- Email: [email protected]
Corporate governance and family business performance
Journal of Business Research 64 (2011) 280–285
Contents lists available at ScienceDirect
Journal of Business Research
Corporate governance and family business performance Esteban R. Brenes a,⁎, Kryssia Madrigal b,1, Bernardo Requena b,1 a b
INCAE Business School, Box 960-4050, Alajuela, Costa Rica Bacyasociados, Torre Meridiano (HSBC), 3rd Floor No. 11, Guachipelín Escazú, San José, Costa Rica
a r t i c l e
i n f o
Article history: Received 1 March 2009 Received in revised form 1 September 2009 Accepted 1 November 2009 Available online 31 December 2009 Keywords: Corporate governance Professional board of directors Family businesses
a b s t r a c t Family business continuity plans commonly establish a governance structure for the family and for the family business. The purpose of those structures is to improve strategy and control mechanisms of the family business and, to organize the communication and relationship between family owners and business executives. This research focuses on assessing the impact of those structures on family business performance. Specifically, the study assesses the impact a professional board of directors has on a company's performance. The research team selected a set of 22 family businesses. Some of these families have undergone a process of developing a family protocol over the last seven years. The authors captured the relevant information for this research by sending out a survey to each family member and to each non-family director or executive. © 2009 Elsevier Inc. All rights reserved.
1. Introduction Evidence over the last ten years shows that, historically, successful Latin American businesses with strong potential have fallen prey to family business problems. A family business is a company mostly owned and managed by a single root family. Succession and equity control are among the critical factors leading to problems within family businesses (Brenes et al., 2006). The main concern of families in relation to business continuity has to do with who will take the role of entrepreneur or patriarch, in other words: who will be the ideal successor to bring peace of mind to the family and ensure business continuity. A related concern is how family members will inherit equity shares in a way that ensures continuous family ownership of the firm. The professional experience of the authors enabled them to meet many families owning one or several businesses who decided to anticipate and prevent conflict by developing a family protocol, setting policies regarding family member involvement in the business and creating mechanisms to implement that protocol (Brenes and Madrigal, 2003). The mechanisms aim at ensuring the implementation of family- and business-related decisions and policies include setting a government structure for the business as well as for the family. The key objective of this structure is to improve the implementation of the company competitive strategy and to establish control mechanisms for the family with respect to the business such that information can flow adequately and transparently between ⁎ Corresponding author. Tel.: + 506 2437 2381, +506 2201 7401. E-mail addresses: [email protected] (E.R. Brenes), [email protected] (K. Madrigal), [email protected] (B. Requena). 1 Tel.: + 506 2201 7400. 0148-2963/$ – see front matter © 2009 Elsevier Inc. All rights reserved. doi:10.1016/j.jbusres.2009.11.013
current and potential stockholders avoiding hindering or direct meddling in the firm's operational management. Professionalization of the board of directors appears to be a key instrument in allowing better family business balance and ensuring family business continuity. This paper provides the results of a study conducted among 22 Latin American families, who own businesses and who established family protocols and/or formalized a corporate governance structure. The paper also evaluates the effects of establishing a board of directors on company performance in the case of these family owned companies. 2. Company government structure Corporate governance is a guidance and management structure aligning and organizing ownership management and business management. Corporate governance comprises three different elements: the stockholders' assembly, the board of directors and the top management team. The stockholders' assembly includes all company stockholders, both inside and outside the family, meeting every year or on an extraordinary basis to make decisions concerning the company. The stockholders' assembly has final authority on company decisions. However, issues concerning corporate governance fall upon the board of directors — how the board members are chosen, how this board operates and the boards responsibilities — and all of those factors in turn impact top management functions and responsibilities. Board composition varies in line with individual company characteristics as well as on a per-country basis. These characteristics include political, historical, legal, and economic factors, as well as business culture, and are critical to defining the board's structure and the selection of board members. Often factors such as confidence, respect, power, and/or family links play a role in appointing board members. Thus, local factors and different patterns lead to significant
E.R. Brenes et al. / Journal of Business Research 64 (2011) 280–285
variation of board makeup. For instance, in Germany usually several union members sit on company boards; in Japan you can find loyal executives serving as board members, and in China Communist Party members usually sit on company boards (¿Es posible, 2008) Traditionally United States boards consist strictly of stockholders, mainly those with the largest number of shares, with a majority stockholder ideally included for control purposes. This model, however, evolved in line with legal requirements for public companies. Boards now include independent, non-executive members as a significant majority with power for making relevant decisions with objective independent criteria. Globalization of financial markets has added pressure to reduce local and cultural board composition particularities. Inflows of foreign capital, mostly from the United States, are leading to a convergence toward a single board model (¿Es posible, 2008; La figura, 2008). In today's environment, if a company needs to access foreign capital markets the company must abide by established rules set in relation to board composition and role, as these boards should reduce uncertainty and investor risk, as well as add transparence to company management (¿Es posible, 2008). Although the model common in the United States has become popular, the model effectiveness raises doubts as a result of business scandals at companies like Enron and WorldCom, which highlight the failure of their boards to detect fraud as the companies neared the brink of collapse. These failures directed attention to the importance of the balance of power between top management, stockholders, and the board of directors. With the passing of the Sarbanes–Oxley Act in 2002, a legal tool exists to reinforce corporate and individual responsibility through control standards and penalties imposed for non-compliance (Lander, 2003). This act regulates financial, accounting and audit functions and strongly penalizes corporate and white collar crime. The law establishes the mechanisms to monitor public companies in the United States, in order to avoid unlawful alteration of shares of capital to represent higher-than-actual value. The act aims at preventing fraud and bankruptcy risk, thus protecting investors. According to the Sarbanes– Oxley Act, boards of directors consist chiefly of highly committed, independent board members not linked to the organization for the last three years, becoming strongly involved with key executives and actively taking part in audit, nomination, compensation, finance, and ethic code committees, among others (Sompayrac, 2007). Current corporate governance requires operating systematically with a strong balanced power base (Gómez and López, 2004.) To achieve this power balance the stockholders have to define clear individual component roles and responsibilities. A part of the stockholders' assembly role comprises values guiding organizational culture, as well as business goals and expectations, and long-term vision. The key role played by the board of directors and its major responsibilities include: ensuring fair and objective treatment of all stockholders; and serving as a communication link between top management and stockholders, bringing together their points of view. The major challenge for all boards of directors is to align business strategy with stockholder interests, as a desire to obtain long-term value influences stockholders' decisions while top management seeks short-term value and growth. Thus, the board plays a key role in successfully implementing a company's competitive strategy (Brenes et al., 2008a.) Also, the board of directors is set-up as an accountability body for top management (Klelman and Horwitz, 2007). On the other hand, the major role played by top management consists of carrying out the strategy and of providing reliable, relevant information to both stockholders and the board of directors. 3. Corporate governance in family business firm Many companies are born as family businesses. Even today, many families still exercise control over several companies, the effects of
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which reflect in their corporate governance. Cultural and local traditions, as well a desire to control, impact board composition in different parts of the world. As a result, not all family businesses have a board of directors or their boards are almost exclusively made up of family members, as either current or future stockholders; this family members only board composition affects the objectivity of corporate governance, in many cases taking precedence over the health of the company. Illiquid capital markets in emerging countries have led to the creation of wealth via family-run businesses (¿Es posible, 2008). This phenomenon is common in Latin America, where over 90% of companies are under family control through family-members-only boards. Over the last few years, however, more and more companies adopt international corporate governance requirements and standards. In many cases, they have done so as a requirement to access capital from international markets. Others have taken this step as a result of their conviction that good corporate governance provides them with a competitive advantage. Family businesses tend to be complex because, in addition to dealing with common business opportunities and requirements, they must consider the needs and desires of the owner family, leading to risk for long-term supervision (Ward, 2002). Statistics show that only 30% of these companies survive beyond a second-generation transition; 10% survive into the third generation and just only 4% remain in existence by the fourth generation. Nonetheless, family businesses display beneficial characteristics (Ward, 2002). Family business leaders remain in their positions for longer periods, a fact that implies added business continuity and stability. Also, beyond profitability, family businesses aim at continuity and prudence, and exercise disciplined growth. Finally, they have more loyal and longlasting employees and executives, as a result of their long-term relationship with the family. Family business boards of directors must be very clear regarding share succession and evaluation of its impact on company strategy, as stockholders' expectations and requirements vary with each successive generation in charge. The decision to set a board of directors in a family business relates closely to the company's stage in the firm's life cycle (Brenes et al., 2008b). Brenes, Madrigal and Molina found some common characteristics shaping the board's composition and role, depending on family generation and company maturity stage (Brenes et al., 2008b). Boards are commonly absent in the first generation, when the owner manages the company directly. The owner usually makes all company decisions and no accountability exists. Entrepreneurs often do not feel the need to have a supporting body for decision-making. When the second generation begins to participate in the family business, entrepreneurs start considering setting a board to help them deal with growth and inherent conflict resulting from the incorporation of his/her children into the company. In transition stages some boards consist of family members or company partners. In many cases they include exclusively family members, including those engaging in operational and/or managerial tasks in the company. Some family businesses without a formal board of directors established a transition process where they learn by creating an executive committee made up of the entrepreneur and his/her children, with an eye to starting a board. They later incorporate non-family board members to bring the knowledge and experience required to manage the company. In the stages of family society, brothers' society, and cooperation between cousins, companies have usually a formal board of directors meeting periodically. However, in these stages, boards have some particular features. In some cases, company executives sit on the board, as a result of their knowledge of the business and as recognition for their loyalty. In other cases, non-family board members who are outside the business are part of the board because they are close friends of a partner/family member. Still in other cases
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non-family board members experienced in a key area of the business serve in the board as advisors and arbitrators for the company and sometimes for the family. Experience shows that the role of boards of directors in family businesses undergoes a transition which is typical for these types of companies (Ward, 2002) First, board members serve as advisors to the company and the family, providing objective advice for decisionmaking and facilitating or ordering transition of shares control and succession. As the family business matures in its handling of boards of directors, the board takes on a catalyzing role between family and company; in other words, the board supports or requires setting other bodies to handle the family/business relationship, ensures fluent communication with the family on relevant business topics, and protects company and stockholders', and thus, family interests. Once the family professionalizes the company, the board of directors ensures good administration and operation; conducts strict evaluations of the markets in which the company invests, as well as its profitability; appraises the analysis and assumptions submitted by managers; sets standards for goals and investment decisions; and supports management's creative ideas. Likewise, the board establishes and handles a rational capital allocation strategy, taking into consideration the needs of various family businesses and expectations. Family businesses usually establish a parallel structure with two additional bodies called the family council and the business council (Brenes et al., 2007a). The family council consists of current and potential stockholders belonging to the family. The family council meets at least once per year to share ideas and proposals and to analyze problems in relation to family commitments towards the company. The business council, on the other hand, includes only family members active in the family business. The business council reports to the family council on the development of the family business and analyzes family expectations for the business (e.g., new business ideas, new projects, and new investments) and brings them to the board of directors and to the CEO. This study gives some attention to these bodies as a part of the research.
