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Loyola guidelines for family business boards of directors

Compiled by Joseph Astrachan (Loyola University Chicago and Kennesaw State University), Andrew Keyt (Loyola University Chicago), Suzanne Lane (Loyola University Chicago), and Kristi McMillan (Kennesaw State University).

The recent meltdown of companies such as Enron, WorldCom, and Global Crossing, generated worldwide media attention on the need to improve corporate governance. Sarbanes-Oxley and proposals from around the globe are trying to address board practices that have allowed massive corporate failure. While perhaps valuable for large public companies, many of these recommendations may be harmful to family-owned businesses.

'Best practice' measures may well be at odds with the fundamental nature of family companies and could harm family unity. Popular corporate governance practices come from a market model of corporate governance, which is relevant for companies with a widely dispersed shareholder base. However, typical family businesses exhibit characteristics of a control model of corporate governance, which involves companies with concentrated shareholders.

Many of the current best practices are generalised laundry lists, rather than specific actions that lead to identifiable results. And although some issues discussed in family and non-family business literature, such as the significance of independent boards, are important, fixating on such issues overshadows the issue at the heart of corporate governance problems today: accountability. Corporate governance guidelines for family firms must focus on the need for boards to have the competencies to be held accountable, and hold others accountable, for their actions. Family business boards need to be competency-based boards.

Family-owned boards must be held accountable
Criteria for director selection
While business competencies and diversity of skills and background are important, they are not sufficient. The most critical qualification is having the ability to hold the company accountable and the discipline to not interfere in company operations. The board of the typical family firm should have competencies, such as communication, open dissent, understanding of business, and collaboration with management, to ensure strategic guidance of the company, effectively monitor management, and be held accountable to the company and its shareholders.

Although smaller boards may be more manageable, a larger board can lead to greater accountability as long as individual board members have the necessary competencies to render good judgment. In addition, an important ingredient that enables the success of larger boards is having a high level of tolerated, open dissent. The most effective board for the typical family firm consists of 7–12 people, depending on the gaps in competency levels that are revealed at the board's collective or individual level.

Independent outsiders
Many recommendations insist upon minimising the use of insiders and including a significant proportion of independent outsiders. However, outsiders can be easily swayed by compensation, perks, recognition, and business dealings; additionally, outside independent board configurations have not been associated with firm performance. In order to promote objectivity and accountability, a director's ability to fulfil the task of accountability as well as render an opinion unfettered by extraneous influences, is more important than whether or not the individual works inside the business.

Frequency of board meetings
The reason to hold board meetings is to provide a forum to conduct regular and purposeful communication and resolve conflict. In order for this to occur, the board of a typical family business should meet 3–6 times per year. This helps keep communication open between the board and management, and between the board and shareholders. When extraordinary events occur, more frequent meetings may be needed.

Content and process of board meetings
The content of board meetings should include all key matters brought forth by senior executives and a review of past activities; additionally, the process boards use to make decisions is best achieved by simple majority vote. While many recommendations for family firms suggest that board members should make consensus decisions, such decision-making enables the most powerful board member to sway others by stature rather than a decision's merits. While some may find voting initially difficult, as long as all directors stand behind decisions, it allows for quicker and less contested decision-making.

Board member selection
Most corporate governance experts hold that a nominating committee should be formed to manage the board selection process. The nominating committee also has the important role of building unity among the board, often by eliciting opinions from all board members, sharing ideas on board needs and criteria, and building agreement on proposed nominees based on all the directors' input. The nominating committee should be formed with board and non-board members to ensure greater accountability and to aid in building shareholder unity.

Board commitment
Many experts believe that a board's role is reactive. However, boards of family businesses should be actively participating in their respective businesses. Accountability requires more than nominal participation. However, an overactive board may undermine the authority of management. To achieve commitment and effective service, it may be wise to limit active participation to no more than three boards.

Board term and turnover
Companies that have term limits typically have them for internal political reasons. A tenure system that promotes accountability is a minimum term limit of approximately three years and an extensive review process after that three-year period. Along with this tenure system, there must be a process for evaluating the progress of the director, as well as clear criteria for 'keep/let go' decision-making.

Board evaluation process
Although evaluating aggregate board performance is necessary, it is not sufficient. To promote accountability, board members must be evaluated individually. A high performance board must be able to distinguish good contributions from poor, and, above all, ensure that all directors act to hold themselves and the company accountable.

