Worldwide: Corporate Governance In Family Businesses

Last Updated: April 26 2018
Article by Juan Sebastian Flor

Introduction

Corporate Governance in a company is a concept relatively easy to define. It is the system formed by the relations between shareholders, organs of administration and of executive management, taking into consideration the processes by which these three figures control and direct the organization. According to Investopedia it "is the system of rules, practices and processes by which a company is directed and controlled. Corporate governance essentially involves balancing the interests of a company's many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community." (Investopedia)

Nevertheless, to understand this notion in the frame of the family businesses, turns out to be a little more complex task, due to its specific structure in what governance and managerial aspects regards. First, because one of the principal characteristics of this type of entities is their variety. There is not such thing as two identical family enterprises. For that reason, it does not exist a unique model of corporate government applicable to all family businesses. Secondly, because the relations that integrate the system are often unknown and difficult to understand, they gather commercial elements with emotional aspects and, as the companies develop, they become increasingly numerous.

In spite of this difficulty, some family businesses have implanted formal structures for both, corporate and family aspects, which supposes, no doubt, a great advance. Nevertheless, for many family businesses it continues being difficult to define the roll of these structures or simply, how to improve its efficiency. In practice, these institutions can become an obstacle for the growth and the capacity of development of these companies.

Family Businesses

Family Businesses are well known types of enterprises that have functioned throughout the years as important elements for the development of a country´s economy. The International Finance Cooperation defines a family business as follows:

"A family business refers to a company where the voting majority is in the hands of the controlling family; including the founder(s) who intend to pass the business on to their descendants. The terms "family business", "family firm", "family company", "family-owned business", "family-owned company", and "family-controlled company" will be used interchangeably through- out the Handbook to refer to family businesses." (IFC, 2008)

The Family Business Governance Handbook drafted by the International Finance Corporation, one of the institutions of the World Bank Group, is a useful document that gathers important facts and elements on how to develop a family business. This Handbook determines that:

"Family businesses constitute the world's oldest and most dominant form of business organizations. In many countries, family businesses represent more than 70 percent of the overall businesses and play a key role in the economy growth and workforce employment. In Spain, for example, about 75 percent of the businesses are family-owned and contribute to 65 percent of the country's GNP on average. Similarly, family businesses contribute to about 60 percent of the aggregate GNP in Latin America." (IFC, 2008)

As examples of well- known family businesses we can find: Salvatore Ferragamo, Benetton, and Fiat Group in Italy; L'Oreal, Carrefour Group, LVMH, and Michelin in France; Samsung, Hyundai Motor, and LG Group in South Korea; BMW, and Siemens in Germany; Kikkoman, and Ito-Yokado in Japan; and finally Ford Motors Co, and Wal-Mart Stores in the United States of America.

These types of companies have specific problems due to its nature, their constitution, and their managerial systems. But at the same time they have demonstrated during the years to have a treasure on its own that have transformed them into indestructible organization. That treasure is the management system and the relationship that each of the members has within the company.

As the company grows, more members, children, grandchildren and so on are incorporated into the family and different types of interests and relationships are generated within the company. The larger the company, the greater the conflict of interest are. Problems arise when the sentimental value collides with the entrepreneurial values. This is why conflicts in Family Companies must be handled corporately with the help of a consultant or lawyer. These conflicts may bring bad consequences to these kind companies, that may end up destroying the family, the company or both.

Family Businesses in the European Union

In 2007 the European Commission launched the project "Overview of family-business- relevant issues: research, networks, policy measures and recent studies". The study demonstrated that the institutions framework and policies regarding family business differ from country to country. And that is an obligation of each State to provide these kind of enterprises with measures that can tackle a range of problems they present such as: "taxation, company law, planning the business transfer, awareness-raising through lobbying and policy advice, research and dissemination of information, promotion of entrepreneurship and family-business-specific education, and family governance." (European Comission, 2009)

According to the European Commission a common Family Business can be defined as such, if it gathers the following elements:

"1. The majority of decision-making rights are in the possession of the natural person(s) who established the firm, or in the possession of the natural person(s) who has/have acquired the share capital of the firm, or in the possession of their spouses, parents, child, or children's direct heirs.

2. The majority of decision-making rights are indirect or direct.

3. At least one representative of the family or kin is formally involved in the governance of the firm.

4. Listed companies meet the definition of family enterprise if the person who established or acquired the firm (share capital) or their families or descendants possess 25 per cent of the decision-making rights mandated by their share capital." (European Comission )

Since these type of companies have an atypical factor that is "family" it must be understood that the same corporate governance that is commonly used for other companies might noy apply to these ones. The family factor brings along a different way of looking the company, its strengths and also its weaknesses. A good managerial strategy for these type of companies would be to find a great balance between the the emotional factor of family with the profitable factor of business.

The before mentioned study highlighted different kinds of challenges that family businesses face. These challenges differ from regular companies because the family factor brings along different perspectives, ideas, problems among others. The report categorized these challenges according to their origin, into 1) environmental, 2) family internal matters and 3) educational aspects:

"1. Challenges that arise from the environment in which companies operate:

  • Unawareness of policy makers of the specificities of family businesses, and their economic and social contribution;
  • Financial issues (e.g. gift and inheritance tax, access to finance without losing control of the firm, favorable tax treatment of reinvested profits).