4. Methodology Statistics on family businesses are virtually non-existent in Latin America. For this reason, and in order to take advantage of authors' experience on this topic, the authors conducted a survey among 22 families in order to ascertain the impact from setting of a board of directors, as well as from family governance on company performance. The research team received replies to this survey from passive stockholders (i.e., family members owning shares but not participating in or working for the family business) as well as from board members and company executives. The research team mailed ninety survey forms and received 20 replies from 12 family businesses, distributed as shown in Fig. 1. The survey included 16-questions. Of these questions, eight use statements evaluated under the Likert scale, with 7 as the highest and 1 as the lowest grade. The survey also included general information questions as well as open-ended questions providing opportunity for comments in order to further clarify survey results. The research team processed the survey statistically to obtain the results shown below. Seventy-five percent of family businesses answering the survey developed a family protocol through participation of family members above 18 years old. The remaining 25% have not yet done so. The research team chose these companies because they have a formal board of directors in a family business environment. Due to Latin American company silence regarding financial information, a question aimed at finding out their success. To analyze results, the research team split companies into two different groups: more successful and less successful companies. The former are those
Fig. 1. Survey respondents' role in the family business.
with scores above 5.5 in the Likert scale. The latter are those with scores below that figure.
5. Research results 5.1. Corporate governance Generally speaking, results show that 70% of the family businesses surveyed had a board of directors or something similar prior to developing their family protocol. The board, however, often fails to play its formal role at its element of corporate governance. Rather, the board serves as a management committee engaged in following-up on company operations. In board performance in most successful companies scores 5.7 points in the 7-point Likert scale. Least successful ones, on the other hand, score only 4.7 points in board performance. In order to evaluate board performance the researchers took nine variables into account (see Fig. 2). As seen in every case, except in Exerts Adequate Management Control, most successful companies score above least successful companies on each single variable. Noticeably, the three variables with the highest score for most successful companies coincide with the three variables with the highest score for least successful ones, namely Clear Strategic Direction, Members' Knowledge of Business, and Objective Decision-making. On the other hand the research team evaluated variables showing the major difference between the most and least successful companies, as they require the most attention to improve board performance. The variables with the most variation are Committees add value to management, and Has Committees on Relevant Topics. Results show that many families surveyed have not created committees on relevant topics. For this reason, they scored rather low. Performance appraisal for non-family board members in most successful companies scores 6.3 points as compared to least successful companies (5.4 points). To assess the performance of non-family board members the research team considered eight variables, as shown in Fig. 3. When evaluating the performance of non-family board members, most successful companies score higher than least successful companies on every variable. The two variables with the highest score for most successful companies coincide with the two variables with the highest score for least successful companies, to wit, Provide a Missing Dimension and Strategic Vision. The research team, then, evaluated the variables whose scores showed the major differences between the most and least successful companies in order to find factors to improve non-family board members' performance. The variables with the highest difference in scores are Commitment to Business, Mediation in Family/Business Conflict, and Active Participation. In both cases the Business Knowledge variable had the lowest score. Survey comments on non-family board members criticize their lack of commitment and scant business knowledge. The degree of commitment from non-family board members reflects a
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Fig. 2. Board performance. Evaluate the Board of Directors in the following areas.
significant difference in terms of contribution and dynamics of the board of directors. Even though a large percentage of least successful companies have a larger number of non-family board members in their boards, these members do not necessarily have the commitment to and/or knowledge of the business required to improve performance. Board dynamics in those cases are not fluid enough. On the other hand, a lack of balance regarding knowledge of business between family and nonfamily board members results in inadequate alignment between recommendations made and implemented. A number of respondents (chiefly passive stockholders) think that, even though their businesses are fine, they could be even better if the board of directors, and mainly non-family board members, commit more and demand better results from the management team. Performance appraisal for family board members in most successful companies scores 6.2 points as compared to 5.6 points in least successful ones. To appraise the performance of family board members the research team took seven variables into account, as seen in Fig. 4. On every variable most successful companies score above least successful ones. The variables with the highest score for most successful companies coincide with the variables with the highest score for least successful ones: Management Advice and Support, Knowledge of Business, and Active Participation. The research team, then, evaluated the variables showing major differences in scores between the most and least successful companies in order to improve family board members' performance. The variables with the highest difference in scores are Strategic Vision and Commitment to Business. Noticeably, both the most successful and least successful companies rate Objective Decision-making with the lowest score. An additional factor directly impacting board performance is meeting frequency. Survey results indicate that 80% of most successful companies' boards met at least 12 times a year, as compared to 71% of least successful companies. Results indicate that the more frequently the board meets the better its performance. The reason for these results is that increased board-meeting frequency leads to better
knowledge of the business in the case of non-family board members, as well as increased commitment and participation. Finally, nobody evaluates board members in 83% of the cases researched. Some survey respondents see evaluation as redundant since they were performing satisfactorily. In one case, however, the reason to skip evaluation was that non-family board members were friends of the family and the family was unwilling to offend them. The remaining 17% of family businesses have evaluation mechanisms in place to appraise board performance. Methodologies vary. In some cases, the board uses an evaluation tool at the end of each member's tenure. In others, an executive interviews board members to provide individual feedback. 5.2. Family structure and family protocol Survey results indicate that 60% of families have established some family government body, either business council or family council. However, respondents were highly critical since they think that the business council and/or family council are very hard to implement when family members lack leadership to start and make these bodies functional. 58% of families implemented business councils. Most successful companies rate business council performance at 5.7 points, while least successful ones give 3.9 points for business council performance. The evaluation of business council performance included five variables. In all variables, most successful companies score above least successful ones, on a variable-per-variable basis (see Fig. 5). The research team, then, evaluated the variables showing major differences in scores between the most and least successful companies in order to improve business council performance. The variable with the most variation is Identifies potential leaders. This variable obtained the highest score in most successful companies. Families who establish a business council find this council to be a valuable tool in handling conflict, as the business council separates rational and emotional stockholder reactions. Families with business
Fig. 3. Non-family board members performance. Evaluate the Non Family Board members performance in the following areas.
