Transcript Family-Owned Enterprizes and Corporate Governance

Corporate Governance and
Family-Owned Businesses
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PROFESSOR CHRIS PIERCE
BAHRAIN
FEBRUARY 2010
What are family owned businesses?
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There are different definitions………
Family owned businesses are companies …
… where the dominant shareholder is a family member
(broad view)
… which are run by heirs of the people previously in charge,
or by families that are clearly in the process of
transferring control to heirs (narrow view)
Separating Ownership from Control
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Non Listed Businesses
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 “Family businesses constitute more than 85% of
non listed businesses in the MENA region.”

Pierce (2008) Corporate Governance in MENA
 “Family businesses constitute more than 85% of
non listed businesses in the EU.”

Pierce (2010) Corporate Governance in the European Union
Listed Companies
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 “The top 5 families had 17% of the total board seats
on listed companies in the UAE.”

Pierce (2008) Corporate Governance in MENA
 “One third of all companies in the
S & P 500 index and 40 % of the 250 largest
companies in France and Germany are family
businesses.”

McKinsey, January 2010
Strengths of family owned businesses
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 Strong set of values: Identity
 Long-term view in decision-making: Consistency
 Possibility of unconventional strategy: Flexibility
 Desire to build a business for future generations: Sustainability
 Commitment of family management to their company:
Continuity
The long-term success of family owned
businesses in the UK are bleak
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 Only 5% continue to create value beyond the 3rd
generation*
 A study** of inherited family firms and
management practices in the UK shows that
choosing a CEO by “primogeniture” (selecting the
eldest son to lead) tends to lead to extremely bad
performance
 *Ward (2004).
**Bloom (2006).
Key Success Factors for FOEs: Define Relationships and
Structures within Family and with Outside Stakeholders
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 Create clarity of roles within the family
 Create fair playing field for non-family
members
 Fair treatment of outside financial
stakeholders
Create clarity of roles within the family
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 Family constitution
 Family values, philosophy, principles and beliefs
 Family code of conduct
 Family Assembly / Forums
 Family Councils
 Family Advisory Board
 Family’s long-term role as shareholder (share retention/voting)
 Family salary-earners vs. dividend receivers
 Self dealing and conflict of interest policies
 Strategy for philanthropy and third party foundations
 Family training and education strategy
 Family employment committee
 Wealth management and other family services
Create fair playing field for non-family
members
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 Succession planning clear from the start
 Family employment policy
 Equality of opportunity in recruitment and
promotion
 Incentives for non-family managers
Fair treatment of outside financial
stakeholders
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Shareholder agreements
Legal structures and tax planning
Disclosure of information
Rights to information
Voting rights at AGM
Control enhancing mechanisms
Key Success Factors for FOEs: Set Formal Corporate
Governance Structure
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 Formalities - They Really Do Matter!
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Clarify roles and responsibilities between board, management and
shareholders
Codify structures and processes for all to see
 Create strong Advisory Board
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Guarantees non-compromising standards of meritocracy in personnel
decisions
Allows clear lines of authority for different areas of business
Ensures the stability and continuity of family policies and values
Distinction made between matters of day-to-day mgmt. and strategy
Allows strategic issues to be properly & objectively addressed
 Nominate outside directors
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To complement the family’s business skills with the fresh strategic
perspectives
Infusion of new ideas due to a broader range of expertise
Ensure equal treatment between family and non-family executives
Why List?
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 Providing a main source of funding
 Creating opportunities for the company to finance
new investments
 Expected future appreciation in the company’s
share price and the value of the company
 Helping the company to expand domestically and
internationally
 Sustainability of family owned business
Benefits associated with Growth Generated Through Retained
Earnings
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 Maintain full control
 Keep core values
 Quick decision-making and ability to experiment
 Keep balance between profit and commitment to
quality and innovation
 No restrictions on how to use capital
Disadvantages associated with
growth generated through retained earnings
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 Limited access to finance
 Slower growth
 Absence of external discipline (strategic decision-
making and oversight)
Benefits associated with growth generated through
private equity
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 Strengthens capital structure
 Fewer restrictions on how funds are used than public listing
 No scheduled (fixed) repayment (dividends can be deferred and cash
can be utilised to address business needs)
 Enhances credibility with stakeholders
 Introduces private equity culture
 Strategic input into the direction of the business by investor
 Access to a broader network of contacts
 Increased financial management controls and reporting
Disadvantages associated with growth generated through
private equity
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 Reduces family share ownership
 Difficulty finding strategic investor
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Need to identify exit mechanism for equity investor