2. Challenges that develop as a consequence of the family firm's internal matters:

  • Unawareness by family firms of the importance of planning business transfers early;
  • Balance between the family, ownership and business aspects within the enterprise;
  • Difficulties in attracting and retaining a skilled workforce.

3. Challenges related to educational aspects, which have an impact on both the business environment and on family firms' internal matters:

  • Lack of entrepreneurship education and family-business-specific management training and research into family-business-specific topics, plus effective coordination with education systems to ensure proper follow-up." (European Comission, 2009)

All these challenges may affect the development of a family business, specially those concerning the internal matters. In these type of organizations, it is always important to draw a delicate line between two main concepts, family and business. If the members of the company do not differentiate the relations between family and business it would be difficult for them to succeed. Therefore, these companies may incorporate some institutions in order to maintain a good relationship between the before mentioned aspects. These institutions may be the Family Protocol, the Family Assembly and the Family Council.

Family Protocol

A family protocol is commonly used in family business as a set of rules that define the internal policies on which the family members agree to work with during the life of the company. The report of the European Commission on Family Businesses referred to the Family Protocol as the Family Constitution and defined it as:

"a statement of the principles that outline the family commitment to core values, vision, and mission of the business. The constitution also defines the roles, compositions, and powers of key governance bodies of the business: family members/shareholders, management, and board of directors. In addition, the family constitution defines the relationships among the governance bodies and how family members can meaningfully participate in the governance of their business. (European Comission, 2009)

The main differences between the family protocol and the bylaws of a company are the following:

Family Protocol Bylaws
It is an agreement of honor based in the family's fellowship It is a public document controlled and approved by a public entity and by the laws
It is elaborated by the family members with the help of an external consultant expert in the field Generally, it is elaborated by the lawyer that incorporates the company. It is reviewed and approved by the shareholders
It harmonizes the interests of the family with the interests of the business They merely look after the interests of the company within the law
Its content is mainly used to mediate conflicts of interest between the family members Its content regulates the whole structure of the company. Legal aspects as well as corporate aspects
Source of rights and duties for all the members of the family Source of rights and duties for all the members of the company
Not binding Binding
Its mainly used for family businesses It is used by every single kind of company
Modifications may be done by the family council Modifications may be done by the general meeting of the shareholders

Family Assembly

The Family Assembly is also called "family forum", it is a formal forum for discussion by all family members about business and family issues. During the stage of the incorporation of the company, the family assembly is replaced by a more frequent and informal "family reunion". These informal meetings allows the founder to communicate family values, generate new business ideas, and prepare the next generation of family business leaders. As family and business become more complex, it becomes crucial to create a formal Family Assembly.

The Family Assembly does not interfere with the general meeting of the shareholders in what business decision regards. This Assembly is mainly used for family matters and it is very important due to the fact that in this forum all the family members could express their ideas and concerns in order to improve the development of the business.

Family Council

Also called "Family Supervisory Board", "Interior Council" or "Family Executive Committee", it is a governing body of work that is elected by the Family Assembly among its members to deliberate on issues of the family. The council is usually created once the family reaches a critical size, for example more than 30 members. In this situation, it becomes very difficult for the Family Assembly to have meaningful discussions during the meeting. This institution may be created to make quicker and more qualified decisions. The Family Council may be created as a representative governing body for the Family Assembly to coordinate the interests of the family members in their company.

Conclusions 

As it was shown in this paper, family businesses have a different element that alters the structure of the company. The family element brings feelings, affections and emotions to the core of the company. The corporate governance of the family business shall be the one that ensures the balance of power between the family branches through the successive generations.

In these companies, the institutions such as the Protocol, the Council and the Assembly must acquire a singular relevance in order to face all the challenges that family businesses bring along. A good managerial structure will help these companies to succeed in their operations but a bad administration between the family interests versus the business interests may brake the company down.

To conclude it must be emphasized that corporate governance in a family businesses must protect the rights of family members, shareholders and future shareholders; ensure equal treatment for all family members by maintaining the balance of power among the different branches of the family, including branches that for any reason have a minority share; recognize the rights of interested third parties and promote active cooperation between them and societies in creating wealth, generating jobs and achieving financially sustainable enterprises; and, ensure adequate and timely disclosure of all relevant.

Bibliography

European Comission . (n.d.). Family Business. Retrieved May 1, 2017, from https://ec.europa.eu/growth/smes/promoting-entrepreneurship/we-work-for/family-business_fr

European Comission. (2009). Overview of family-business- relevant issues: research, networks, policy measures and recent studies. Retrieved May 2, 2017, from http://ec.europa.eu/DocsRoom/documents/10389/attachments/1/translations

IFC. (2008). Family Business Governance Handbook. Retrieved May 4, 2017, from http://www.ifc.org/wps/wcm/connect/159c9c0048582f6883f9ebfc046daa89/FB_English_final_2008.pdf?MOD=AJPERES

INC. (n.d.). Encyclopedia. Retrieved May 2, 2017, from Family Business: https://www.inc.com/encyclopedia/family-owned-businesses.html

Investopedia. (n.d.). Corporate Governance. Retrieved May 2, 2017, from http://www.investopedia.com/terms/c/corporategovernance.asp

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