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Fig. 4. Family board members performance. Evaluate the Family Board members performance in the following areas.
councils are those who have undergone family-member conflict or those who need to engage in management succession. These think the business council helped them reduce and solve conflict in a simple way, and to orderly conduct chairperson succession. In most cases they believe business councils can be even more useful. Fifty percent of families have implemented family councils. Most successful companies rate family council performance at 6 points while least successful ones rate family council performance with 3.7 points. The evaluation of family council performance included six variables. In every variable, most successful companies score above least successful ones, on a variable-per-variable basis (see Fig. 6.) In this section the highest-ranking variable does not coincide between both types of companies. On the one hand, most successful companies rated the highest the variable Conducts philanthropy activities while least successful ones did so for Conveys Values. However, both the most successful and least successful companies coincide on two variables in terms of significance. These are Solves family business conflict and Develops Family Business Agreements. Many families find implementing family councils more advantageous than not as the implementation of family councils has led to improved communication and joint efforts on issues significant to families not necessarily related to the business. Survey respondents see the family protocol as a guide for both company and family order and structure. The family protocol major benefit is additional transparency of company management, as the rules of the game have been set in a highly participatory process involving the entire family with a conflict-solving mechanism established. They also think the family protocol led to a change of attitude from the board of directors, specifically, increased director commitment, meetings held more frequently, and clearer understanding of their role by the family. However, survey respondents believe that family protocol implementation has not taken place as quickly as desired. Implementation relates to owners' leadership and commitment, but they feel the necessity for the board of directors to get involved to assist in
implementation and supervision. Family protocol results have generally not been highly visible to management, although managers perceive increased fluidity and decentralization regarding the organization. A large number of families said they have not felt the need to implement their family protocol, although creating the family protocol has resulted in improved family unity. 6. Conclusions Research results show that the greater the evaluation of board performance the better company performance vis-à-vis competitors. Obviously, setting a formal board of directors is a key component in improving company's performance and bringing peace of mind to the family. Global trends come together in a single board model. Even though this model becomes a key prerequisite for companies entering international financial markets, families shouldn't overlook the features that are fundamental to family businesses governance. The authors' experience points out that, although family owned companies have a goal to attain in relation to board role and composition, a transition process toward best practices tailored to individual company culture has to take place. This transition stage will depend heavily on individual company maturity, not only in terms of life cycle stage but also in terms of company experience with boards of directors. Research findings indicate that boards of directors have enriched company management by bringing in additional objectiveness. Including non-family board members was determinant to perceived increased transparency and increased confidence in company management for family members who are not actively participating in the family business. A board made up of non-family and family board members results in a balance that is very important to dynamic operation. Results show that contributions from both types of director complement each other. On the one hand, family board members have experience and knowledge of their business. On the other hand, non-family board members bring to the company an objective vision and a professional
Fig. 5. Business council performance. How does the Business Council contribute to the famly business.
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Fig. 6. Family council performance. How does the Family Council contribute to the famly business.
point of view. In a large number of family businesses non-family board members take on an arbitrator role in solving business/family conflict. This role provides owner family members with peace of mind since, when emotions take control, the objectiveness provided by someone outside the family avoids resentment which, in the long run, can lead to broken family unity and/or company sustainability. In relation to both family and business councils, families are aware of their importance but have not fully implemented these structures. Findings show that many families chose only one of those (Family or Business Council) as they do not consider both necessary. In the authors' opinion two basic reasons exist for this consideration. First, families who had to activate their family protocol due to conflict, shares purchase/sale, and/or the need to set in motion the managerial succession mechanism, have found increased functionality in implementing the business council as the business council comprises conflict resolution. The families, however, have not yet considered the protocols that address family wealth management because families manage dividends customarily on an individual basis. In other words, management of personal wealth prevails over management of family wealth. Second, families that have not undergone conflict find the family council even more functional as a means to socialize and communicate with each other. In other words, they see the family council as a way to deal with matters families desire to tackle (e.g., corporate social responsibility, paying homage to family members, and improving family relationships). Family governance, however, seems more relevant for larger families where a large number of members do not take active part in the family business. Otherwise, they consider family governance redundant and irrelevant to implement. 7. Limitations and future research The total number of families in the data set was relatively small. In addition, the response rate of only 22% was also low. Members of
family businesses, both family and non-family members, are usually hesitant to respond to this type of survey in Latin America due to the fear of information leaks. Future research should consider applying the same survey to a larger sample from different regions to compare with the results in this article. Authors are planning to expand their own data set to include families that had been recently participating in family business seminars through INCAE Business School. Acknowledgment The authors thank Stuart Perez for his help in correcting this paper. References Brenes, Esteban and Madrigal, Kryssia. (2003) Anticipando el Conflicto en los Negocios Familiares. INCAE Magazine, Vol. XII, Issue 3, October 2003. Brenes Esteban, Madrigal Kryssia, Molina German. Family business structure and succession: critical topics in Latin American experience. J Bus Rev 2006;59(3):372–4. Brenes Esteban, Mena Mauricio, Molina German. Key success factors for strategy implementations in Latin America. J Bus Rev 2008a;61(6):590–8. Brenes, Esteban, Madrigal, Kryssia, and Molina, German. (2008b). Estrategias para asegurar la continuidad de las empresas familiares. INCAE Magazine, Volume I, Issue 5, May–August 2008. ¿Es posible -e incluso deseable- un único modelo global de gobernabilidad Corporativa? (2008), Universia Knowledge @ Wharton. Retrieved from http:// www.wharton.universia.net/index.cfm?fa=viewArticle&ID=1458. Gómez Gonzalo, López María Piedad. El Corporate Governance y la Ley Sarbanes–Oxley: Balance entre Propiedad, Dirección y Board of Directors. INALDE-Universidad de la Sabana; 2004. Klelman, Robert, update by Horwitz, Ronald. (2007) The Role of the Board of directors. Encyclopedia of Management, 2007. La figura del presidente único tiene los días contados (2008) Universia Knowledge @ Wharton Retrieved from http://www.wharton.universia.net/index.cfm? fa=viewArticle&id=1211. Lander, Guy (2003) What is Sarbanes Oxley. McGraw Hill; 1 edition. November 2003. Sompayrac Joanie. Corporate governance — key governance issues. Encyclopedia of Management; 2007. Ward John. The role of the board in family business strategy. Family Business KnowHow; 2002. June 2002.
