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Home > Corporate Governance Checklists > Governance Practices in Family-Owned Firms

Corporate Governance Checklists

Governance Practices in Family-Owned Firms


Checklist Description

This checklist considers the impact of rising corporate governance requirements on family-owned businesses and outlines a corporate governance framework suited to such businesses.

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Definition

Corporate governance practices have come under greater scrutiny in recent years, particularly in the wake of the 2001 corporate debacle that was the collapse of the energy trader Enron. Even at the opposite end of the capitalization spectrum, family-owned businesses have not entirely escaped some suspicious investors’ attention, leading to increased pressure for reform. Many businesses owned largely by families have responded by making the governance practices more formal, while generally increasing the transparency of their operations.

Family ownership of listed companies is commonplace, with wealthy families continuing to own large stakes in listed companies. In some European countries, powerful families effectively control their family-owned companies using voting rights that exceed their actual economic stake in the business.

Family-owned businesses benefit from a stronger personal bond between the owners and the actual business, and between the owners and employees, with the result that the family owners can be less focused on short-term earnings growth and more on long-term strategic development. However, governance structures within family businesses typically evolve with the development of the business—a process formalized in the model of family-business growth and governance developed in the late 1990s by Kelin Gersick, John Davis, Marion Hampton and Ivan Lansberg. This widely accepted model identifies three stages of transition of family businesses:

1. Founder or controlling owner stage

Management and ownership are in the hands of one individual or a couple benefiting from the input of close advisers such as accountants and legal professionals. Governance is typically informal, although the personal attitudes of the owner(s) are often reflected in the way the business operates.

2. Sibling partnership stage

With the approaching retirement of the founder(s), control passes to the next family generation. Governance is frequently complicated by the involvement of a wider base of stakeholders than at the founder stage. Some governance needs are best overseen by a board of directors or a separate advisory body.

3. Cousin consortium

Control of the business becomes further diversified as the siblings pass control of the business to their own children. Some may exit the business completely, potentially selling their stake to outsiders and conceivably diluting the family interest to the extent that the business may no longer be regarded as a family operation. In other cases, some siblings may seek to concentrate control by buying out other stakeholders. The need for an independent governance structure increases considerably.

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Advantages

  • Greater transparency can improve the public perception of how family-controlled businesses hope to serve the needs of all stakeholders.

  • Understanding the development pattern of a business can help to identify how its governance needs are changing.

  • The centralized nature of family ownership can help to keep the costs of corporate governance lower than is the case for firms with wider public share ownership.

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Disadvantages

  • Some investors may be skeptical as to how committed family-run businesses are to equally serving the interests of all shareholders.

  • Some growing family businesses can be slow to recognize the need to put in place measures to satisfy outsiders.

  • Liquidity in family-owned companies is often tighter than in other companies, with some families creating legal barriers to the disposal of stock. This can lead to greater resistance to the transparency demanded by modern corporate governance standards.

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Action Checklist

  • Family businesses should play to their greatest strength—the ability to pursue a strategy for longer-term gain.

  • Family-owned businesses should also resist short-term industry fads and instead focus on building a long-term market presence.

  • It is necessary to be aware of the risk that some stakeholders in family businesses might languish in the comfort zone away from mainstream shareholder pressure and instead pursue their personal goals on the business’s time and at the expense of other stakeholders.

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Dos and Don’ts

Do

  • Recognize how governance needs evolve over time.

  • Appreciate that an external perspective can help family members better understand the need for more formal governance procedures to reassure non-family investors.

  • Understand that accepting the accountability to an independent governance board can bring real advantages to the business.

Don’t

  • Don’t fall into the trap of thinking that corporate governance only amounts to protecting the reputation of the family.

  • Don’t ignore the benefits that external accountability can bring, such as an increased incentive to drive the company’s strategy.

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Further reading

Articles:

  • Steier, Lloyd P., James J. Chrisman, and Jess H. Chua (eds). Special issue on “Entrepreneurial management and governance in family firms.” Entrepreneurship Theory and Practice 28:4 (June 2004): 295–411. Online at: tinyurl.com/3tujmkc
  • Ward, John L. “Governing family businesses.” eJournal USA (February 2005): 38–41.

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