UNTANGLING COMPLEXITY: AN ANALYSIS OF CORPORATE GOVERNANCE CHALLENGES AND SOLUTIONS IN FAMILY-OWNED BUSINESSES

Abstract

Corporate governance refers to the system by which companies are directed and controlled^[1]” (Cadbury report 1992, p. 15). This article explores the nuanced perspective of corporate governance challenges in family-owned businesses. This article begins with providing a well-framed introduction to the topic, defining the concept of corporate governance by various definitions, and providing the 6 main concepts of corporate governance, the article explains background of the family-owned businesses with their characteristics, subsequently providing the importance of family-owned business in the economy and the significance of corporate governance in family-owned business. The article explored critical challenges related to corporate governance faced by family-owned businesses. Subsequently, the article provided the solutions to the challenges, mainly focusing on 5 principles:- Accountability, Transparency, Awareness, Impartiality & Responsibility. The article concluded with affirmative action towards the family businesses with a framework of a diverse representation in the decision-making process ensuring long-term sustainability. To avoid conflict of interests within management the family can formulate a clear code of roles and responsibilities.

Keywords

corporate governance, family-owned businesses, family business constitution, sustainability, challenges, solutions.

Introduction To Corporate Governance

Corporate governance refers to a set of predefined mechanisms, processes & procedures made by competent authority to govern the corporate institutions. In the opinion of notable business and corporate coach Shailer Greg, in their book ‘Encyclopaedia of Business and Professional Ethics, corporate governance is described as processes, structures and mechanisms that influence the control and direction of the company^[2]. Simply it refers to all forms of system including Legislative acts, executive rules and the judicial precedents by which a corporate entity is directed and controlled by the State. Corporate governance plays a vital role in balancing the interests of all parties in a company which includes many stakeholders, such as management, shareholders, government, customers, financiers, suppliers, distributors and society. Corporate governance practices play a vital role in mitigating and resolving several conflicts of interest among parties^[3].

Corporate governance establishes and ensures the well-defined framework of a company, through which the objectives of the company are set and in furtherance monitored for the welfare of the company and society. It also aims to secure the long-term success of the company. The world is witnessing rapid technological advancements, global economic-fiscal uncertainties, strict legal requirements and geopolitical changes; to cope with all the uncertainties it has become a strategic imperative for corporate organisations to have internal corporate governance mechanisms, especially for the family-owned businesses which possess several inherent and unique threats such as lack of accountability, transparency, responsibility. etc. The conventional wisdom holds that the special and unique ownership structure of family businesses gives them a long-term orientation that traditional public firms often lack^[4]. This article explores the possibility of welfare of the family-owned businesses by establishing corporate governance practices. The corporate government is key in ensuring that the company is transparent, accountable and responsible. Corporate governance practices play a significant role in guiding & regulating every major industry^[5]. It ensures safety protocols, secure business operations and sustainable business techniques^[6]. The corporate government holds a key position in ensuring that the company is transparent, accountable and responsible. Some significant aspects of corporate governance are:-

The concept of Corporate governance revolves around certain key principles which are:-

Recognising and ensuring the rights of Shareholders:- the corporate governance practices recognise the rights of shareholders and ensure the continuance of rights by compliance mechanism.
Maintaining transparency in the corporate world:- corporate governance practices promote and ensure effective transparency in the company.
Holding directors and executives accountable for fraudulent & mischievous actions:- corporate governance ensures the lifting up of the corporate veil to hold accountable and punish the directors/ office holders in case of fraudulent activities.
Promoting ethical behaviour within the company:- The corporate governance practices ensure ethical behaviour within the company.
Establishing a process of identifying, assessing and managing the risks faced by the company:- corporate governance plays a key role in the risk management framework, corporate governance includes establishing a framework to assess, recognise, analyse, control and mitigate the risks involved in the business.
Ensuring compliance with the relevant legislation applicable to the company:- It becomes important for corporate governance, to check for whether the companies are complying with the relevant legislation. Corporate governance also includes the compliance mechanism and in furtherance, it punishes those companies who fail to comply.

