Good governance is different for family firms

John L Ward is co-director of the Center for Family Enterprises at Kellogg School of Management (USA) and the Wild Group Professor of Family Business at IMD (Switzerland). He serves on the boards of four family companies in Europe and the US.

In family-owned businesses, ownership is uniquely important and influential to the system of governance, where its values and vision are crucial elements in the financial success of the company

Governance has certainly captured business headlines in the past year. But this article is not about the aftermath of Enron, WorldCom and Vivendi – it is about the meaning of Ford, Bertelsmann and Hewlett-Packard. In the former cases, management power and greed ran amok. In the latter cases, ownership has exerted its values and vision. That is the key difference for the governance of family firms: ownership matters.

Two years ago the Ford family took back the CEO job at Ford because they did not like what was happening to the company's culture. This year the ownership of Bertelsmann changed CEOs because they did not like the direction the firm was headed. The Hewlett and Packard families attempted to veto the Compaq acquisition because they felt it risked the company's continuity.

These are only the most visible of numerous examples of family ownership using its role in the governance process to help shape the business's future. In the non-family firm, governance is left to the board, to management, to the financial markets and to government regulation. For family firms it is the special role of ownership that makes the difference.

And that difference is a very positive one. Research has proved that family ownership leads to superior financial business performance. A recent study by Professors Gedajlovic and Shapiro concluded: "Owner-controlled firms are more profitable than manager-controlled firms."

An earlier article in Families in Business on strategy proposed: "Trust in the governance system is the most valuable competitive advantage of family firms."

When ownership matters in the governance process it is because ownership has influence and because ownership cares about more than simply economic value. With this influence and care comes the added responsibility of ownership to express its expectations clearly.

The public model of governance
The owners of public companies do not actively shape the destiny of their businesses. Dissatisfied shareholders find exiting ownership is more practical than attempting to influence management. As a result, the board of directors must take the lead in the governance process. Its job becomes protecting the interests of an ill-defined ownership from the possible abuses of self-interested management. The board represents abstract, absentee owners, and it directs and monitors management.

Because ownership for non-family firms is typically abstract and absentee, the board must operate on two premises: ownership's sole goal is to maximise near-term share value; and the board's first responsibility is to be the fiduciary for that goal.

Today, boards are under greater scrutiny and they are held increasingly accountable for corporate performance. Boards feel they must focus exclusively on share value and must be wary of risks to that goal. Therefore the board, as guardian of share value, is most likely to follow conventional wisdom in strategy and avoid unique, unconventional strategies that might better capture long-term value.

In addition to relying on conventional wisdom in strategy, boards now invest much energy and effort into examining management's intentions and interests – note all the attention directed now at executive compensation systems. This focus is costly, both in monitoring systems and in strategic distraction. It also reinforces a presumption of distrust, at a time when government regulations are focusing on strengthening the power of boards. Such, in simplistic terms, is the governance system controlling most large companies in the world.

The family business model
Governance, however, should be different for family controlled firms. With the strong influence and care of ownership, the board is just one partner in the governance system rather than the dominant player. 

As a partner in governance the board supports discrete, visible owners and serves as a resource to management. The board can now operate on two very different premises: ownership may have goals beyond near-term share value, and the board can focus more on increasing value than on watching over self-interested management.

In short, the function of the governance system – and especially the board – is more about creating value than being a costly source of checks and balances.

Trust
The key ingredient to that value creation is mutual trust among the owners, the board and management. Having trust allows the board to focus more on contributing to management's strategic thinking and on aiding ownership's efforts to unify its point of view. Building and strengthening mutual trust among the governance
partners – the board, ownership and management – is the most critical issue of family business governance.

The clarification of roles and responsibilities in governance is central to building this valuable trust. Figure 2 provides a framework for defining the roles and responsibilities of each governance partner.

The roles and responsibilities of ownership are what distinguish this framework from the public model.   Ownership sets the values that drive the culture; ownership provides goals that set performance expectations; ownership offers a vision that sets boundaries for strategy. Common ingredients of that vision include public versus private ownership, degree of diversification, geographic scope of the business, and the relative importance of various constituents of the business
(ie, shareholders, employees, society, etc).

Interdependence
Good family business governance should not rely exclusively on the role of ownership, despite its special and important role (any more than non-family business governance should rely exclusively on the role of the board). Instead, it is the effective functioning of each part of governance – owners and board and management – as
a team that leads to the best results.

The best example of this is in the CEO/managing director succession process. Each partner in the governance process plays a critical role. Constructive dialogue among the parties leads to the best outcome.

Management, for example, needs to accept succession planning and successor development as part of its mandate. Ownership needs to clarify the conditions for family versus non-family selection of a CEO or managing director, and be comfortable with the choice. The board needs to help evaluate the criteria and candidates, and establish the timing of the selection process.

Summary
In family-controlled firms, ownership is uniquely and vitally important and influential to the business's system of governance. For owners to fulfill their role successfully, they need to communicate their expectations effectively, perhaps in something like an Owners' Statement. Special efforts should be made to define in detail each governance partner's roles and responsibilities.

Doing so will enhance the mutual trust among all the partners. That trust allows for more long-term value creating dialogue on the critical issues facing the business, such as succession, rather than on monitoring and control systems to hold check on management.

Family controlled firms can focus on the process of governance and the quality of decisions. Non-family controlled firms focus much more on the structure of governance and addressing external suspicions. The difference is seen in the bottom line and in the long-term value of the business.