Family Versus Professionally-managed Businesses

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IntroductionFamily Business constitutes world’s oldest and most

dominant form of business organization.Family Businesses range from small and medium sized

companies to large conglomerates that operate in multiple industries and countries.

Definition of Family Business: A family business refers to a company where the voting majority is in the

hands of the controlling family; including the founder(s) who intend to pass the business on to their descendants.

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The Importance of Family Business—and Hence Corporate Governance—to the Economy

75

80

85

90

90

99

0 50 100 150

UK

Spain

EU

Sweden

US

Italy

Proportion of OECD Firms That are Family-RunIn percent

Source: Nancy Upton and William Petty, “Venture Capital Investment in Family Business,” Venture Capital, 2000, Vol. 2, No. 1, pp. 27-39

Over 85% of EU/US businesses are family run

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Strengths of Family Business

They outperform non-family owned companies in sales, profit, and other growth measures.Thomson Financial study compared family firms to rivals on the six major indexes in Europe and showed

that family companies outperformed their rivals on all of these indexes (2003).

Strengths: High commitment/dedication from family as business

owners. Family members willingness to work harder and reinvest

profits into the business for long term growth. Willingness to pass on knowledge and experience Family name and pride associated with the business.

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Weaknesses of Family Business

Weaknesses:• Poor Management, insufficient cash to fund growth.• Non-alignment of incentives among family members.• Lack of articulated practices and procedures.• Lack of discipline.

Two-thirds to three-quarters collapse or are sold by the founders during their own tenure.

Family Businesses have short life span. 95% do not survive third generation of ownership.1

1Fred Neubauer and Alden G.Lank (1998)

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Stages of Family Business and Common Issues

Ownership Stage Dominant Shareholder issuesStage 1: The Founder(s)

- Leadership transition- Succession - Estate planning

Stage 2: The Sibling Partnership

-Maintaining teamwork and harmony -Sustaining family ownership-Succession

Stage 3: The Cousin Confederation

- Allocation of corporate capital: dividends, debt, and profit levels- Shareholder liquidity- Family conflict resolution- Family participation and role- Family vision and mission- Family linkage with the business

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Overlapping Roles and Responsibilities of Family Members

Familymember Manager

Owner Director

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How Can Good Family Governance Help?

• Communicating the family values, mission, and long term vision to all family members.

• Keeping family members (especially non-executives) informed about major business accomplishments, challenges, and strategic directions.

• Communicating the rules and decisions that might affect family members’ employment, dividends, and other benefits they usually get from the business.

• Establishing formal communication channels that allow family members to share their ideas, aspirations and issues.

• Allowing the family to come together and make any necessary decisions.

Well-Functioning Family Governance Structures aim at:

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Family InstitutionsFamily institutions can have different forms and purposes

• Family Assembly: A formal forum to discuss all business and family issues.

• Family Council: it is the governance body for the assembly in coordinating the family members interest in the business.

• Family Office: It is an investment and administrative center that is organized and overseen by the family council.

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Family ConstitutionFamily Constitution helps formally codify many of the family

governance structures. Typically defines:

Family values, mission statement, and vision.

Family institutions, including the family assembly, the family council, the education committee, the family office, etc.

Board of directors (and board of advisors if one exists).

Senior management.

Authority, responsibility, and relationship among the family, the board, and the senior management.

Key Family Governance Policies (see next)

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Key Family Governance Policies Family Employment Policy: Policies should not discriminate or favor family members. Must

establish atmosphere of fairness and motivation for all employees.

Family Shareholding Policy: Establishes rules for share ownership and transfer to ensure shares are kept in the family when desired (e.g., Share Redemption Fund).

Family Dividend Policy: Establishes guiding principles for family dividend payments to help resolve differing family cash demands.

Family Director Nomination Policy: Guidelines for electing family members to the company Board of Directors.

Family Education Policy: Guidelines for helping family members gain educational and professional training (may include Education fund).

Conflict Resolution Policy (and Committee): Describes measures to help resolve conflicts between family members within a defined scope.

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Putting ‘Business First’Sample Issues

Family First Cos.