Contents lists available at ScienceDirect
Journal of Business Research
Corporate governance and family business performance Esteban R. Brenes a,⁎, Kryssia Madrigal b,1, Bernardo Requena b,1 a b
INCAE Business School, Box 960-4050, Alajuela, Costa Rica Bacyasociados, Torre Meridiano (HSBC), 3rd Floor No. 11, Guachipelín Escazú, San José, Costa Rica
a r t i c l e
i n f o
Article history: Received 1 March 2009 Received in revised form 1 September 2009 Accepted 1 November 2009 Available online 31 December 2009 Keywords: Corporate governance Professional board of directors Family businesses
a b s t r a c t Family business continuity plans commonly establish a governance structure for the family and for the family business. The purpose of those structures is to improve strategy and control mechanisms of the family business and, to organize the communication and relationship between family owners and business executives. This research focuses on assessing the impact of those structures on family business performance. Specifically, the study assesses the impact a professional board of directors has on a company's performance. The research team selected a set of 22 family businesses. Some of these families have undergone a process of developing a family protocol over the last seven years. The authors captured the relevant information for this research by sending out a survey to each family member and to each non-family director or executive. © 2009 Elsevier Inc. All rights reserved.
1. Introduction Evidence over the last ten years shows that, historically, successful Latin American businesses with strong potential have fallen prey to family business problems. A family business is a company mostly owned and managed by a single root family. Succession and equity control are among the critical factors leading to problems within family businesses (Brenes et al., 2006). The main concern of families in relation to business continuity has to do with who will take the role of entrepreneur or patriarch, in other words: who will be the ideal successor to bring peace of mind to the family and ensure business continuity. A related concern is how family members will inherit equity shares in a way that ensures continuous family ownership of the firm. The professional experience of the authors enabled them to meet many families owning one or several businesses who decided to anticipate and prevent conflict by developing a family protocol, setting policies regarding family member involvement in the business and creating mechanisms to implement that protocol (Brenes and Madrigal, 2003). The mechanisms aim at ensuring the implementation of family- and business-related decisions and policies include setting a government structure for the business as well as for the family. The key objective of this structure is to improve the implementation of the company competitive strategy and to establish control mechanisms for the family with respect to the business such that information can flow adequately and transparently between ⁎ Corresponding author. Tel.: + 506 2437 2381, +506 2201 7401. E-mail addresses: [email protected] (E.R. Brenes), [email protected] (K. Madrigal), [email protected] (B. Requena). 1 Tel.: + 506 2201 7400. 0148-2963/$ – see front matter © 2009 Elsevier Inc. All rights reserved. doi:10.1016/j.jbusres.2009.11.013
current and potential stockholders avoiding hindering or direct meddling in the firm's operational management. Professionalization of the board of directors appears to be a key instrument in allowing better family business balance and ensuring family business continuity. This paper provides the results of a study conducted among 22 Latin American families, who own businesses and who established family protocols and/or formalized a corporate governance structure. The paper also evaluates the effects of establishing a board of directors on company performance in the case of these family owned companies. 2. Company government structure Corporate governance is a guidance and management structure aligning and organizing ownership management and business management. Corporate governance comprises three different elements: the stockholders' assembly, the board of directors and the top management team. The stockholders' assembly includes all company stockholders, both inside and outside the family, meeting every year or on an extraordinary basis to make decisions concerning the company. The stockholders' assembly has final authority on company decisions. However, issues concerning corporate governance fall upon the board of directors — how the board members are chosen, how this board operates and the boards responsibilities — and all of those factors in turn impact top management functions and responsibilities. Board composition varies in line with individual company characteristics as well as on a per-country basis. These characteristics include political, historical, legal, and economic factors, as well as business culture, and are critical to defining the board's structure and the selection of board members. Often factors such as confidence, respect, power, and/or family links play a role in appointing board members. Thus, local factors and different patterns lead to significant
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variation of board makeup. For instance, in Germany usually several union members sit on company boards; in Japan you can find loyal executives serving as board members, and in China Communist Party members usually sit on company boards (¿Es posible, 2008) Traditionally United States boards consist strictly of stockholders, mainly those with the largest number of shares, with a majority stockholder ideally included for control purposes. This model, however, evolved in line with legal requirements for public companies. Boards now include independent, non-executive members as a significant majority with power for making relevant decisions with objective independent criteria. Globalization of financial markets has added pressure to reduce local and cultural board composition particularities. Inflows of foreign capital, mostly from the United States, are leading to a convergence toward a single board model (¿Es posible, 2008; La figura, 2008). In today's environment, if a company needs to access foreign capital markets the company must abide by established rules set in relation to board composition and role, as these boards should reduce uncertainty and investor risk, as well as add transparence to company management (¿Es posible, 2008). Although the model common in the United States has become popular, the model effectiveness raises doubts as a result of business scandals at companies like Enron and WorldCom, which highlight the failure of their boards to detect fraud as the companies neared the brink of collapse. These failures directed attention to the importance of the balance of power between top management, stockholders, and the board of directors. With the passing of the Sarbanes–Oxley Act in 2002, a legal tool exists to reinforce corporate and individual responsibility through control standards and penalties imposed for non-compliance (Lander, 2003). This act regulates financial, accounting and audit functions and strongly penalizes corporate and white collar crime. The law establishes the mechanisms to monitor public companies in the United States, in order to avoid unlawful alteration of shares of capital to represent higher-than-actual value. The act aims at preventing fraud and bankruptcy risk, thus protecting investors. According to the Sarbanes– Oxley Act, boards of directors consist chiefly of highly committed, independent board members not linked to the organization for the last three years, becoming strongly involved with key executives and actively taking part in audit, nomination, compensation, finance, and ethic code committees, among others (Sompayrac, 2007). Current corporate governance requires operating systematically with a strong balanced power base (Gómez and López, 2004.) To achieve this power balance the stockholders have to define clear individual component roles and responsibilities. A part of the stockholders' assembly role comprises values guiding organizational culture, as well as business goals and expectations, and long-term vision. The key role played by the board of directors and its major responsibilities include: ensuring fair and objective treatment of all stockholders; and serving as a communication link between top management and stockholders, bringing together their points of view. The major challenge for all boards of directors is to align business strategy with stockholder interests, as a desire to obtain long-term value influences stockholders' decisions while top management seeks short-term value and growth. Thus, the board plays a key role in successfully implementing a company's competitive strategy (Brenes et al., 2008a.) Also, the board of directors is set-up as an accountability body for top management (Klelman and Horwitz, 2007). On the other hand, the major role played by top management consists of carrying out the strategy and of providing reliable, relevant information to both stockholders and the board of directors. 3. Corporate governance in family business firm Many companies are born as family businesses. Even today, many families still exercise control over several companies, the effects of
