Is UK productivity low because of poor governance?

As regular readers know, I am obsessed with productivity and why it is so low in many countries like the UK. A key driver for low productivity and low productivity growth in the UK is a lack of investment, particularly in infrastructure. But as I dig deeper into the literature on productivity, I came across a paper that claims that poor governance practices in unlisted companies may partially contribute to the problem as well.

Not too long ago, I wrote about the many drivers of the decline in productivity in the UK and other countries. One result there was that the ‘misallocation of resources’ as the second largest contributor to the decline in productivity. This misallocation stems from a misallocation of human resources, a lack of competitive pressures, and a lack of creative destruction.

The study I came across recently focused on management practices in listed and unlisted manufacturing firms in the US, the UK, Germany, and France. Though when I say listed and unlisted companies, I mean mostly unlisted companies. The sample of 151 companies examined in the UK consisted of 43 listed and 108 unlisted firms. In Germany, 41% of the examined firms were listed, and in France 16.1%. Only in the US were all firms listed.

For each firm in their sample, the researchers calculated a management quality score based on management practices in operations (e.g. is the company introducing lean manufacturing techniques?), monitoring of employees (e.g. does the company track end review the performance of employees?), target setting (e.g. what kind of targets does the company set for its employees?), and incentives (e.g. are promotions based on performance or purely tenure based?).

Then they checked if the quality of management had an influence on sales, profitability and – for listed companies – valuations. I am not going to surprise anyone when I say that better management practices are associated with higher productivity, profitability, sales growth, and valuation.

What is more interesting to note is that companies with poor management practices tended to be active in areas with limited competition where inferior companies with low productivity can survive since nobody forces them to innovate or become more efficient.

And companies with poor management practices were particularly prevalent among companies with dominant family ownership. If a company is owned by the founder or the founder’s family, it isn’t a bad sign. We know from other studies that family-owned and founder-run firms tend to have better long-term performance because they are less beholden to short-term earnings management.

But the problem starts when the family exerts too much control over a company, for example if a member of the family is also the CEO of the company. And it gets even worse, when the CEO job is not given to qualified candidates but passed from father to first-born son. And according to this study, the practice of primo geniture (handing the company to the first-born son) is particularly prevalent in France and the UK, the two countries in this sample with particularly poor productivity and relatively large resource misallocation. So maybe, just maybe, we could improve productivity in the UK by improving governance among unlisted, family-owned businesses. But of course that would require controlling families to admit that their first-born sons aren’t necessarily the best person to run the business.

Share of family CEOs and first-born sons as CEOs

Source: Bloom and van Renen (2006).