice full control over the corporate insiders i.e. the paid executive directors of the board as well as the overall management. This gives freedom to the family controlled firms and organizations from suffering or incurring a huge cost of agency and can therefore is of enormous benefit for the promoters. Further this ensures a lot of involvement from the firm’s promoters ultimately leading to the fullest utilization of the resources and other capabilities of the promoter. This results in a better performance by the firm for the investors. There is enough evidence and research that has been documented suggesting that the firms controlled by a family exhibit better performances in comparison to firms in which family control is unimportant.

While researches and studies have shown positive results of this form of relationship, some evidences show contradictory results as well. It has been argued that the level of managerial ownership does not affect the value of a firm. It has also been said that the status of the founder does not have any relationship on the firm’s value. Moreover, it is interesting to observe the findings of Stulz in 1988 that there is a curvilinear relationship between managerial ownership and the firm value. According to him, the value of the firm increases in the initial period where ownership is more concentrated and the monitoring costs decrease. However, as management becomes more insulated, the value of the firm falls. There are various threatening factors in family controlled firms such as family instability, lack of succession planning, etc. which may influence the value of the firm in a negative manner. So pointing out clearly the positive and negative determinants of family owned firms and their impact on the value of the firm, we get the following results:

Positive Determinants

  • Greater independence, which means the ability to be flexible and make quick decisions
  • Long term family involvement that leads to:
  1. low monitoring costs
  2. effective monitoring and disciplining of managers
  3. clearly defined culture
  4. continuity in leadership thereby leading to and encouraging long term orientation
  5. family members’ extensive knowledge of the firm
  6. co-ownership within the family leading to better investment strategies
  7. fewer principal-agent problems.

Negative Determinants

  • autocracy and paternalism
  • messy organizational structure
  • family instability due to conflict among the members of the family for control and power
  • nepotism and favouritism
  • costly inter-generational transfers i.e. family inheritance
  • placing personal or family interest ahead of business
  • difficulties with succession planning
  • generation gap
  • financial limitations
  • attracting and retaining non-family employees
  • inability to sustain competition against MNCs

There is a famous cliché: “The first generation builds, the second generation consolidates and the third generation destroys the family business”. Although 85% of the companies in India are family-run that employ over 57% of the Indian workforce, just 13% survive till the third generation. They usually disintegrate due to generational conflict.  

For instance, the No. 1 law firm Amarchand & Mangaldas & Suresh A Shroff & Co., ultimately dissolved for separate businesses over a family dispute. Many lawyers at the firm feel that the family wields too much control and exercises too much power over the firm and thus does not share enough of the profits, which in turn is stifling their careers and its growth. Also the personality differences between the two Managing Partners have led to internal competition between the two offices at Delhi and Mumbai over time. Many employees, especially the ones working at the lower rungs, don’t buy the two-engine theory and feel that there is a glass ceiling for non-family members. They say that the firm is run by the Shroffs, for the Shroffs. We can very well see that personal life and professional life gets intermingled.

Professionally managed Anand & Anand, which conceived to meet the challenges of an imminent new order in India. The transition from a closed economy to a liberalized one came about in the early 1990s. With a futuristic vision the firm tapped into the change on the horizon in a country awakening to a heightened intellectual property environment and took the lead in making available from a single window multi-faceted legal service of a high quality. Of late, it has been recognized as the winner, Patents 2016, India at the 7th Annual Asia IP Awards, October 2016. They generally operate in multiple industries and countries. Here unlike family-owned business the voting majority is in the hands of the shareholders and not in the hands of the family members who are in control of the firm.

The traits that make professionally managed firms preferable over family owned firms are:

  1. Planning, execution and control
  2. Defined mission, vision, goals and objectives
  3. Defined roles, rules and regulations
  4. Succession planning of a professional
  5. Modern methods of business
  6. Performance driven
  7. Effective delegation of authority
  8. Financial strength
  9. Sustainability in highly competitive markets
  10. Performance based culture

As it is said, there are two sides of a coin, professionally managed firms also face a few challenges and thus lead to its demerits. Some of these challenges are:

  1. Organizational conflict
  2. Adherence to systems
  3. Succession planning
  4. Retention of talent
  5. Less focus on human development
  6. Poor commitment levels of middle and junior management
  7. High attrition levels
  8. Chances of shut downing without approval of all the members of the organization

Both the kinds of firms has its pros and cons. It can be said that to ensure success, the family owned business or firm must devise a well-defined strategic plan, ensuring cost effectiveness, customer satisfaction, higher returns to shareholders and good operational management. There must be clarity in succession planning and must opt for professional management. Similarly, professionally managed firms must also take care of their goals and objectives that must be clear. There must be right delegation of authority and the people must have defined roles and job profiles. They must undertake employee engagement programs.  

As far as Indian perspective is concerned, our legal service section is hugely crowded. We are gradually shifting from the family owned system to the professionally owned one. I would like to conclude on a very simple note, that however globalized and professional the world may become, in the race whosoever may win, they shall continue to remain agencies through which common people can get justice.

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