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which reflect in their corporate governance. Cultural and local traditions, as well a desire to control, impact board composition in different parts of the world. As a result, not all family businesses have a board of directors or their boards are almost exclusively made up of family members, as either current or future stockholders; this family members only board composition affects the objectivity of corporate governance, in many cases taking precedence over the health of the company. Illiquid capital markets in emerging countries have led to the creation of wealth via family-run businesses (¿Es posible, 2008). This phenomenon is common in Latin America, where over 90% of companies are under family control through family-members-only boards. Over the last few years, however, more and more companies adopt international corporate governance requirements and standards. In many cases, they have done so as a requirement to access capital from international markets. Others have taken this step as a result of their conviction that good corporate governance provides them with a competitive advantage. Family businesses tend to be complex because, in addition to dealing with common business opportunities and requirements, they must consider the needs and desires of the owner family, leading to risk for long-term supervision (Ward, 2002). Statistics show that only 30% of these companies survive beyond a second-generation transition; 10% survive into the third generation and just only 4% remain in existence by the fourth generation. Nonetheless, family businesses display beneficial characteristics (Ward, 2002). Family business leaders remain in their positions for longer periods, a fact that implies added business continuity and stability. Also, beyond profitability, family businesses aim at continuity and prudence, and exercise disciplined growth. Finally, they have more loyal and longlasting employees and executives, as a result of their long-term relationship with the family. Family business boards of directors must be very clear regarding share succession and evaluation of its impact on company strategy, as stockholders' expectations and requirements vary with each successive generation in charge. The decision to set a board of directors in a family business relates closely to the company's stage in the firm's life cycle (Brenes et al., 2008b). Brenes, Madrigal and Molina found some common characteristics shaping the board's composition and role, depending on family generation and company maturity stage (Brenes et al., 2008b). Boards are commonly absent in the first generation, when the owner manages the company directly. The owner usually makes all company decisions and no accountability exists. Entrepreneurs often do not feel the need to have a supporting body for decision-making. When the second generation begins to participate in the family business, entrepreneurs start considering setting a board to help them deal with growth and inherent conflict resulting from the incorporation of his/her children into the company. In transition stages some boards consist of family members or company partners. In many cases they include exclusively family members, including those engaging in operational and/or managerial tasks in the company. Some family businesses without a formal board of directors established a transition process where they learn by creating an executive committee made up of the entrepreneur and his/her children, with an eye to starting a board. They later incorporate non-family board members to bring the knowledge and experience required to manage the company. In the stages of family society, brothers' society, and cooperation between cousins, companies have usually a formal board of directors meeting periodically. However, in these stages, boards have some particular features. In some cases, company executives sit on the board, as a result of their knowledge of the business and as recognition for their loyalty. In other cases, non-family board members who are outside the business are part of the board because they are close friends of a partner/family member. Still in other cases
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non-family board members experienced in a key area of the business serve in the board as advisors and arbitrators for the company and sometimes for the family. Experience shows that the role of boards of directors in family businesses undergoes a transition which is typical for these types of companies (Ward, 2002) First, board members serve as advisors to the company and the family, providing objective advice for decisionmaking and facilitating or ordering transition of shares control and succession. As the family business matures in its handling of boards of directors, the board takes on a catalyzing role between family and company; in other words, the board supports or requires setting other bodies to handle the family/business relationship, ensures fluent communication with the family on relevant business topics, and protects company and stockholders', and thus, family interests. Once the family professionalizes the company, the board of directors ensures good administration and operation; conducts strict evaluations of the markets in which the company invests, as well as its profitability; appraises the analysis and assumptions submitted by managers; sets standards for goals and investment decisions; and supports management's creative ideas. Likewise, the board establishes and handles a rational capital allocation strategy, taking into consideration the needs of various family businesses and expectations. Family businesses usually establish a parallel structure with two additional bodies called the family council and the business council (Brenes et al., 2007a). The family council consists of current and potential stockholders belonging to the family. The family council meets at least once per year to share ideas and proposals and to analyze problems in relation to family commitments towards the company. The business council, on the other hand, includes only family members active in the family business. The business council reports to the family council on the development of the family business and analyzes family expectations for the business (e.g., new business ideas, new projects, and new investments) and brings them to the board of directors and to the CEO. This study gives some attention to these bodies as a part of the research.
4. Methodology Statistics on family businesses are virtually non-existent in Latin America. For this reason, and in order to take advantage of authors' experience on this topic, the authors conducted a survey among 22 families in order to ascertain the impact from setting of a board of directors, as well as from family governance on company performance. The research team received replies to this survey from passive stockholders (i.e., family members owning shares but not participating in or working for the family business) as well as from board members and company executives. The research team mailed ninety survey forms and received 20 replies from 12 family businesses, distributed as shown in Fig. 1. The survey included 16-questions. Of these questions, eight use statements evaluated under the Likert scale, with 7 as the highest and 1 as the lowest grade. The survey also included general information questions as well as open-ended questions providing opportunity for comments in order to further clarify survey results. The research team processed the survey statistically to obtain the results shown below. Seventy-five percent of family businesses answering the survey developed a family protocol through participation of family members above 18 years old. The remaining 25% have not yet done so. The research team chose these companies because they have a formal board of directors in a family business environment. Due to Latin American company silence regarding financial information, a question aimed at finding out their success. To analyze results, the research team split companies into two different groups: more successful and less successful companies. The former are those
Fig. 1. Survey respondents' role in the family business.
with scores above 5.5 in the Likert scale. The latter are those with scores below that figure.