Family Employment

Open-Door Policy for all family members, regardless of qualifications

Compensation Equal pay for all, regardless of their experience or performance

Leadership Leadership based on Seniority in Family, regardless of merit or qualifications

Resource Allocation

Business Resources used for personal needs (e.g., loans, grants)

Decision-Making

Unilateral & Concentrated with Senior Family Member (e.g., Chairman/CEO)

Business First Cos.

Qualification-Based Employment, as for any other new hire

Merit-Based pay, based on experience, performance

Leadership granted to the right person (family or non-family), based on merit and qualificationsBusiness resources only used for business purposes – separate family reserve fund utilized for family needs.Mulit-lateral, based on Defined Governance Structure (e.g., Executive Committee)

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Board of Directors – Key Considerations The Board of Directors is the central institution in the governance of family-owned business.

Initial stage of the board is only to comply with the legal requirements but as the business grows.

As interim step, many family cos. consider Advisory Board that complements the skills and qualifications of their current directors.

Ultimately, the board must transform for long-term sustainability. For example:

Move to a full professional board with outside members.

Clearly define the roles of the board and separation between family institutions and senior management.

Ensure Board has full autonomy to direct and control the organization, separate from family influence.

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Independent Directors

• Once family business size grows, then it is important to establish an independent board.

• Normally, board membership is given to family members and few trusted non-family members.

• Independent directors » Bring outside perspective on strategy and control.» Add new skills and knowledge to the firm.» Independent hiring decisions can be made.» They have an objective ear to disagreements in the among family-

member managers.» They can use their connections to the advantage of the business.

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Senior Management – Key Considerations Senior managers are an integral part of family governance structure.

They manage the day to day operations of the business and the direction that is set out by the board of directors.

The founder(s) initially manage the family business but as it grows in size a formal management structure is required.

Ultimately, Senior Mgt must transform for long-term sustainability. For example:

Ensure that the right senior managers are in place. Decision-making processes are not unilateral (e.g., only Family

CEO/Chairman) – consider Executive Committee Remuneration system based solely on performance Evaluations of Senior Executives conducted fairly and objectively

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Advisory Boards

Advantages Disadvantages-Easy to recruit since members have no legal responsibilities

-Provides company with additional skills, technical expertise and knowledge.

-Advice is usually unbiased

-Members may offer new contacts leading to sales or source of capital.

-Advice may not be followed by the company.

-No authority to request information from the company.

-No influence over strategy and performance oversight of the management.

-Cannot be held accountable for their advice.

-May not take their role seriously.

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Senior Management Succession

Most important issue for family-owned business is Senior Management Succession plan.

• Poor senior management succession is the main reason why family businesses collapse before they reach the third generation.

• Formal succession plan should allow selection of the most competent person (whether it is a family member or not).

• Family members must be involved in the selection process as also the board, key senior managers, and other important external stakeholders and they all must agree on the choice.

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Steps of a Formal Succession Plan

• Starting Early» To ensure continuity of business, it is important when current CEO is appointed, plans for the next

one should start.

• Create Career Development systems» Consider strategic direction of company and what executive skills will be needed» Create development systems to help executives fill skills gaps

• Seeking advice» External independent directors or senior non-family members should be consulted on the choice.

• Building Consensus» Mandatory to involve key stakeholders in the selection process.

• Clarifying the transition process» A transition plan must be developed between the current CEO and the successor. The process

should specify the transition date and also the level of involvement of current CEO after retirement

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Conclusion• The inherent challenges of family businesses can be mitigated by adopting a sound

corporate governance structure.

• The corporate governance structure must clearly define the roles, responsibilities, rights, and interaction between the companies main governing bodies.

• In a family, corporate governance responsibility is shared among owners, board of directors, and senior management.

• Setting-up a corporate governance structure early will help anticipate and resolve conflicts among family members about business issues.

• Families must set-up adequate structure for the board of directors and senior management.

• A clear governance structure will make it easier to maintain family cohesion and its members’ interest in the family and business and ensure long-term sustainability!

Better Companies,Better Societies

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Outline

• What is Corporate Governance?• Building effective Board Governance• The different roles related to the Board• Some Concluding Thoughts!

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What is Corporate Governance?

Corporate Governance is a mechanism through which boards and directors are able to direct, monitor and supervise the conduct and operation of the corporation and its management in a manner that ensures appropriate levels of authority, accountability, stewardship, leadership, direction and control.