Background of Family-Owned Businesses

Family-owned businesses are types of commercial organisations that are owned and managed by members who are interconnected by blood, marriage or adoption^[7]. The family-owned business has a long history, which can be traced back to early ancient civilizations. It is believed to be the most ancient form of commercial organisation. Apart from being the oldest, it is the most common form of commercial operation. As per Forbes 400 richest Americans, over 44% of them derive their wealth or are associated with the family business^[8]. It is very often that people underestimate the role & importance of family-owned businesses, this is due to the entrepreneurial and family firms, with their particular management models and complicated psychological processes, often falling short by comparison^[9]. In the 18th and 19th centuries, the Rothschild family-owned banking and financial business dominated Europe’s banking industry. Many of the world’s largest commercial groups are owned & managed by families, such as Walmart, Berkshire Hathway and Cargill, Inc. in the United States, Volkswagen and Schwarz Group in Germany, Samsung Group in South Korea and The Tata Group and Reliance Industries ltd in India^[10]. A report published by Ernest and Young(EY) and The University of St. Gallen in 2023, suggested that the largest 500 family businesses are growing faster than the global economy. Bin Saleh (2006) estimates that family businesses employ between 50-60% of those who work in companies around the world^[11]. All these facts reveal the economic importance of family-owned businesses.

Key Characteristics of Family-Owned Businesses

Some of the characteristics of family business are^[12]:-

Single families possess the majority of ownership of a commercial organisation.
The family has power over strategic decisions with integrity and control over corporate operations.
Has the involvement of multiple generations of the same family members associated by the relationship of blood, marriage or adoption.
Family has the power to decide the top management of the company and the senior management of the firm is drawn from the same family.
The family has a mutual interest and mutual trust in business welfare.

Need for Corporate Governance Framework in Family-Owned Businesses

Sometimes, academicians expect family-owned businesses to adhere to common corporate government practices as other registered and listed businesses. however, the same strategy, measures and framework of corporate governance that apply to any company doesn’t need to apply as well to family-owned businesses. The family-owned businesses need special measures apart from compliance, maintaining accounting standards, sound financial reporting machinery, transparency, accountability and integrity. The special measures are:- engagement with shareholders, preparation of family code of business operations, preparing succession of business, and preparing roles and responsibilities of members. etc. Thus, it becomes essential to provide a different perspective on the need for corporate governance practices in family-owned businesses.

Purpose of the Research

This article aims and objectives to:-

To highlight the significance of corporate governance in family-owned businesses.
To detect and analyse the corporate governance challenges faced by family-owned businesses.
To provide key Solutions to corporate governance challenges in family-owned business

Corporate Governance Challenges in Family-Owned Business

Corporate governance practices play a significant importance in regulating family-owned businesses. It is estimated that approximately 40% of the Fortune 500 are family-owned or controlled (Gersick et al, 1997). It can be challenging to maintain all four principles of corporate governance – People, Purpose, Processes, and Practices – in a family-owned business^[13]. The OECD i.e. organisation for Economic Cooperation and Development pointed out to corporate governance faced by family-owned businesses as Family-owned businesses face certain unique challenges of corporate governance. However, many failures of family-owned companies indicate that such firms also face a multitude of challenges that risk destroying shareholder value or even the business itself and the corporate governance measures lead to long-term success and keep peace in the family businesses^[14].

There are several other challenges related to corporate governance in family-owned businesses such as:-

