corporate governance and family-owned businesses
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Corporate Governance and Family-Owned Businesses. Professor Chris Pierce Bahrain February 2010. What are family owned businesses?. There are different definitions……… Family owned businesses are companies … … where the dominant shareholder is a family member ( broad view ) - PowerPoint PPT PresentationTRANSCRIPT
What are family owned businesses?
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)
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Non Listed Businesses
“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
4
Listed Companies
“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
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Strengths of family owned businesses
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
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The long-term success of family owned businesses in the UK are bleak
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).
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Key Success Factors for FOEs: Define Relationships and Structures within Family and with Outside
Stakeholders
Create clarity of roles within the familyCreate fair playing field for non-family
membersFair treatment of outside financial
stakeholders
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Create clarity of roles within the family
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
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Create fair playing field for non-family members
Succession planning clear from the startFamily employment policyEquality of opportunity in recruitment
and promotionIncentives for non-family managers
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Fair treatment of outside financial stakeholders
Shareholder agreements Legal structures and tax planning Disclosure of information Rights to information Voting rights at AGM Control enhancing mechanisms
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Key Success Factors for FOEs: Set Formal Corporate Governance Structure
Formalities - They Really Do Matter! Clarify roles and responsibilities between board, management and
shareholders Codify structures and processes for all to see
Create strong Advisory Board 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 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
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Why List?
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
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Benefits associated with Growth Generated Through Retained Earnings
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
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Disadvantages associated with growth generated through retained earnings
Limited access to finance
Slower growth
Absence of external discipline (strategic decision-making and oversight)
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Benefits associated with growth generated through private equity
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
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Disadvantages associated with growth generated through private equity
Reduces family share ownership
Difficulty finding strategic investor Need to identify exit mechanism for equity investor No means of reversing the transaction Pressure to produce a high ROI
Costs More expensive than debt when successful High cost of capital if company elects to re-purchase shares More onerous management reporting requirements
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Benefits associated with growth generated through a public listing
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
Monetization options Creates a tool for monetization of members’ equity interest over time
Help secure sustainability
Public equity culture Fosters ownership culture with employees Creates long term employee incentives
Visibility Further raise the public profile of the firm Enhance credibility with counterparties
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Disadvantages associated with growth generated through a public listing
Reduces family share ownership
Legal & regulatory compliance Initial and ongoing compliance with disclosure regimes can be a
burden
Increased public scrutiny Financial and organizational details disclosed to the public Public reaction may contribute to stock price volatility
Public shareholder base Public shareholder base requires time, attention and information Risk of adversarial shareholder base Potentially less say over operation of the business and strategic
goals
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A Roadmap for Smooth Progression
Create a three to five-member transitional Advisory Board
Appoint a Corporate Secretary
Develop the company’s organic documents (by-laws and charter)
2
Strive for full compliance with Listing rules and regulations
Non Listed Listed
Strengthen Disclosure & Control Environment
Protect Rights of Shareholder & Stakeholders
Formalize. Create Advisory
Board
Transition to Board of Directors
1 3 4
Formalize the Advisory Board to be a real Board of Directors
Appoint a professional CEO
Define roles and set responsibilities
Form an audit committee, with non-executive members
Form an independent Audit Committee
Form Governance, Nominations and/or Remuneration Comm.
Develop, adopt, and publicly disclose a written corporate governance policy
Establish risk mgmt. internal control & audit
Keep an eye on these rules and regulations from day 1
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Specific Challenges for FOEs
Need to distinguish family and company relationships Dissensions between family members who are actively working and those who are
not Financial relationships
Informality of governance policies “Common” understandings not universally held or understood by outsider (or
insiders!)
Weakness of control environment Founder is still is on top of everything …
Managing growth: More complex with succeeding generation Owner / manager equation shifts Growing number of non-family managers require formal system Incentivising non-family managers
Succession Who from the next generation is up for the challenge … do they have the same
drive?