5. Research results 5.1. Corporate governance Generally speaking, results show that 70% of the family businesses surveyed had a board of directors or something similar prior to developing their family protocol. The board, however, often fails to play its formal role at its element of corporate governance. Rather, the board serves as a management committee engaged in following-up on company operations. In board performance in most successful companies scores 5.7 points in the 7-point Likert scale. Least successful ones, on the other hand, score only 4.7 points in board performance. In order to evaluate board performance the researchers took nine variables into account (see Fig. 2). As seen in every case, except in Exerts Adequate Management Control, most successful companies score above least successful companies on each single variable. Noticeably, the three variables with the highest score for most successful companies coincide with the three variables with the highest score for least successful ones, namely Clear Strategic Direction, Members' Knowledge of Business, and Objective Decision-making. On the other hand the research team evaluated variables showing the major difference between the most and least successful companies, as they require the most attention to improve board performance. The variables with the most variation are Committees add value to management, and Has Committees on Relevant Topics. Results show that many families surveyed have not created committees on relevant topics. For this reason, they scored rather low. Performance appraisal for non-family board members in most successful companies scores 6.3 points as compared to least successful companies (5.4 points). To assess the performance of non-family board members the research team considered eight variables, as shown in Fig. 3. When evaluating the performance of non-family board members, most successful companies score higher than least successful companies on every variable. The two variables with the highest score for most successful companies coincide with the two variables with the highest score for least successful companies, to wit, Provide a Missing Dimension and Strategic Vision. The research team, then, evaluated the variables whose scores showed the major differences between the most and least successful companies in order to find factors to improve non-family board members' performance. The variables with the highest difference in scores are Commitment to Business, Mediation in Family/Business Conflict, and Active Participation. In both cases the Business Knowledge variable had the lowest score. Survey comments on non-family board members criticize their lack of commitment and scant business knowledge. The degree of commitment from non-family board members reflects a
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Fig. 2. Board performance. Evaluate the Board of Directors in the following areas.
significant difference in terms of contribution and dynamics of the board of directors. Even though a large percentage of least successful companies have a larger number of non-family board members in their boards, these members do not necessarily have the commitment to and/or knowledge of the business required to improve performance. Board dynamics in those cases are not fluid enough. On the other hand, a lack of balance regarding knowledge of business between family and nonfamily board members results in inadequate alignment between recommendations made and implemented. A number of respondents (chiefly passive stockholders) think that, even though their businesses are fine, they could be even better if the board of directors, and mainly non-family board members, commit more and demand better results from the management team. Performance appraisal for family board members in most successful companies scores 6.2 points as compared to 5.6 points in least successful ones. To appraise the performance of family board members the research team took seven variables into account, as seen in Fig. 4. On every variable most successful companies score above least successful ones. The variables with the highest score for most successful companies coincide with the variables with the highest score for least successful ones: Management Advice and Support, Knowledge of Business, and Active Participation. The research team, then, evaluated the variables showing major differences in scores between the most and least successful companies in order to improve family board members' performance. The variables with the highest difference in scores are Strategic Vision and Commitment to Business. Noticeably, both the most successful and least successful companies rate Objective Decision-making with the lowest score. An additional factor directly impacting board performance is meeting frequency. Survey results indicate that 80% of most successful companies' boards met at least 12 times a year, as compared to 71% of least successful companies. Results indicate that the more frequently the board meets the better its performance. The reason for these results is that increased board-meeting frequency leads to better
knowledge of the business in the case of non-family board members, as well as increased commitment and participation. Finally, nobody evaluates board members in 83% of the cases researched. Some survey respondents see evaluation as redundant since they were performing satisfactorily. In one case, however, the reason to skip evaluation was that non-family board members were friends of the family and the family was unwilling to offend them. The remaining 17% of family businesses have evaluation mechanisms in place to appraise board performance. Methodologies vary. In some cases, the board uses an evaluation tool at the end of each member's tenure. In others, an executive interviews board members to provide individual feedback. 5.2. Family structure and family protocol Survey results indicate that 60% of families have established some family government body, either business council or family council. However, respondents were highly critical since they think that the business council and/or family council are very hard to implement when family members lack leadership to start and make these bodies functional. 58% of families implemented business councils. Most successful companies rate business council performance at 5.7 points, while least successful ones give 3.9 points for business council performance. The evaluation of business council performance included five variables. In all variables, most successful companies score above least successful ones, on a variable-per-variable basis (see Fig. 5). The research team, then, evaluated the variables showing major differences in scores between the most and least successful companies in order to improve business council performance. The variable with the most variation is Identifies potential leaders. This variable obtained the highest score in most successful companies. Families who establish a business council find this council to be a valuable tool in handling conflict, as the business council separates rational and emotional stockholder reactions. Families with business
Fig. 3. Non-family board members performance. Evaluate the Non Family Board members performance in the following areas.