Ownership and control dynamics:- Family-owned businesses face several issues related to ownership and control dynamics. These issues include shared participation within the family, conflict of opinions of family members about business operations or during mergers and acquisitions and succession-related issues. Such issues need to be efficiently solved through the process of corporate governance and these issues can hamper the future well-being of the business and its stakeholders. In several family-owned businesses due to a lack of succession planning, the average lifetime of commercial operations turns out to be much less comparatively. The leadership and management of this business are often not selected on merit, but on family relations, this system hampers the business’s success^{^[15]}.
Conflicts of interest among family members:- Continuing to the previous issue, the personal interests of members of the family play a crucial role in determining the future commercial operations of the business, but due to joint ownership of the business there are several members of the decision making body, which may not have unanimous opinion on future endeavours of the business and their difference often results into severe conflict of interests in the business, often the interests of the family may not be balanced with the interests of their business^{^[16]} . Several business experts suggest that the conflict of interests among family members harms the stability of the business furthermore the conflict of interests may result in wrong decisions or confused decisions resulting in losses of the business and all stakeholders^{^[17]}.
Lack of separation between ownership and management:- One of the major issues faced by family-owned businesses are lack of separation between ownership & management. In joint Stock Companies, the shareholders are the real owners of the company and they have very little power in daily management and operations of the company. However, in family-owned businesses the entire estate, assets and rights of business are owned by the family members and several members are correspondingly in management of the business. This may create double responsibility and, a lack of checks and balances and may result in a difficult situation for the business^{^[18]}.
Limited external oversight and accountability:– The joint stock companies, partnerships and many other forms of commercial associations are subjected to several external oversight mechanisms and accountability systems, however, the family-owned businesses are not subsequently regulated by enough external oversights and accountability mechanisms. The lack of external oversights may result in unethical and dangerous practices by the business which may affect negatively the environment, society and future operations of the business. Furthermore, in family-owned businesses, the boundaries operating the roles and duties of ownership, management and governance can be blurred. Due to the family holding crucial positions on the board of directors and executive positions without sufficient checks and balances, the business may lack independent oversight which hinders the best interests of the business and may blur the diverse perspectives essential for long-term success.
Lack of Accountability:– Due to the prevalent business operations in family-owned businesses, they often face a unique challenge when it comes to accountability, affecting corporate governance practices^{^[19]}. The business methods in family-owned organisations are closed-knit in nature and they lack the formal framework of commerce due to which they often lack transparency and accountability. Favoritism and nepotism prioritise the family members over the meritorious and qualified favoritism such practices undermine meritocracy and hinder the overall well-being of the business.
Informal decision-making process:- In family-owned businesses, personal relationships and trust play a pivotal role in communication, while these processes can be efficient in small businesses, they may lack the rigour and accountability of formal business in large operations. The informal information may be inadequate, and vague and may result in misinterpretation in some cases, which increases the risk of failure.
Lack of transparency: Family-owned businesses may be less transparent in their operations compared to publicly traded companies. Financial reporting and disclosure practices may be less rigorous, and information may be shared selectively among family members. This lack of transparency can erode trust among stakeholders, including employees, investors, and business partners. It can also limit the ability of external parties to assess the financial health and performance of the business accurately.

Overall, family-owned businesses have challenges in all 5 principles of corporate governance practices, I.e. Accountability, responsibility, awareness, transparency & impartiality^[20].

Solutions

Due to the above challenges, family-owned businesses require a special and concerted framework to formulate a robust corporate governance practice. These practices include the introduction of independent directors, the implementation of a transparent communication(reporting and disclosure) mechanism, formal decision-making mechanism, by implementing the best corporate governance practices, the family-owned businesses can ensure accountability, transparency and sustainable performance.

A. Independent boards of directors:

One of the most effective corporate governance practices in worldwide practices is the implementation of an Independent board of directors. These individuals are not related to the family by blood, marriage or adoption and are not employees of the business. The purpose of independent directors is to ensure that a diverse perspective & field expertise in decision-making processes. The prominent automobile industry leader BMW AG, has implemented an independent board of directors with diverse backgrounds and expertise in technology, accountancy, law & other industries.

B. Developing family business codes constitutions and governance structures:

The Family constitutions or family charters, are the formal documents that outline the principles, values, and governance structures of the family-owned business. These family codes provide clarity on the roles and responsibilities of members in business operations and decision-making processes. These documents avoid future conflicts and ensure transparency and accountability. For example. Walmart Inc. has a well-structured framework for family business governance. Walmart is a multinational retail corporation which is owned by the Walton family. Walton family has a family council that operates the family matters in the business. This framework helps in maintaining family harmony & supports effective corporate governance. This framework can prove to be efficient in securing effective family governance and succession planning for a sustainable future.

C. Professionalizing management and decision-making processes:

A professional management and formal decision-making process can professionalize business operations and can be effective in risk management. This governance mechanism includes several steps such as hiring qualified professionals, and independent directors, clear performance metrics and adopting lucid formal decision-making frameworks. Ford Motor Company is a relevant example dealing with professional management, Ford Motor Company is a renowned automobile company owned by the family, it has a professionalized management by appointing non-family members to key positions as a corporate governance practice. Alan Mulally was a former Boeing executive who served as the CEO of Ford from 2006 to 2014 and was not related to the Ford family. This approach also ensures the separation of powers, roles and responsibilities between ownership & management. This approach also brings external field expertise based on performance metrics and diverse perspectives in the decision-making process.