No means of reversing the transaction
Pressure to produce a high ROI
 Costs
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More expensive than debt when successful
High cost of capital if company elects to re-purchase shares
More onerous management reporting requirements
Benefits associated with growth generated
through a public listing
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Capital structure
 Allows company to pursue acquisitions and strategic growth alternatives
 Facilitates access to other financial instruments (debt, preferred shares)
 Ability to pursue long term investment strategies
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Monetization options
 Creates a tool for monetization of members’ equity interest over time
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Help secure sustainability
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Public equity culture
 Fosters ownership culture with employees
 Creates long term employee incentives
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Visibility
 Further raise the public profile of the firm
 Enhance credibility with counterparties
Disadvantages associated with growth generated through
a public listing
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 Reduces family share ownership
 Legal & regulatory compliance
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Initial and ongoing compliance with disclosure regimes can be a burden
 Increased public scrutiny
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Financial and organizational details disclosed to the public
Public reaction may contribute to stock price volatility
 Public shareholder base
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Public shareholder base requires time, attention and information
Risk of adversarial shareholder base
Potentially less say over operation of the business and strategic goals
A Roadmap for Smooth Progression
Non Listed
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Formalize.
Create Advisory
Board
 Create a three to fivemember transitional
Advisory Board
 Appoint a Corporate
Secretary
 Develop the company’s
organic documents (bylaws and charter)
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Listed
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Transition to
Board of
Directors
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Formalize the
Advisory Board to be
a real Board of
Directors
Strengthen Disclosure &
Control Environment
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Form an independent
Audit Committee
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Form Governance,
Nominations and/or
Remuneration Comm.
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Develop, adopt, and
publicly disclose a
written corporate
governance policy
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Establish risk mgmt.
internal control & audit
Appoint a
professional CEO
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Define roles and set
responsibilities
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Form an audit
committee, with nonexecutive members
Keep an eye on these rules and regulations from day 1
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Protect Rights of
Shareholder &
Stakeholders
 Strive for full
compliance with
Listing rules and
regulations
Specific Challenges for FOEs
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Need to distinguish family and company relationships
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Dissensions between family members who are actively working and those who are not
Financial relationships
Informality of governance policies
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“Common” understandings not universally held or understood by outsider (or insiders!)
Weakness of control environment
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Founder is still is on top of everything …
Managing growth: More complex with succeeding generation
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Owner / manager equation shifts
Growing number of non-family managers require formal system
Incentivising non-family managers
Succession
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Who from the next generation is up for the challenge … do they have the same drive?
Challenges: Overlapping Roles and
Responsibilities
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Family
member
Manager
Owner
Director
Conclusions
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For the family-owned business, good
governance makes all the difference.
Family firms with effective governance
practices are more likely to do strategic
planning and to do succession planning.
On average, they grow faster and live
longer.
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We must not be managers. We must be
experts in corporate governance.*
*Source: A fourth-generation family leader
A Self-Assessment and Client Orientation Tool
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LEVELS
1.
Acceptable
2. Extra
Steps
ATTRIBUTES
Commitment to
Good Corporate
Governance
Structure and
Functioning of the
Board of Directors
Control
Environment and
Processes
Transparency and
Disclosure
Treatment of
Minority
Shareholders
PROGRESSION
3. Major
Contribution
s
4.
Leadership
Attribute 1: Commitment to Good Corporate Governance
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LEVEL 1
Understanding the
need to
professionalize
the Company
A. COMMITMENT TO CORPORATE GOVERNANCE
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The basic
formalities of
corporate
governance are in
place including a
(i) Board of
Directors, (ii)
Annual
Shareholders
meeting and (ii)
Shareholders
identified and
recorded.
Board member or
high-level
executive
explicitly charged
with responsibility
for improving
corporate
governance
practices.
LEVEL 2
First concrete steps
toward best
practices
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
Written policies
established
addressing key
elements in family
firm governance,
including (i)
succession
planning; (ii)
human resources
and familymember
employment; and
(iii) non-familymember share
ownership.
Management/Boar
d approves annual
calendar of
corporate events.
LEVEL 3
Implementation of
best practices

