By Dr Ashraf Gamal El Din – Chief Executive Officer, Hawkamah, The Institute for Corporate Governance
Corporate governance practices in the MENA region have improved significantly over the past decade. Regulators across the region have developed corporate governance codes and frameworks for listed companies and, in many cases, for banks, which have resulted in substantial improvements.
State and family-owned enterprises often fall outside governance regulations, but increasingly such companies are recognising the benefits of good corporate governance in terms of better decision- making and control processes and many have taken steps to ensure that effective governance structures are in place. However, for family businesses the effectiveness of corporate governance is largely dependent on an additional element – on family governance.
Family businesses in the region
Listed companies and state-owned enterprises may be the most visible companies, but family businesses are the core of the Gulf economies. Figures suggest that around 80 per cent of the companies in the region, producing more than 90 per cent of its non-oil wealth, are family-owned or controlled. Most of these companies are relatively young, with many of the successful businesses having been set up in the 1970s boom years. It is also estimated that over the next decade half of these companies, controlling assets worth $1trillion dollars, will be passed on to the next generation. This is a case for concern.
Family businesses are notoriously vulnerable during periods of transition. The oft-quoted statistic states that only about 30 per cent of family and businesses survive into the second generation, 12 per cent are still viable into the third generation, and only about three per cent of all family businesses operate into the fourth generation or beyond. Or as the Chinese saying goes: ‘fu bu guo san dai’, which roughly translates as: ‘wealth does not pass three generations’.
The most critical issues facing family businesses are not business-based but family-based. And the challenge facing family businesses is often understood to be a problem of succession, both management and ownership succession. Who will take over the reins at the company? How will the ownership be shared among the family members? And how will the owners be involved in the business? These are all sources of potential conflict among family members. It has been estimated that the great majority of Saudi family businesses have at least one succession related dispute in the courts.
Succession as a long-term process
Succession is often a sensitive topic to discuss. Founders often find it difficult to let go of the business they have built and from which they derive much of their identity – they see the company as an extension of themselves. The children are often uncomfortable discussing their parent’s mortality and do not wish to open such conversations for fear of being seen greedy. Non-family employees are often not in a position to instigate such discussions, either, and they may not be comfortable with potential changes.
There is a tendency to view succession as a one-off event, for which the required responses are deemed to be rather technical in nature, best dealt with by estate lawyers, accountants, tax advisors and recruitment consultants in the case of hiring a non-family CEO. However, instead of looking at succession from the technical perspective, family businesses should view succession as a long-term process which is personal and often emotional, addressing family issues and anxieties. In fact, successful succession is typically dependent on how well the overall family governance systems have been instituted.
Family governance process
Studies show that family businesses tend to outperform their non-family counterparts and this is often because of the family element, meaning that there is a higher level of trust and commitment than usually found in non-family businesses. The family element, i.e. the emotional bond that helps the family business strive, may become the source of interference. The key is to develop a mechanism to preserve the inherent strengths of family businesses, while minimising their inherent weaknesses. The family governance process should start by articulating the vision for the business and its relationship with the family.
“Studies show that family businesses tend to outperform their non-family counterparts and this is often because of the family element, meaning that there is a higher level of trust and commitment than usually found in non-family businesses”
The success of family businesses is dependent on their owners. During the first generation, family members, executives and employees tend to be aligned on what the business stands for and are united towards the same goals, but there is a danger of this alignment breaking down in subsequent generations. As the second generation starts to take over the business, the issues tend to become more complex and the level of complexity depends on the number of family members. Owners who are unanimous about the direction and means for developing their company, and who select the best representatives from among themselves and external professionals to manage the company, are able to run profitable and successful family business. Diverse expectations of the business among various family members will dissociate and weaken the business, family and ownership.
The key is to create conditions in which not only the ownership of the business is transferred to the next generation, but also the values and purpose of the business, and to build family legacy – i.e. attachment to the company that goes beyond mere financial relationship.
This requires open communication within the family, between the generations, identifying the expectations, values and ultimately determining whether the governing principle should be ‘family first’ or ‘business first’. The outcome of these discussions should be formalised in a mission statement or a family constitution, which then regulates the family’s relationship with the business.
The family owners should then establish policies to support this relationship. Such policies include a family employment policy that clarifies expectations to both family and non-family employees. It may contain several conditions for family members before entering the business on a full-time basis, such as required education and outside work experience. Employment policies often stipulate that family employees should not report to other members of the family, that family employees are subject to regular performance review practices and that their compensation levels are based on market value. Other key policies that family owners should formulate include dividend policy, family ownership policy and philanthropy policy, which are typically included in the family constitution.
In order to maintain continuity across the generations, family owners should formulate mechanisms for regular communication between family members. Some family constitutions specify annual family retreats or regular family forums to ensure a good flow of information as well facilitate sharing of ideas and opinions. Such forums also help nurture the next generation of stewards of the family business.
In families with a large number of members, family owners often set up a family council in which selected family members are entrusted to engage with the company, while reporting to the wider family (or family assembly). The underlying principle is that the family members should have systems in place for communicating with each other as well as a mechanism through which the family can speak to the company with one voice.
One size does not fit all when it comes to family governance. Each family will have their own solutions to each step of this process, depending on their history, values, resources and circumstances. The contents of each family constitution vary greatly, but what is important is that families follow a similar process to establish the rules and values governing the relationship between the family and the business.
“In order to maintain continuity across the generations, family owners should formulate mechanisms for regular communication between family members”
A proper family governance framework provides a solid ground for the company’s corporate governance framework to grow. When the family speaks with one voice, the company’s board of directors will have a clear long-term vision on what is expected of them and this will result in an empowered board reporting to active, long-term owners. Without a proper family governance framework, boards and management are often subjected to operational and even contradictory interference by various family members. A strong family governance framework will limit such interference and help management focus on executing the long-term strategy for the company.
Family governance is about putting in place frameworks to allow for business continuity to the next generation while protecting the legacy of the founders. Some of the most famous companies around the world, including Mars, Cargill, BMW and Walmart are family businesses and they continue to be successful across multiple generations. This is not a matter of luck. Such families put in the effort to maintain and refine their family governance frameworks on an ongoing basis. They recognise the challenge and earn their success. Instituting a family governance framework is challenging but it is essentially about fixing the roof while the sun is shining.
About the Author:
Dr. Ashraf Gamal El Din is the Chief Executive Officer of Hawkamah, the Institute for Corporate Governance. Prior to joining Hawkamah, Dr. Ashraf was the Executive Chairman of Egypt Post. Before that, he was the Deputy Executive Director of the Egyptian Banking Institute, the training arm of the Central Bank of Egypt. He was also the founder and Project Manager of the Egyptian Corporate Responsibility Center working on promoting the concepts and application of CSR in Egypt. Furthermore, he was the Executive Director of the Egyptian Institute of Directors (EIoD), the Institute of Corporate Governance in Egypt and the Arab Region Dr Ashraf served as a board member and head of the Audit Committee in a number of listed, non-listed, State Owned and family owned companies. He also served a member of the General Assembly of the Holding Company for Transportation.