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Three-fold mantra for corporate governance in family businesses

By Tulsi Jayakumar

Governance determines success or failure in any organization. In the case of family firms, issues of governance acquire a different dimension altogether since organisational goals may be driven by the motives of multiple owners. Further, business interests may not be aligned among members of a single family, leave aside multiple stakeholders. The challenges are particularly stark for family businesses which have grown in size and complexity, have moved on to the path of professionalization, and yet, which carry on with a ‘ promoter mindset’, governed primarily by personal relations and deference to tradition.

More than 75 per cent of businesses in India are family businesses, and 15 of the top 20 business groups in India are family -owned. Listed family business firms which possess a ‘family business edge’, have been found to outperform their listed non-family rivals globally, both in terms of superior returns and higher profitability. However, such outperformance happens only when the interests of shareholders and management are aligned.

The importance of a well-defined and transparent corporate governance mechanism, both at the family and business level, cannot be overstated. Such a mechanism is required for long term business success as also to maintain peace in the family, especially with the succeeding generations. Investors- both shareholders and creditors- are concerned about the abuse of minority shareholder rights when it comes to investing in family-controlled companies. They are likely to distrust companies with poor corporate governance reflected in highly concentrated ownership, poor transparency and absence of accountability and fairness principles.

Several family businesses, even though on the path to transformation to large professionally managed groups, continue to be driven by a promoter-mindset characteristic of family firms in the ‘ founder stage’. As the business develops, corporate governance in family firms is not simply about constituting a Board of Directors and mandated committees for audit, remuneration for directors and investors’ grievances. It also goes beyond being ‘good’, ‘not being crooked or corrupt’, and having a code of conduct which enforces this through prohibition of insider trading etc. It refers to a laying in place a transparent and robust corporate governance mechanism.

The three-fold mantra to ensuring an effective corporate governance mechanism in family businesses includes:

One, delineating and legally separating the family from the company-owned assets, so that there are no problems of use of company-owned assets by the family as a shareholder.

Two, ensuring that internal controls, audits and risk management systems are not tailored to the needs of the founders’ families and that ‘ Independent Directors’ are truly independent.

Three, ensuring the reliance on structures and processes for key decisions, rather than relying on key people.

Governance challenges for family businesses differ based on the ownership stage at which the controlling company is. Such challenges may probably be higher as the company matures than in the founding stage, threatening corporate reputation, profits and the firm’s very survival. Studies have found an inverse relationship between ownership concentration and company valuation. Investors were found to place a 3% valuation premium on emerging market firms in which family insiders wielded significant, but not absolute, control. Conversely, for emerging market firms where families were majority owners, investors assigned a valuation discount of 5-20 percent. Investors thus want family businesses to have structures and processes that are globally recognized as good practices. The message is out there loud and clear: Corporate Governance may well prove to be the Achilles’ heel for several family businesses, which fail to read the writing on the wall.

Tulsi Jayakumar is Professor and Program Head, PGP-Family Managed Business at S.P. Jain Institute of Management & Research, Mumbai. Views are personal.

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