Corporate
Governance policy
covers (i) role of
Board vis-à-vis
management; and
(ii) long-term
planning for
corporate
governance of
company
commensurate
with business
plan.
LEVEL 4
Leadership


Applicable
corporate
governance,
accounting,
auditing and
internal controls,
and shareholder
information
practices are
equivalent to
those in place at
best practice
public companies
(i.e., little would
needed to make an
IPO).
Company fully
complies with all
applicable
provisions of
voluntary code of
best practices of
Attribute 2: Structure and Functioning of the Board
B. STRUCTURE AND FUNCTIONING OF THE BOARD
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
LEVEL 1
Understanding
the need to
professionalize
the Company
Board of
Directors
constituted and
meets
periodically
LEVEL 2
First concrete steps
toward best practices


Board meetings held
according to a regular
schedule, agenda
prepared in advance,
minutes prepared and
approved.
Non-family members
(probably company
executives or exexecutives) appointed
to the Board and core
competency (skill
mix) review of Board
conducted, or
advisory Board of
independent
professionals
established and
consulted on a
regular basis.
LEVEL 3
Implementation of
best practices
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Board composition
(competencies/ski
ll mix) adequate to
oversight duties.
Annual evaluation
conducted.
Audit Committee
of non-Executive
Directors
established.
Directors
independent of
management and
owners appointed
to the Board
(perhaps
“graduated” from
the advisory
Board).
LEVEL 4
Leadership


Audit committee
composed entirely
of independent
directors.
Nominating
Committee
established.
Attribute 3: Transparence and Disclosure
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LEVEL 1
Understanding the need
to professionalize
the Company
C. TRANSPARENCY AND DISCLOSURE
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
Adequate accounting
and auditing systems
in place including:
Adequate internal
accounting and
control system
reviewed periodically
by independent
external auditors and
quarterly financial
reports prepared by
internal accounting
and approved by the
Board
Annual financial
statements audited
by independent
external auditors and
approved by
Shareholders
Meeting.
LEVEL 2
First concrete steps
toward best
practices

Accounting and
auditing
performed in
accordance with
highest national
standards and
audit performed
by recognized
international
accounting firm.
LEVEL 3
Implementation of
best practices

Accounting,
auditing and
internal control
systems up to
international
standards.
LEVEL 4
Leadership

Same
Attribute 4: Control Environment & Processes
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C. CONTROL ENVIRONMENT AND
PROCESSESS
LEVEL 1
Understanding the
need to
professionalize the
Company

Adequate
internal control
systems are in
place and are
periodically
reviewed by
independent
external
auditors.
LEVEL 2
First
concrete
steps
toward best
practices

Internal
audit and
internal
control
systems
are in
accordanc
e with
highest
national
standards
.
LEVEL 3
Implement
ation of
best
practices

Internal
audit and
internal
control
systems
are
consistent
with
highest
internatio
nal
standards
.
LEVEL 4
Leadership

Same
Attribute 5: Shareholder Rights
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LEVEL 1
Understanding the
need to
professionalize the
Company
D. SHAREHOLDER Rights


All shareholders
kept informed of
company policy,
strategy and
results of
operations.
Annual
shareholders
meetings held.
LEVEL 2
First concrete steps
toward best
practices

Shareholders
provided with all
material
information and
detailed agenda
in advance of
shareholders
meetings.
LEVEL 3
Implementation of
best practices

Family council
established (if
number of family
members large
or substantial
portion are not
working in the
business).
LEVEL 4
Leadership

Company in
position to
quickly
implement all
aspects of best
practice code
with respect to
shareholders
were company to
go public.
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 Professor Chris Pierce
 Global Governance Services Ltd.
 [email protected]
 (+44) 1689 878399