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Conclusions
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
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A Self-Assessment and Client Orientation Tool25
1. 1. AcceptableAcceptable
2. Extra 2. Extra StepsSteps
3. Major 3. Major ContributionContribution
ss4. 4.
LeadershipLeadership
Commitment to Commitment to Good Corporate Good Corporate GovernanceGovernance
Structure and Structure and Functioning of the Functioning of the Board of DirectorsBoard of Directors
Control Control Environment and Environment and ProcessesProcesses
Transparency and Transparency and DisclosureDisclosure
Treatment of Treatment of Minority Minority ShareholdersShareholders
LEVELS
AT
TR
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TE
S
PROGRESSION
Attribute 1: Commitment to Good Corporate Governance
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LEVEL 1LEVEL 1Understanding the Understanding the
need to need to professionalize professionalize the Companythe Company
LEVEL 2LEVEL 2First concrete steps First concrete steps
toward best toward best practicespractices
LEVEL 3LEVEL 3Implementation of Implementation of
best practicesbest practices
LEVEL 4LEVEL 4LeadershipLeadership
The basic The basic formalities of formalities of corporate corporate governance are in governance are in place including a place including a (i) Board of (i) Board of Directors, (ii) Directors, (ii) Annual Annual Shareholders Shareholders meeting and (ii) meeting and (ii) Shareholders Shareholders identified and identified and recorded. recorded.
Board member or Board member or high-level high-level executive executive explicitly charged explicitly charged with responsibility with responsibility for improving for improving corporate corporate governance governance practices. practices.
Written policies Written policies established established addressing key addressing key elements in family elements in family firm governance, firm governance, including (i) including (i) succession succession planning; (ii) planning; (ii) human resources human resources and family-and family-member member employment; and employment; and (iii) non-family-(iii) non-family-member share member share ownership. ownership.
Management/Management/Board approves Board approves annual calendar of annual calendar of corporate events. corporate events.
Corporate Corporate Governance policy Governance policy covers (i) role of covers (i) role of Board vis-à-vis Board vis-à-vis management; and management; and (ii) long-term (ii) long-term planning for planning for corporate corporate governance of governance of company company commensurate commensurate with business with business plan. plan.
Applicable Applicable corporate corporate governance, governance, accounting, accounting, auditing and auditing and internal controls, internal controls, and shareholder and shareholder information information practices are practices are equivalent to equivalent to those in place at those in place at best practice best practice public companies public companies (i.e., little would (i.e., little would needed to make needed to make an IPO). an IPO).
Company fully Company fully complies with all complies with all applicable applicable provisions of provisions of voluntary code of voluntary code of best practices of best practices of the country the country
A. C
OM
MIT
ME
NT
TO
CO
RP
OR
AT
E G
OV
ER
NA
NC
E
Attribute 2: Structure and Functioning of the Board
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LEVEL 1LEVEL 1Understanding Understanding
the need to the need to professionalize professionalize the Companythe Company
LEVEL 2LEVEL 2First concrete steps First concrete steps
toward best practicestoward best practices
LEVEL 3LEVEL 3Implementation of Implementation of
best practicesbest practices
LEVEL 4LEVEL 4LeadershipLeadership
Board of Board of Directors Directors constituted constituted and meets and meets periodicallyperiodically
Board meetings held Board meetings held according to a regular according to a regular schedule, agenda schedule, agenda prepared in advance, prepared in advance, minutes prepared and minutes prepared and approved. approved.
Non-family members Non-family members (probably company (probably company executives or ex-executives or ex-executives) appointed executives) appointed to the Board and core to the Board and core competency (skill competency (skill mix) review of Board mix) review of Board conducted, or conducted, or advisory Board of advisory Board of independent independent professionals professionals established and established and consulted on a consulted on a regular basis. regular basis.
Board composition Board composition (competencies/skil(competencies/skill mix) adequate to l mix) adequate to oversight duties. oversight duties.
Annual evaluation Annual evaluation conducted. conducted.