D. Enhancing transparency and disclosure practices:

Transparency and clear disclosure of facts are crucial for building trust among the stakeholders of the business. Family-owned businesses can improve their corporate governance by implementing robust reporting mechanisms and disclosure practices that align with industry standards and regulations. For example, Cargill Inc. is a renowned multinational agricultural corporation owned by the Cargill- MacMillan family, The Cargill. Inc. has made a robust mechanism to enhance transparency & accountability. The company publishes an annual report to provide a piece of comprehensive information on its financial performance, audit governance and sustainable reporting practices.

E. Engaging in shareholder communication and engagement:

It is recommended for family-owned businesses to ensure an effective shareholder communication and engagement are critical for family-owned businesses. Regular communication with the shareholders, including family members and external investors, helps in aligning interests, addressing concerns, and fostering a sense of ownership and accountability. For example, The LEGO group which is owned by a family, is a renowned toy manufacturing company. LEGO actively engages with the shareholders through annual meetings among the owners and stakeholders. The LEGO has established a robust communication framework mechanism to ensure formal and professional communication to provide all necessary updates to the stakeholders.

Conclusion

Corporate governance practices are key for the welfare of the community, business and the nation.

Corporate governance is often supported by the 4 P’s i.e. “People”, “Purpose”, “Processes” & “Practices”. Understanding the deep-rooted importance of corporate governance, the Ministry of Corporate Affairs, in the year 2003 established the National Foundation for Corporate Governance (NFCG) as a not-for-profit trust. The NFCG provides a framework to deliberate on issues related to good governance in Companies and other business enterprises. In family-owned businesses, there are several challenges related to corporate governance practices such as lack of accountability, transparency, presence of vicious conflict of interests, lack of formal communication, impartiality, blurry separation between management and ownership, lack of managerial expertise & meritocracy, no external oversight, lack of government regulation, lack of risk management framework; all such challenges hinders the business operations of the family and may result into long term failures impacting all stakeholders. Thus, it is essential to formulate a well-structured mechanism for family-owned businesses. As per a report from a reputed source(Gary A. Plaster and Laurie Price, 2023), it is affirmed that with proper governance, family-owned businesses can thrive and achieve long-term success^[21]. To facilitate the decision-making process, long long-term sustainability and to ensure no conflict of interests within management, the family can formulate a clear code of roles and responsibilities. What makes the corporate governance practices in family-owned businesses difficult is its unique institutional evolution, high level of heterogeneity and high goal diversity, furthermore, in multi-family businesses and complex family businesses, corporate governance practices can be more challenging. As per a journal report, “In a well-governed business, families are likely to increase the family members’ potential for self-development and self-determination^[22]”. For this to happen, the family should strengthen their corporate governance practices for the well-being of the family, business and sustainability.

