The uncertain destiny of proprietary capitalism: Family connections and the allocation of entrepreneurial talent Maria Rosaria Carillo University of Naples Parthenope Vincenzo Lombardo * University of Naples Parthenope Alberto Zazzaro Polytechnic University of Marche October 8, 2012 VERY PRELIMINARY Abstract This paper focuses on the problem of continuation of the firms, when the manage- rial capital of the entrepreneurs depends on the individuals innate ability and possibly on the system of relations transmitted across the generations of entrepreneurs of the same family. It argues that in societies in which the family connections have a produc- tive value, entrepreneurs choose to transfer the control of the firms within the family not only to the highest, but also to the lowest ability heirs since the connections em- bedded in the family networks guarantee a minimum level of profitability to the family businesses. We develop a model consistent with the observed patterns of the firm level and aggregate performance differentials of the family and non-family firms. We show that although there is no difference in the firm level performance of the family and non-family firms operated by the entrepreneurs at the top of the ability distribution, at aggregate level the family connections lower the average performance of the family firms, since a mass of low ability heirs manages the family business without the rele- vant entrepreneurial competencies. Increases in the rate of the technological progress erode the productivity of the family connections and raise the return of the innate abilities, hence decreasing the mass of low ability heirs and increasing that of the high ability individuals who operate the firms. However, if the family connections are ex- tremely productive, the economies converge to fully immobile societies, with no exit and no entry in the entrepreneurial sector as all the firms of the economy are managed by the heirs who exploit the system of relations of the families. JEL: J24, J62, L26, O40 Keywords: Family firms, connections, allocation of talents, technological change, economic growth ∗ Corresponding author: Department of Economics, University Parthenope, Via Medina, 40, 80133 - Napoli, Italy. E-mail: vincenzo.lombardo@uniparthenope.it. 1