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CEP policy analysis

Inherited Family Firms and Management Practices: The Case for Modernising the UK's Inheritance Tax

• What role does hereditary family management play in the long-standing poor managerial performance of UK firms? We address this question using a new survey of the management practices of over 730 medium-sized manufacturing firms in France, Germany, the UK and the United States undertaken jointly by the Centre for Economic Performance and McKinsey & Company. • Analysis of the data reveals that firms that are family-owned but not managed by family members are typically well managed. An example is Wal-Mart, which is still largely owned by the Walton family but which has had a professional (non-family) CEO since the retirement of Sam Walton, the firm’s founder. • While family ownership seems to improve management practices modestly, family management by the children of founders is typically less good. When the CEO is selected by ‘primogeniture’ – that is, selecting the eldest son – the management practices of the firm tend to be extremely bad.

• The UK has a high share of family-managed firms who follow primogeniture practices compared with Germany and the United States. This arises in part from traditions dating back to the feudal society, but more importantly from the country’s highly generous inheritance tax exemption of 100% for family firms, which make it possible for family ownership to remain concentrated and provides an incentive for even badly managed family firms to be kept within families. • We believe this exemption should be modernised by introducing a cap on the relief of £1m, with this cap additional to the standard inheritance tax cap of £275,000. This would have several potential benefits: 1. It should raise approximately £250m to help fund inheritance tax reform or other government spending priorities. 2. It should improve productivity in the UK economy. 3. It should improve intergenerational equity. 4. It should bring about international alignment of the UK tax system. 5. It should provide continued support for small and medium-sized family firms.

March 2006     Paper Number CEPPA004

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