References

Cadbury, A. (1992). Report of the Committee on the Financial Aspects of Corporate Governance. London: Gee & Co. Ltd.
Shailer, G. (2018). Corporate governance. Encyclopedia of Business and Professional Ethics, pp.1–6. doi: https://doi.org/10.1007/978-3-319-23514-1_155-1.
Tricker, B. (2012). Corporate governance: Principles, Policies and Practices. Oxford University Press
Kachaner, N. (2012). What You Can Learn from Family Business. [online] Harvard Business Review. Available at: https://hbr.org/2012/11/what-you-can-learn-from-family-business.
TY – BOOK AU – Gong, Stephen AU – Firth, Michael AU – Cullinane, Kevin PY – 2001/07/18 SP – T1 – Corporate Finance and Corporate Governance in the Transport Industry VL – ER –
“Transport Corporate Governance: Transport Corporate Governance: A Strategic Approach for Startups.” Faster Capital, fastercapital.com/content/Transport-Corporate-Governance–Transport- Corporate- Governance–A-Strategic-Approach-for-Startups.html. Accessed 3 May 2024.
De Massis, Alfredo; Josip Kotlar; Jess H. Chua; James J. Chrisman (2014). “Ability and Willingness as Sufficiency Conditions for Family-Oriented Particularistic Behavior: Implications for Theory and Empirical Studies” (PDF). Journal of Small Business Management. 52 (2): 344–364. doi:10.1111/jsbm.12102. S2CID 53582751.
https://www.forbes.com/forbes-400/
Carlock, Randel S; Manfred Kets de Vries; Elizabeth Florent-Treacy (2007). “Family Business”. International Encyclopedia of Organizational Studies.
familybusinessindex.com. (n.d.). EY and University of St. Gallen Global Family Business Index. [online] Available at: https://familybusinessindex.com.
Sapovadia, V. (2012). Munich Personal RePEc Archive Corporate Governance Issues in Indian Family-Based Businesses Corporate Governance Issues in Indian Family-Based Businesses. [online] Available at: https://mpra.ub.uni-muenchen.de/55226/1/MPRA_paper_55226.pdf.
Business Jargons (2021). What is Family Business? definition, characteristics, types, structure and examples. [online] Business Jargons. Available at: https://businessjargons.com/family-business.html.
Kaur, R. (2019). (PDF) Corporate Governance in Family Businesses – A Review. [online] ResearchGate. Available at: https://www.researchgate.net/publication/331257007_Corporate_Governance_in_Family_Businesses_-_A_Review.
F., D. (2009d). GovernanCe ChallenGes FoR FAMilY-oWnED BuSinESSES Motivation. [online] Available at: https://www.oecd.org/daf/ca/corporategovernanceprinciples/43654301.pdf.
ref. Flaur, J. (2018). Corporate Governance In Family Businesses – Corporate/Commercial Law – Worldwide. [online] www.mondaq.com. Available at: https://www.mondaq.com/unitedstates/corporate-governance/695974/corporate-governance-in-family-businesses.
Loewen, Jacoline (2008). Money Magnet: Attract Investors to Your Business: John Wiley & Sons. ISBN 978-0-470-15575-2.
Kapoor, V. (2024). Corporate governance in family-owned businesses. [online] iPleaders. Available at: https://blog.ipleaders.in/corporate-governance-in-family-owned-businesses/#:~:text=Conflicts%20of%20interest%3A%20When%20family [Accessed 13 Apr. 2024].
Tannenbaum, F. and Llp, R. (n.d.). All in the Family: Corporate Governance Issues Facing Family-Owned Businesses. [online] Available at: https://www.gouldratner.com/assets/publications/FDT_All-in-the-Family-Corporate-Governance-Issues.pdf.
Kaur, R. (2019). (PDF) Corporate Governance in Family Businesses – A Review. [online] ResearchGate. Available at: https://www.researchgate.net/publication/331257007_Corporate_Governance_in_Family_Businesses_-_A_Review.
Dan Byrne, What are the five principles of corporate governance?, The Corporate Governance Institute (2022), https://www.thecorporategovernanceinstitute.com/insights/lexicon/what-are-the-five-principles-of-corporate-governance/.
Gary A. Plaster and Laurie Price (2023). The need for governance in family-owned businesses. [online] www.bakertilly.com. Available at: https://www.bakertilly.com/insights/the-need-for-governance-in-family-owned-businesses.
Entrepreneurship Theory and Practice (2015), Vol. 39, No. 6, pp. 1265-1280.

^[1] Cadbury, A. (1992). Report of the Committee on the Financial Aspects of Corporate Governance. London: Gee & Co. Ltd.

^[2] Shailer, G. (2018). Corporate governance. Encyclopedia of Business and Professional Ethics, pp.1–6. doi: https://doi.org/10.1007/978-3-319-23514-1_155-1.

^[3]Tricker, B. (2012). Corporate governance: Principles, Policies and Practices. Oxford University Press

^[4] Kachaner, N. (2012). What You Can Learn from Family Business. [online] Harvard Business Review. Available at: https://hbr.org/2012/11/what-you-can-learn-from-family-business.

