Keeping it in the family

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CONTEMPLATING THE FUTURE - Family-agreed rules can ensure a business practises good corporate governance

By Dr. Ashraf Gamal El Din – Chief Executive Officer, Hawkamah – The Institute for Corporate Governance

 

 

After years of working on governance for all sorts of companies and government institutions, I can claim, with a great deal of confidence, that applying good governance in family-owned businesses is one of the most challenging tasks.

There are many reasons why I came to that conclusion, all of which are based on the practices and issues facing families who are running businesses in the Middle East and North Africa (MENA) region. In other regions, this might not be such a significant problem. But in a region that is dominated by large, family-owned conglomerates, operating in all sorts of industries and employing hundreds of thousands of employees, the risk becomes too high to ignore.

If the business case for good governance is well-established, if the benefits are known almost to everyone, and if the risks have been proven many times from different parts of the world, why is it that difficult to sell the concept of good governance to family-owned businesses?

To be able to answer this question, we need to go back to basics; what is governance all about? One cannot help but refer back to the definition of corporate governance by Sir Adrian Cadbury, a system by which companies are directed and controlled. The commonly agreed structure of corporate governance is the one in which we have shareholders, who have the ultimate power, an elected board of directors, composed of professional directors, who act on behalf of the shareholders in appointing the management, motivating and supporting it, evaluating its performance, and dismissing it, if so needed.

When shareholders elect directors, they make sure that they are qualified, have diverse experiences and knowledge, have the time and commitment, and are loyal to the company. Ideally, directors are free from any biases and take decisions that maximise the long-term success of the company. In doing so, the management is accountable to the board and the board is accountable to the shareholders. In other words, shareholders evaluate the performance of the board and, if not happy, they can dismiss the entire board or some of its directors. Boards, being accountable to shareholders and having full control over the management, assess the performance of the CEO and have the right to reward, or fire, him/her. This system of hierarchical accountability is key to the success of any organisation. We always remind ourselves of the wisdom that says: ‘power corrupts, absolute power corrupts absolutely’.

How does the system work in family businesses? Many of these businesses now are either in the first generation, where the patriarch is still in power, or in the second generation. Those who are on the third generation are either facing serious challenges or were divided into smaller organisations or have been sold out or closed down. Focussing on companies governed by first and second generations will help us shed the light on the challenges to good governance.

The model we have seen in most of the families we interacted with is almost the same; the founder (usually male), either alone or along with, usually, the eldest son, are the ones in control. They manage the business closely and control its operations. The board, if there is one, is the family. The father, sons and daughters, sometimes the mother, are the directors. In a few cases you may find one non-family member, usually a family friend or trusted advisor, on the board. Needless to say that the ‘shareholder’ function is practised either by the patriarch alone or in partnership with his sons and daughters. In such a model, it is quite difficult to establish the concepts of responsibility, fairness, accountability and independence.

One might think that it is the founder or patriarch who resists good governance. The assumption might come from the perception that he would like to remain in control and be the ultimate decision-maker. This is partially true. The founder perceives the company as his empire; he built it, made it successful and hence must remain in control. In some cases, it is his main source of the social status and prestige. Losing control over the company means that the founder loses his social status. While interacting with families, however, we found that in many cases, it is the second generation that resists establishing good governance in their companies. This is because they are either in control or they are enjoying many privileges that they would lose under good governance. Examples of such privileges include exaggerated packages, access to corporate money and assets, unlimited corporate cards, and the like. In other cases, the family as a whole perceives the company to be part of the ‘family legacy’. In this case, the family and the company represent a sort of one, inseparable structure. Does this mean that we cannot have good governance in family-owned businesses? The answer is no, but we need to start somewhere else; with the family.

Good governance starts from the family, because that is where the problems are. The family, led by the founder or the second generation, needs to answer one key question; do we need the company to be a source of wealth for us or do we prefer to have it as a source of jobs for family members? The answer to this fundamental question makes a huge difference. If the family decides that it wants the company to be a source of wealth, then it needs to be run on a professional basis. That does not prevent family members from working in the company and leading it, but this is to be based on merit, not family name. In this case, the family will establish a professional employment policy for the company that applies even to family members. If, on the other hand, the family wants the company to be a source of jobs for its members, this must come with the realisation of the cost of such policy.

The family acts as the ‘shareholders’; it appoints  a board of directors who then appoints a CEO and works with the management towards fulfilling the vision of the shareholders’

The family will be paying from its own wealth to make sure that family members must find jobs in their business. However, this is a destructive policy in the long term. There are no guarantees of the quality of all family members who aspire to work in the company, and while some might be really clever, it might be hard to convince those who are not that clever that they do not qualify to work in the business. This is like setting a series of time-bombs, hoping that none of them will actually explode. Family businesses cannot flourish under this system and the family will sooner or later lose its business.

If the family decides to have its company as a source of wealth, it needs to go back to the classical governance structure we mentioned earlier. The family acts as the ‘shareholders’; it appoints a board of directors who then appoints a CEO and works with the management towards fulfilling the vision of the shareholders. Nothing prevents one or two of the family from being board members, and nothing prevents family members from joining the company, but based on the regular employment policy of the company, that is approved by the board, who acts on the best interest of the shareholders.

But for the shareholders to act as a professional general assembly, the family needs to put some rules for its functioning. These family-agreed rules will keep the family from conflicts between its members and from manipulation by some members. Patriarchs are best advised, to have wider roles in the society and many non-business engagements that help maintain their status, even if they leave their businesses. Needless to say, that in fact they do not need to leave their businesses; the patriarch can continue to be the chairman of the board or the head of family assembly. This suggested system does not mean that the family loses control, it rather means that the family will practise a different type of control than managing the daily operations of the company.

A final word on regulation. While governments may perceive family businesses to be a family business, it is not. As mentioned earlier, they operate in all industries, employ loads of employees, and generate income for thousands of families. It might be a good idea that once a family business reaches a certain threshold, it needs to be regulated differently and made to adopt a governance structure that protects the interests of the economy and society at large.

 

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.