Leadership: role of chairman and CEO
The issue of whether or not the  chairman and CEO roles should be combined is controversial. The roles of  chairman and CEO should only be combined when a single person can do the two jobs effectively. Although the role of the  chairman may be to counsel the CEO, it is not to direct the CEO. Therefore, combining the role of the CEO with the additional responsibilities of  chairman presents a limited number of conflict of interest issues. Additionally, the board should annually evaluate the CEO using the opinions of individual directors and managers. This should be discussed privately with the CEO.

As long as the successor is able to initiate change and assert his/her leadership, and sufficient knowledge transfer occurred from old leadership to new, then a former CEO can remain on the board as  chairman, taking care not to undermine the authority of the new leader. It is advisable for separate committees to monitor the situation and act to remedy any problems if the former CEO undermines the new one.

Board compensation
Many corporate governance experts advocate compensating board members according to market norms. However, family businesses often provide owning family members non-financial returns. Instead of the market rate, directors should be paid for their time commensurate to that of the CEO. A simple heuristic is to divide the CEO's annual pay by 250 working days and then pay each board member the resulting amount per day for each day spent on board matters. This communicates that the board is as important as the CEO.

Boards must be accountable to shareholders
Shareholder influence on board composition
Control model companies, particularly family firms, must ensure adequate board composition, but not to the detriment of minority shareholders.  One way to influence board composition while not alienating minority shareholders is through cumulative voting. Cumulative voting, which allows shareholders to accumulate their vote for a single candidate, is an important mechanism to ensure accountability; however, it is generally invoked after a family breakdown or poor corporate performance. To guard against this, an effective nominating committee that works in concert with the board review process helps insure the protection and promotion of all interests.

Another way to influence board composition is via shareholder agreements. Shareholder agreements can highlight issues such as how the board or the  chairman will be selected, succession planning issues, estate planning issues, and dispute resolution mechanisms.

Communication between shareholders and the board
Particularly in family businesses, communication between the board and family shareholders is crucial. The board must understand the needs, vision and goals of the family shareholders it represents, and shareholders need reassurance that the board is attending to those needs. The board should communicate basic strategic plans, values, and industry and supplier information to shareholders, as well as conduct surveys, questionnaires, and meetings with shareholders. As for shareholders, regular letters to the board, family meetings, family councils, and other meetings with the board are all mechanisms that enhance communication and promote accountability.

Shareholders and strategic decision-making
Shareholders of family firms should establish the values, vision, and goals of the business, and become a 'partner' in strategy. This means helping management and the board understand owner goals as a basis for developing business strategy, and supporting the strategy proposed by both management and board. This form of involvement in strategic decision-making allows shareholders, the board, and management to become united in their support of the company.

Boards must hold management accountable for their actions
Monitoring strategic execution
Boards should effectively monitor management by critiquing and, when satisfied, approving the strategic plans of management. The board must periodically "check in" with executives in the short-term to ensure that plans are executed, and results are benchmarked against long-term indicators. By continuing this monitoring function, board members can help identify obstacles and figure ways to overcome them when performance falls short. Management should be rewarded when plans are achieved or exceeded and penalised when they are not met.

Executive compensation
Even though privately held family businesses are not obligated to announce executive remuneration, family businesses must create an atmosphere of trust and transparency among family members. Information concerning compensation should be easily available to family member shareholders and reviewed annually.

Boards should tie compensation to the organisation's mission, annual business performance, long-term financial results, and performance of non-financial measures. Family businesses are well advised to develop their own compensation philosophy and, in turn, a written compensation policy to help assure that the family's value system and vision are consistent with the way the business operates.

A competency-based board is best suited to achieve accountability in the typical family business, where the shareholders are concentrated in the family and often active in the business. However, as family businesses move away from the typical control model, as shareholder activism diminishes and the number of shareholders increases, family businesses migrate towards a market model (Quadrant 4), and ways to assure accountability may shift.

Additionally, when members of the family firm become less active in business management (a shift from Quadrant 1 to 3), but family shareholders retain their ownership stakes, family shareholders become passive investors and view the family business as another investment in their portfolio. Once these "portfolio model" shareholders become disinterested, they may sell shares and may be prone to litigation to do so.

Another scenario occurs when family members remain active in management or the board, but as the business moves through generations, the family expands and becomes less unified. This type of "dynastic model" of governance (Quadrant 2) is unstable and the lack of unity can create a desire for the sale of shares

There is no one single model for corporate governance that can account for the many differing configurations of family, shareholders, and business conditions but with careful analysis and consideration of family, ownership, and business characteristics, these guidelines can be tailored to meet most family business situations.

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