^[5] TY – BOOK AU – Gong, Stephen AU – Firth, Michael AU – Cullinane, Kevin PY – 2001/07/18 SP – T1 – Corporate Finance and Corporate Governance in the Transport Industry VL – ER –

^[6] “Transport Corporate Governance: Transport Corporate Governance: A Strategic Approach for Startups.” Faster Capital, fastercapital.com/content/Transport-Corporate-Governance–Transport- Corporate- Governance–A-Strategic-Approach-for-Startups.html. Accessed 3 May 2024.

^[7] De Massis, Alfredo; Josip Kotlar; Jess H. Chua; James J. Chrisman (2014). “Ability and Willingness as Sufficiency Conditions for Family-Oriented Particularistic Behavior: Implications for Theory and Empirical Studies” (PDF). Journal of Small Business Management. 52 (2): 344–364. doi:10.1111/jsbm.12102. S2CID 53582751.

^[8] https://www.forbes.com/forbes-400/

^[9] Carlock, Randel S; Manfred Kets de Vries; Elizabeth Florent-Treacy (2007). “Family Business”. International Encyclopedia of Organizational Studies.

^[10] familybusinessindex.com. (n.d.). EY and University of St. Gallen Global Family Business Index. [online] Available at: https://familybusinessindex.com.

^[11] Sapovadia, V. (2012). Munich Personal RePEc Archive Corporate Governance Issues in Indian Family-Based Businesses Corporate Governance Issues in Indian Family-Based Businesses. [online] Available at: https://mpra.ub.uni-muenchen.de/55226/1/MPRA_paper_55226.pdf.

^[12] Business Jargons (2021). What is Family Business? definition, characteristics, types, structure and examples. [online] Business Jargons. Available at: https://businessjargons.com/family-business.html.

^[13] Kaur, R. (2019). (PDF) Corporate Governance in Family Businesses – A Review. [online] ResearchGate. Available at: https://www.researchgate.net/publication/331257007_Corporate_Governance_in_Family_Businesses_-_A_Review.

^[14] F., D. (2009d). Governance Challenges For Family- Owned Business Motivation. [online] Available at: https://www.oecd.org/daf/ca/corporategovernanceprinciples/43654301.pdf.

^{^[15]} ref. Flaur, J. (2018). Corporate Governance In Family Businesses – Corporate/Commercial Law – Worldwide. [online] www.mondaq.com. Available at: https://www.mondaq.com/unitedstates/corporate-governance/695974/corporate-governance-in-family-businesses.

^{^[16]} Loewen, Jacoline (2008). Money Magnet: Attract Investors to Your Business: John Wiley & Sons. ISBN 978-0-470-15575-2.

^{^[17]} Kapoor, V. (2024). Corporate governance in family-owned businesses. [online] iPleaders. Available at: https://blog.ipleaders.in/corporate-governance-in-family-owned-businesses/#:~:text=Conflicts%20of%20interest%3A%20When%20family [Accessed 13 Apr. 2024].

^{^[18]} Tannenbaum, F. and Llp, R. (n.d.). All in the Family: Corporate Governance Issues Facing Family-Owned Businesses. [online] Available at: https://www.gouldratner.com/assets/publications/FDT_All-in-the-Family-Corporate-Governance-Issues.pdf.

^{^[19]} Kaur, R. (2019). (PDF) Corporate Governance in Family Businesses – A Review. [online] ResearchGate. Available at: https://www.researchgate.net/publication/331257007_Corporate_Governance_in_Family_Businesses_-_A_Review.

^{^[20]} Dan Byrne, What are the five principles of corporate governance?, The Corporate Governance Institute (2022), https://www.thecorporategovernanceinstitute.com/insights/lexicon/what-are-the-five-principles-of-corporate-governance/.

^[21] Gary A. Plaster and Laurie Price (2023). The need for governance in family-owned businesses. [online] www.bakertilly.com. Available at: https://www.bakertilly.com/insights/the-need-for-governance-in-family-owned-businesses.

^[22] Entrepreneurship Theory and Practice (2015), Vol. 39, No. 6, pp. 1265-1280.

Disclaimer: The materials provided herein are intended solely for informational purposes. Accessing or using the site or the materials does not establish an attorney-client relationship. The information presented on this site is not to be construed as legal or professional advice, and it should not be relied upon for such purposes or used as a substitute for advice from a licensed attorney in your state. Additionally, the viewpoint presented by the author is of a personal nature.