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This was authored by Chengwei Lui, Associate Professor of Strategy and Behavioural Science, and Dawn Eubanks, Associate Professor of Behavioural Science at Warwick Business School

If you are extremely successful, what are the chances that your offspring will be equally as good or even more successful?

According to the egression to the mean principle it is in fact quite unlikely. It is much more likely that the best successor will not be a blood relative but an outsider, because this opens up a much larger selection pool.

Selecting a successor

But when it comes to selecting a successor most family businesses stick to a family member, most don’t see it as nepotism either, but see them as the best candidate.

And you can see why, after all, a more in-depth view of their offspring is held by company bosses compared to an individual who only has an opportunity to present him or herself in an interview. Therefore, there is more rationalising of the offspring’s poor performance plus they have more chances to display knowledge, skills and abilities through informal contexts that present themselves in families.

The failure of family succession planning

And yet 70% of family businesses fail in the hands of the second generation. We argue that this could be a result of overconfidence. On one hand, the son or daughter does not have what it takes to run the business – one should expect the skill is likely to regress downward to the mean from the founder to the son or daughter.

On the other hand, the sampling bias and the expectations from others may make the offspring (and the parent) to believe they are qualified for running the business. This combination is the most notorious business killer: overconfidence.

This is illustrated through the following example we presented in a paper entitled The weakness of strong ties: Sampling bias, social ties, and nepotism in family business succession published in The Leadership Quarterly.

The story of Jack and his family business

In the example Jack, a family business owner, is considering two candidates to succeed his position, his nephew Tom, and another non-related candidate Sam. Due to adverse economic conditions, both Tom and Sam failed to impress Jack and left the company.

Although neither got the job initially, Jack later hears from Tom’s mother in a family gathering that Tom is doing well in a new job and Jack then reconsiders offering him the role.

The same luxury is not afforded to the second candidate, however, as he is not part of Jack’s social network.

This case illustrates a subtle sampling bias. It is natural for us to reduce interactions with those who disappoint us, even when the disappointment may result from factors beyond their control, like the bad luck suffered by Tom and Sam.

Second chance luck

But a second chance may favour those connected through a social network. This can lead to an overestimation of the ability of those within one’s clique and underestimation for those outside the clique, resulting in nepotism.

The need to increase interactions with specific people

One solution to overcome the sampling bias is to increase the interactions with the failed, rejected candidates who are outside the family.

If leaders can use some contacts that enable information to be collected about external candidates, the sampling bias induced by nepotism can be weakened. So looking back at our example, Jack may have given Sam the same second chance he gave Tom.

Leaders have to act against their natural tendency and sample those external candidates with initial negative impressions to avoid hidden gems being wrongly dismissed.

Another, more drastic solution is to follow the example in Japan. Family businesses in Japan have taken to adoption to find an appropriate successor, with adoption of males between 25-30 making up 98% of total adoptions.