“The importance of corporate governance lies in its contribution both to business prosperity and to accountability.”

Paragraph 1.1, Committee on Corporate Governance:

Final Report Hampel Committee

“Corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals…… The aim is to align as nearly as possible the interests of individuals, corporations and society.”

Sir Adrian CadburyCorporate Governance Overview, 1999

[World Bank Report]

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It’s about Leadership………!

• Leadership for efficiency……– to compete in the global economy, create jobs

• Leadership for probity– because investors require confidence– to provide assurance of management's integrity

• Leadership with responsibility….– to take account of broader stakeholder interests

• Leadership that is accountable and transparent– to build trust in companies and in the economy!!

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Building Effective Board Governance

• Defining key board roles – Board Chairman– Chief Executive Officer– Board Directors - executive and non-executive

• Putting in place board governance arrangements– Board committees to support decision process– Supporting functions to regulate processes– Board procedures and rules, e.g. conflicts of interest– Delegated authorities for management

• Ensuring proper oversight and supervision– Management reporting and public disclosures– Assurance processes and controls

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The Board of Directors is Pivotal

“The board should exercise compelling and relentless leadership and should not underestimate the power of leading by example - evidenced by high levels of visibility and integrity, strong communications, and demanding expectations. This leadership should be clear to ALL within the organization, as well as shareholders and other stakeholders.”

Boardroom BehavioursA report prepared for Sir David Walker

by the Institute of Chartered Secretaries and Administrators , UKJune 2009

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AuditCommittee

Remuneration Committee

OtherCommittees

Board Committees

Strategy

Board of Directors• Achievement of strategic objectives and value creation• Fulfil responsibilities and duties in law and prescribed functions

Boar

d O

pera

tions

Chairman

Board Meetings

Reporting &Disclosure

Internal Controls & Assurance

Executive Committee

Internal Audit External Audit Other Assurance Providers Management

Combined Assurance Model

GovernanceSystem andControls

Corporate Policies & Procedures

Board Governance Instruments

Monitoring and Evaluation Key

Area

s of R

espo

nsib

ility

CEO & Management

Shareholders

Info

rmati

on a

nd C

omm

unic

ation

CorporateSecretary

Source: KPMG

Board Governance Framework

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Chairman as Leader of the Board

• Primary role – Provide overall leadership to the board

• Function– Principal link between board and CEO/management team– Responsible for board agenda and work plan– Work with board committee chairmen– Involved in selection and induction of new directors– Counsel individual directors on their performance– Participate in discussions with investors, key stakeholders

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CEO as Leader of the Company

• Primary role – Lead the management team, reporting to the board

• Function– Work closely with board chairman– Responsible for performance of management team– Formulate corporate strategy, annual business plan and budget– Responsible for corporate and financial objectives– Formulate major corporate policies– Ensure continuous improvement in services and products – Manage relations with investors, major customers, regulators– Responsible for company’s long-term sustainability

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Board Structure and Composition

• Balancing executive and non-exec. participation • Ensuring an effective selection process

– Key personal and professional attributes– Skills aligned to strategy and business– Also fill board committee requirements, where appropriate

• Some general guidelines – Must have time to devote to responsibilities– Must exercise judgment in best interests of company– Must be informed about the business and its markets– Must avoid interest conflicts between personal and business– Must treat board information confidentially– Should act objectively and be receptive to other perspectives– Should prepare adequately for meetings, regular attendance

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Common Legal Principles of Directorship

Exercise reasonable standard of care – Special business acumen or expertise not necessarily

required– Not necessarily liable for errors of judgment– Given events following financial crisis, will this change?

Duty to act in best interests of the company– In other words, for ALL shareholders, not special interests

“The legal framework and company charters should not permit practices (such as “pre-meetings” and instructions on how to vote by shareholders whose votes placed a director on the board) wherein shareholders may limit the ability of directors to exercise their duties to act in the best interest of the company and all shareholders.”

Paragraph 90, OECD’s White Paper on Corporate Governance in Latin America

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Benefits of Effective Board Committees

• Assist the board in its decision making – Brings together non-executives and management– Allows detailed discussion on management matters– But, filters out operational issues that remain with management– And, focuses on strategic decisions required of the board

• Supports board responsibilities in key areas– Audit, internal controls and risk– Executive compensation and management appointments– Governance issues and corporate policies – Nomination and selection of non-executive directors– Others, e.g. health, safety, environment, etc.

