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Corporate governance comes of age in Lebanon

Josiane Fahed-Srieh is Assistant Professor of Management and Director of the Family and Entrepreneurial Business Institute at the Lebanese American University.

Crises in emerging economies and scandals in developed countries have converged business opinion the world over on one central issue: corporate governance. But what is it and how does it affect family businesses in Lebanon?

The International Finance Corporation, a Washington DC-based group that promotes private sector investment in developing countries, defines it as the rules, regulations, codes and practices enabling long-term economic value creation for shareholders, while respecting social values and attracting human and financial capital. The universal principles of corporate governance include fairness accountability, transparency and responsibility.

In other words, it means setting the 'rules of the game' by which companies are managed internally. The control is done through boards of directors, ensuring the business is protecting and preserving the interests of shareholders who are not directly involved in the business. This mechanism should be transparent so that shareholders can judge whether their investments are managed in a non-corrupted, proper manner.

Key factors
In Lebanon corporate governance has gained interest among family businesses for both external and internal reasons. The internal factors stem from the fact that organisations want a managerial system favouring control, as is often the case in larger organisations.

Organisations – particularly family businesses – want more emphasis on systematic rules and procedures. Family businesses tend to suffer from an overlap of the 'family system' and 'business system'. Indeed, in some cases they will maintain a degree of secrecy behind their financial operations, perhaps operating two accounting systems in tandem – one secret, the other disclosed – in a bid to avoid paying high amounts of taxes. But the overlap can lead to 'financial leakages' where family members use company funds in lieu of the personal funds.

The external factors stem from the fact that organisations in Lebanon tend to follow a western style of management that, in many cases, is applied without difficulty but in some cases fails to consider the cultural perspective of the Lebanese firm and the way operations are managed.

There are other factors. Lebanese businesses are keen to attract international investors and foreign capital. Meanwhile, the globalisation phenomenon has changed the way business is conducted, especially for family-owned organisations. Although international investors can impose strict rules for conducting business in underdeveloped countries, companies that adapt to this new competitive environment stand a good chance of success.  It is for this reason that organisations are looking at corporate governance as a tool to achieve success and to help them adapt to international standards.

The private sector accounts for 95% of Lebanon's GDP with family businesses accounting for 85%. In addition, Lebanese families dominate most of the companies listed on Beirut's stock exchange.  Where a majority stake is not the case and where voting power is not in the hands of a single shareholder (a shareholder with more than 50% of the voting power), power and strategic direction is often influenced by a single family. Moreover, many of these large groups are controlled by holding companies, which means heavy involvement of the family.

For a family business characterised by a multiple-ownership structure and transitioning to a third generation of ownership, the evolution can be fraught with tension.  Indeed, several questions arise. Who will manage the business? How will the transfer of power play out? How will the business be run over the long term? How will family members motivate and attract non-family employees to the firm? Who will hold the control torch?

Family businesses must realise that if they are to compete with international and institutionalised firms, they must establish their policies, rules and procedures. Corporate governance is the tool for success. What family business executives must also realise is that they must change how they do business if they are to survive in this new institutionalised environment.

Bereft of a corporate governance framework, few family businesses will succeed and most will suffers at the hands of their institutionalised and corporate competitors. Family firms should establish a governance system that clearly defines the duties, responsibilities and rights of family members and shareholders, as well as the management team and the board.

Although some aspects of the family-owned firm structure contrast sharply with the basic principles of corporate governance, other family-owned firms' characteristics might be advantageous within a sound governance environment. In family businesses, management and ownership are not separated. In many cases this overlap of the family system over the business system has helped family firms overcome the 'agency' problem (the conflict between owners and managers or employees).

In Lebanon family unity is critical, as are harmonious relationships within the family. And in some cases the understanding of the term 'family' can include friends and fellow citizens. This sense of belonging and the strong ties help the family firm motivate managers and employees to work harder for the well being of the family company and the greater group. It is these ties that help the business preserve its secrets, especially at start-up.

