Can a mastery of six fundamental areas of corporate governance propel more family enterprises beyond the third generation? Scott McCulloch reports.
Think you know governance? Think again.
A recent survey by the Institute of Corporate Directors and the Clarkson Centre for Board Effectiveness revealed that 33% of Canadian family businesses had neither a fiduciary board nor an advisory board.
Lack of structure doesn’t necessarily equate to poor governance, the report asserts, but governance mechanisms often grow in necessity as a family business matures.
A family’s growth and its enterprise’s progression do not necessary occur at the same pace. But both are intertwined, and it is here where governance can get tricky.
Which is why it is crucial to understand the distinction between corporate and family governance.
Family governance refers to formal processes that enable decision-making and policy enforcement concerning the management of family affairs.
The goal of corporate governance is to enable investors (owners) to get a good return on their investment in the firm.
In business families both concepts intersect, and within that intersection lies six vital governance components: ownership structure, control mechanisms, boards, executive compensation, dividend policy and succession.
Family-controlled firms have long proven their edge over their non-family rivals, and good governance is a core ingredient in the winning formula.
One famous study by the Cyprus Institute of Management of 42 companies on the London Stock Exchange showed that listed family firms outperformed non-listed rivals by 40% between 1999 and 2005.
Yet the study noted that the outperformance of the Family Business Index only applied when the interests of shareholders and management were aligned.
Alignment is a form of purpose, and many family businesses have that in spades.
Widely-held public corporations are saddled with the so-called “agency problem” – managers and investors with conflicting incentives, according to a World Economic Forum study.
Family firms more easily align management and ownership incentives. Yet they are more likely to face another agency problem – the potential conflict of interest between family and non-family shareholders.
Attention to this issue is vital in all aspects of family firm governance, especially in families with investible assets north of US$100 million.
Many family business owners reach a point where they want to take some value out of the enterprise they have built up over decades by, say, an IPO or setting up of a family office.
The IPO route does not always appeal to all family business owners. They can be reluctant to dilute family ownership, for fear of the potential loss of control.
Meanwhile, stock market investors may sometimes worry that the families might be too self-interested to ensure good stock performance.
Either way, as a family business matures, good governance instruments become essential.
Why? Markets depend on it. In fact, it is impossible to overstate the importance of entrepreneurial families to the global economy.
In the US alone, family firms generate 64% of GDP or $5.9 trillion and 82 million jobs. Many of the world’s largest multinational corporations began as family firms.
And yet who hasn’t heard the received wisdom that first generation starts the company, the second builds it and the third destroys the business?
The reality is that a paltry 12% of family business get to third generation. That is a disturbing figure. So why not reverse it with better governance?
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