Audit Committee Audit Committee of non-Executive of non-Executive Directors Directors established. established.
Directors Directors independent of independent of management and management and owners appointed owners appointed to the Board to the Board (perhaps (perhaps “graduated” from “graduated” from the advisory the advisory Board). Board).
Audit committee Audit committee composed entirely composed entirely of independent of independent directors. directors.
Nominating Nominating Committee Committee established. established.
B. S
TR
UC
TU
RE
AN
D F
UN
CT
ION
ING
OF
TH
E B
OA
RD
Attribute 3: Transparence and Disclosure
28LEVEL 1LEVEL 1
Understanding the Understanding the need to need to
professionalize the professionalize the CompanyCompany
LEVEL 2LEVEL 2First concrete steps First concrete steps
toward best toward best practicespractices
LEVEL 3LEVEL 3Implementation of Implementation of
best practicesbest practices
LEVEL 4LEVEL 4LeadershipLeadership
Adequate accounting Adequate accounting and auditing systems and auditing systems in place including: in place including:
Adequate internal Adequate internal accounting and accounting and control system control system reviewed periodically reviewed periodically by independent by independent external auditors external auditors and quarterly and quarterly financial reports financial reports prepared by internal prepared by internal accounting and accounting and approved by the approved by the Board Board
Annual financial Annual financial statements audited statements audited by independent by independent external auditors external auditors and approved by and approved by Shareholders Shareholders Meeting. Meeting.
Accounting and Accounting and auditing auditing performed in performed in accordance with accordance with highest national highest national standards and standards and audit performed audit performed by recognized by recognized international international accounting firm. accounting firm.
Accounting, Accounting, auditing and auditing and internal control internal control systems up to systems up to international international standards. standards.
SameSame
C. T
RA
NS
PA
RE
NC
Y A
ND
DIS
CL
OS
UR
E
Attribute 4: Control Environment & Processes
29
LEVEL 1LEVEL 1Understanding the Understanding the
need to need to professionalize the professionalize the
CompanyCompany
LEVEL 2LEVEL 2First First
concrete concrete steps steps
toward best toward best practicespractices
LEVEL 3LEVEL 3ImplementaImplementation of best tion of best practicespractices
LEVEL 4LEVEL 4LeadershipLeadership
Adequate Adequate internal control internal control systems are in systems are in place and are place and are periodically periodically reviewed by reviewed by independent independent external external auditors. auditors.
Internal Internal audit and audit and internal internal control control systems systems are in are in accordancaccordance with e with highest highest national national standardsstandards..
Internal Internal audit and audit and internal internal control control systems systems are are consistenconsistent with t with highest highest internatiointernational nal standardsstandards..
SameSame
C.
CO
NT
RO
L E
NV
IRO
NM
EN
T
AN
D
PR
OC
ES
SE
SS
Attribute 5: Shareholder Rights
30
LEVEL 1LEVEL 1Understanding the Understanding the
need to need to professionalize the professionalize the
CompanyCompany
LEVEL 2LEVEL 2First concrete steps First concrete steps
toward best toward best practicespractices
LEVEL 3LEVEL 3Implementation of Implementation of
best practicesbest practices
LEVEL 4LEVEL 4LeadershipLeadership
All shareholders All shareholders kept informed of kept informed of company policy, company policy, strategy and strategy and results of results of operations. operations.
Annual Annual shareholders shareholders meetings held. meetings held.
Shareholders Shareholders provided with all provided with all material material information and information and detailed agenda detailed agenda in advance of in advance of shareholders shareholders meetings. meetings.
Family council Family council established (if established (if number of family number of family members large members large or substantial or substantial portion are not portion are not working in the working in the business). business).
Company in Company in position to position to quickly quickly implement all implement all aspects of best aspects of best practice code practice code with respect to with respect to shareholders shareholders were company to were company to go public. go public.
D. S
HA
RE
HO
LD
ER R
igh
ts