Problems and transparency
A fundamental element of corporate governance is the notion of transparency. The problem, however, is that family firms in Lebanon are reluctant to become transparent. Many neither wish to unveil business secrets nor engage in financial disclosures. And while many family firms have gone public, many have also tried to buy back their shares. This hermetically-sealed approach to organisational structure, therefore, can be a serious obstacle.

In addition, most founders of family firms are reluctant to delegate their responsibilities to solve key business issues. Owners and managers in Lebanon and the wider Middle East have resisted delegating authority and 'empowering' others for fear that business secrets and strategies will be unveiled to competitors, putting the firm at a disadvantage.

The reluctance to hire outsiders into key positions reflects a fear of leaking strategic knowledge or key financial information (profits, losses, tenders) to outsiders, competitors or the wider public. To a degree, this has put some Lebanese family businesses at a disadvantage and, over the long term, can cause them to underperform. In some cases, this lack of professionalism and absence of formal policies has led to tensions that intensify over time – even bankruptcy.

Another obstacle to good governance in Lebanese family firms is the lack of established human resource policies for the employment and compensation of family members and family managers. Yet obstacles to incorporating sound corporate governance systems can be overcome by developing and instituting a sound code of conduct – by implementing family governance and company governance models and differentiating between the two. This allows the family firm to choose intellect and productivity over blood.  It also allows the firm to prioritise performance over family relations. Establishing sound family governance systems, such as family councils, family meetings and a family constitution, helps the firm move towards a performance-based style of manage­ment, resolve succession issues, as well as make compensation and human resource policies transparent and based on merit. 

A governance system that is in line with the local culture will have:

- clear rules and procedures for family members duties and responsibilities;
- a qualified board capable of objective decision making;
- good strategic planning system;
- a sound human resource policy that recruits, promotes and compensates based on merit – an essential tool for the survival and profitability of family firms in the future.

The concepts of transparency, fairness, accountability and responsibility are critical to enhance competitiveness. Lebanese rules and regulations stipulate that the chairman of the board and CEO should be the same person, whereas current opinion amongst corporate governance commentators suggest the CEO should be a separate individual from the chairman in order to ensure a more professional board.

Reforming board practices
Reforming board practices is a logical place to start when instituting governance. Knowing how the board operates is crucial to how a firm is governed. In most family firms, the board is made up of only family members who are shareholders. If the company is still in the first generation transition, this informal board might work out. As the number of shareholders multiplies, a formal board of directors should be put in place. As the number of shareholders increases, there is usually one representative of every branch of the family. Although this works for many families in the Middle East, it can lead to 'family branches' operating as separate units and ultimately can result in disunity between branches of the same family.

There's a preference in the Middle East to have exclusively family members on boards, with no room for outsiders nor independent directors. In reforming board practice, board members' duties and responsibilities should be clearly defined, including how the board and management should operate, and how they interact with each other as well as shareholders and stakeholders. It is important to emphasise that family firms are not encouraged to focus on the form as opposed to the substance of the corporate governance practices. The basic principles outlined in the family policies developed are expected to serve as the starting point for the implementation of the best corporate governance practices in Lebanon and the region.

So-called value-adding  boards play a critical role since the duties go far beyond the mere monitoring of legal compliance. Boards that closely become involved with strategy development, top management selection and subsequent evaluation will be able to contribute significantly to transparency and accountability. Only if the board is committed to working on all three aspects – compliance, strategy and management selection – will it add true value to a company.

Although there is no single best governance practice that works for all organisations, every corporate governance system is the result of four forces in varying degrees: the personalities, the capital market, the business model and strategy, and the rules and laws.

Corporate governance for a bold strategy in volatile markets requires a different practice from more cautious development in a more mature market, mainly due to different levels of risk-taking and the variances in speed and responsiveness required. Capital markets expectations can shift rapidly and the rules and laws of the country have an influence on corporate governance, in addition to the personalities of the various members and the personality of the CEO.

Family members ought to be careful in applying corporate governance principles. They should apply those tools while keeping in mind that the business should always preserve its dynamism and its entrepreneurial spirit. Striking a balance between dynamism and governance should mean long-term success and prosperity for the company.

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