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Fig. 4. Family board members performance. Evaluate the Family Board members performance in the following areas.
councils are those who have undergone family-member conflict or those who need to engage in management succession. These think the business council helped them reduce and solve conflict in a simple way, and to orderly conduct chairperson succession. In most cases they believe business councils can be even more useful. Fifty percent of families have implemented family councils. Most successful companies rate family council performance at 6 points while least successful ones rate family council performance with 3.7 points. The evaluation of family council performance included six variables. In every variable, most successful companies score above least successful ones, on a variable-per-variable basis (see Fig. 6.) In this section the highest-ranking variable does not coincide between both types of companies. On the one hand, most successful companies rated the highest the variable Conducts philanthropy activities while least successful ones did so for Conveys Values. However, both the most successful and least successful companies coincide on two variables in terms of significance. These are Solves family business conflict and Develops Family Business Agreements. Many families find implementing family councils more advantageous than not as the implementation of family councils has led to improved communication and joint efforts on issues significant to families not necessarily related to the business. Survey respondents see the family protocol as a guide for both company and family order and structure. The family protocol major benefit is additional transparency of company management, as the rules of the game have been set in a highly participatory process involving the entire family with a conflict-solving mechanism established. They also think the family protocol led to a change of attitude from the board of directors, specifically, increased director commitment, meetings held more frequently, and clearer understanding of their role by the family. However, survey respondents believe that family protocol implementation has not taken place as quickly as desired. Implementation relates to owners' leadership and commitment, but they feel the necessity for the board of directors to get involved to assist in
implementation and supervision. Family protocol results have generally not been highly visible to management, although managers perceive increased fluidity and decentralization regarding the organization. A large number of families said they have not felt the need to implement their family protocol, although creating the family protocol has resulted in improved family unity. 6. Conclusions Research results show that the greater the evaluation of board performance the better company performance vis-à-vis competitors. Obviously, setting a formal board of directors is a key component in improving company's performance and bringing peace of mind to the family. Global trends come together in a single board model. Even though this model becomes a key prerequisite for companies entering international financial markets, families shouldn't overlook the features that are fundamental to family businesses governance. The authors' experience points out that, although family owned companies have a goal to attain in relation to board role and composition, a transition process toward best practices tailored to individual company culture has to take place. This transition stage will depend heavily on individual company maturity, not only in terms of life cycle stage but also in terms of company experience with boards of directors. Research findings indicate that boards of directors have enriched company management by bringing in additional objectiveness. Including non-family board members was determinant to perceived increased transparency and increased confidence in company management for family members who are not actively participating in the family business. A board made up of non-family and family board members results in a balance that is very important to dynamic operation. Results show that contributions from both types of director complement each other. On the one hand, family board members have experience and knowledge of their business. On the other hand, non-family board members bring to the company an objective vision and a professional
Fig. 5. Business council performance. How does the Business Council contribute to the famly business.
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Fig. 6. Family council performance. How does the Family Council contribute to the famly business.
point of view. In a large number of family businesses non-family board members take on an arbitrator role in solving business/family conflict. This role provides owner family members with peace of mind since, when emotions take control, the objectiveness provided by someone outside the family avoids resentment which, in the long run, can lead to broken family unity and/or company sustainability. In relation to both family and business councils, families are aware of their importance but have not fully implemented these structures. Findings show that many families chose only one of those (Family or Business Council) as they do not consider both necessary. In the authors' opinion two basic reasons exist for this consideration. First, families who had to activate their family protocol due to conflict, shares purchase/sale, and/or the need to set in motion the managerial succession mechanism, have found increased functionality in implementing the business council as the business council comprises conflict resolution. The families, however, have not yet considered the protocols that address family wealth management because families manage dividends customarily on an individual basis. In other words, management of personal wealth prevails over management of family wealth. Second, families that have not undergone conflict find the family council even more functional as a means to socialize and communicate with each other. In other words, they see the family council as a way to deal with matters families desire to tackle (e.g., corporate social responsibility, paying homage to family members, and improving family relationships). Family governance, however, seems more relevant for larger families where a large number of members do not take active part in the family business. Otherwise, they consider family governance redundant and irrelevant to implement. 7. Limitations and future research The total number of families in the data set was relatively small. In addition, the response rate of only 22% was also low. Members of
family businesses, both family and non-family members, are usually hesitant to respond to this type of survey in Latin America due to the fear of information leaks. Future research should consider applying the same survey to a larger sample from different regions to compare with the results in this article. Authors are planning to expand their own data set to include families that had been recently participating in family business seminars through INCAE Business School. Acknowledgment The authors thank Stuart Perez for his help in correcting this paper. References Brenes, Esteban and Madrigal, Kryssia. (2003) Anticipando el Conflicto en los Negocios Familiares. INCAE Magazine, Vol. XII, Issue 3, October 2003. Brenes Esteban, Madrigal Kryssia, Molina German. Family business structure and succession: critical topics in Latin American experience. J Bus Rev 2006;59(3):372–4. Brenes Esteban, Mena Mauricio, Molina German. Key success factors for strategy implementations in Latin America. J Bus Rev 2008a;61(6):590–8. Brenes, Esteban, Madrigal, Kryssia, and Molina, German. (2008b). Estrategias para asegurar la continuidad de las empresas familiares. INCAE Magazine, Volume I, Issue 5, May–August 2008. ¿Es posible -e incluso deseable- un único modelo global de gobernabilidad Corporativa? (2008), Universia Knowledge @ Wharton. Retrieved from http:// www.wharton.universia.net/index.cfm?fa=viewArticle&ID=1458. Gómez Gonzalo, López María Piedad. El Corporate Governance y la Ley Sarbanes–Oxley: Balance entre Propiedad, Dirección y Board of Directors. INALDE-Universidad de la Sabana; 2004. Klelman, Robert, update by Horwitz, Ronald. (2007) The Role of the Board of directors. Encyclopedia of Management, 2007. La figura del presidente único tiene los días contados (2008) Universia Knowledge @ Wharton Retrieved from http://www.wharton.universia.net/index.cfm? fa=viewArticle&id=1211. Lander, Guy (2003) What is Sarbanes Oxley. McGraw Hill; 1 edition. November 2003. Sompayrac Joanie. Corporate governance — key governance issues. Encyclopedia of Management; 2007. Ward John. The role of the board in family business strategy. Family Business KnowHow; 2002. June 2002.