• Defined terms of reference and limitations• Generally, no executive powers

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Instruments to Enhance Effectiveness

• Board Charter setting out procedural rules– Clarifies leadership roles and core responsibilities– Reserves matters specifically reserved to board– Sets management delegations and reporting arrangements

• Comprehensive induction for new directors– Legal and regulatory obligations– Financial structure of business, budgets and KPIs– Understanding of strategic priorities and current status– Familiarize with business operations, e.g. site visits

• Annual board work plan– Meetings and budget cycle, annual reporting

• Code of ethics or statement of business principles– Defines corporate values and conduct of staff and directors

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Role of Corporate Secretary

Supervises and co-ordinates board papers & presentations

Takes the minutes ofboard meetings

Resolves organizational matters for board meetings

Works closely with Chairman and CEO on board agenda

Arranges the annual shareholders meeting and other special meetings

Ensures compliance with the board procedures

Oversees, conducts induction trainings for newly elected directors

Explains the procedural requirements of laws, the charter, and by–laws of the company

Key link between company and non-executive directors

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Board Role in Financial Oversight

Duty to maintain proper accounting records Periodic reporting of financial position, performance Establishing, monitoring proper internal controls Ensuring proper external controls and audit Skills, knowledge required by directors

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Board’s Role in Risk Management The board should know about and evaluate the:

↳ Most significant risks facing the company↳ Possible effects on shareowners↳ Company’s management of a crisis↳ Importance of stakeholder confidence in the organization↳ Communications with the investment community

The board should ensure that:↳ Sufficient time is devoted to discuss risk strategy↳ Appropriate levels of awareness exist throughout the company↳ Risk-management processes work effectively↳ A clear risk-management policy is published

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Not an easy task - Identified Risks Strategic

↳ Unfocused strategy↳ Strategy not aligned with capabilities↳ Complacency arising from past success↳ Unsuccessful acquisition/abortive bid↳ Failure to manage major changes↳ Reputational risk↳ Loss of investors’ confidence↳ Political/general economic risk

People↳ Management leadership weak↳ Inadequate succession planning↳ Loss of key executives↳ Poor employee motivation↳ Internal communication weaknesses

Marketplace↳ Failure to respond to market trends↳ Missed opportunities – new tech., global

markets↳ Weak or obselete brands↳ Over-reliance on a few customers↳ Poor customer satisfaction – quality/timeliness

Ethical↳ Failure to enact high standards of ethics↳ Obtaining contracts unethically↳ Stakeholder concerns on products/business

probity – poor community relations Suppliers/Outsourcers

↳ Over-dependence on suppliers/outsourcers ↳ Failure to manage cost/quality of outsourced

service↳ Supply chain problems↳ Joint ventures, strategic alliances not working

Financial↳ Cash flow/going concern problems↳ Treasury operations risk↳ Susceptibility to fraud/accounting irregularities

Legal/Compliance↳ Failure to protect intellectual property↳ Health, safety, environmental issues↳ Litigation risk↳ Breach of competition, corporate,

employee, tax laws

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“Boards must re-establish and enforce the standard that risks are to be undertaken for the benefit of their constituents, not for the personal gain of management.”

George VojtaChairman of the Advisory Board of the Yale School of Management Millstein Center for Corporate

Governannce and Performance and Former Vice-Chairman, Bankers Trust Corp.

Restoring Integrity and Trust

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Six Critical Questions for Directors!

• Do I believe I have all the information?• Have I the necessary skills to make this

decision? • Do I have any conflict in this matter?• Objectively, is this a rational business decision?• Can I explain this in a transparent manner?• Is it a responsible discharge of my duties?

MCI’S (former WorldCom) GUIDING PRINCIPLES

Build Trust and Credibility!↳Respect for the Individual↳Create a Culture of Openness

and Honesty↳Set the Tone at the Top

Uphold the Law!↳Avoid Conflicts of Interest↳Set Metrics and Report Results

Accurately

Do the Right Thing!↳Promote Substance over Form↳Be Loyal to your Company,

your Family, yourself 39