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One of the most acute observations in literature comes from the first line of Leo Tolstoy’s Anna Karenina. He wrote: "Happy families are all alike; every unhappy family is unhappy in its own way." It is an observation that investors in emerging markets would be advised to take very seriously.

Stanley Ho is an 89 year old billionaire who lives in Macao. Like almost all Asian billionaire, Mr. Ho had some very good connections. From 1557 to 1999, Macao was a colony of Portugal. Thanks to his first wife’s connections in Portugal, Mr. Ho was able to get a monopoly on gambling in 1961 that even survived the Chinese takeover in 1999 and ended only in 2002. By that time it didn't matter. Stanley Ho's fortune was in excess of $3 billion.

Mr. Ho also was quite successful in begetting children. He fathered 17 by 4 wives. Predictably over the past month, there has been a dispute as to who controls his empire with a contest over his estate between wife number three and five children from the wife number two. This contest has been so far carried out in the press and on different media including television commercials, YouTube and often daily press reports.

Although the final outcome remains rather uncertain what is clear is that the minority shareholders of Mr. Ho’s company SJM Holdings (OTCPK:SJMHF) have suffered. The company took in almost a third of the gross gaming revenues in Macao last year, but its shares have declined almost 10% and are selling at a steep discount to its competitors.

The problems of a family company are hardly unique to Mr. Ho. In Asia, families control almost two thirds of the biggest 1000 companies. In Hong Kong alone over 70% of the listed companies are controlled either by their founders, or members of the founder's family.

South Korea is another example. South Korea is dominated by several dozen large family owned corporate group generally referred to as chaebols. These companies once controlled over 75% of the South Korean economy. Even today they dominate the most important part of the South Korean economy, the export sector, which represents 43% of the GDP. The small to medium size firms are relegated to the service sector which is in fact shrinking from 55.8 % of the economy to 52.5%.

The heads of these chaebols have a long history of acting badly. For example Lee Kun-hee, the chairman of Samsung Electronics and South Korea's richest man, was convicted of tax evasion. But the conviction was expunged. Lee Kun-hee is hardly unique. South Korea's president Lee Myung-bak recently pardoned 74 top executives.

In essence the power of these firms extends throughout the economy. One way they are able to show disdain for the law is through their employees connections. At one point Samsung employed forty-four former ranking bureaucrats, 28 former judges, attorneys and prosecutors, and five former journalists.

Like South Korea, India too is dominated by a few large family firms and the state. By 2005 56% of the firms in India were under 20 years old, but they accounted for only 15% of corporate assets, 17% of the sales and 13% of profits. Almost three quarters of the economy was in the hands of either state firms or firms that existed prior to 1985. Again the network of connections of such family firms like the Ambanis and the Tatas can exercise enormous power in favor of their organizations as was illustrated by recent scandals.

But it is not just Asia where large family owned companies dominate the economy. One of the worst examples is the power exercised in Mexico by Carlos Slim. Carlos Slim is one of the world's richest men. Through his company, Telmex, he operates 92% of all fixed phone lines in Mexico. His mobile phone company, America Movile, controls 77% of the market. Slim’s wealth is due to his virtual monopoly that has remain strong despite a decade long law suit.

The reason for the dominance of family corporations in emerging markets is simple. These are strongly relationship-based systems. The rules, the law, the legal infrastructure are not sufficiently well developed to perpetuate the trust necessary for a more economically efficient rule based system. You must do business with who you trust and, without the law, the people you trust are often only in your family.

Family owned businesses can do very well, but they can cause problems in two areas. First, minority share holders always will take second place to the demands of the family. This is especially true in relationship based systems.

Most important though is that emerging markets will never be able to fulfill their promise, growth or completive potential until the government strengthens the rules to limit the power of monopolies and duopolies (both public and private), politically connected and protected businessmen, and other vested interests (such as privileged unions) that impede innovation, competition and growth.


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Family Financial Dramas Affect Emerging Market Economies