Corporate Governance and Family-Owned Businesses

1. Corporate Governance and Family-Owned Businesses Professor Chris Pierce Bahrain February 2010

2. What are family owned businesses? There are different definitions……… Family owned businesses are companies … … where the dominant shareholder is a family member (broad view) … which are run by heirs of the people previously in charge, or by families that are clearly in the process of transferring control to heirs (narrow view)

3. Separating Ownership from Control

4. Non Listed Businesses • “Family businesses constitute more than 85% of non listed businesses in the MENA region.” • Pierce (2008) Corporate Governance in MENA • “Family businesses constitute more than 85% of non listed businesses in the EU.” • Pierce (2010) Corporate Governance in the European Union

5. Listed Companies • “The top 5 families had 17% of the total board seats on listed companies in the UAE.” • Pierce (2008) Corporate Governance in MENA • “One third of all companies in the S & P 500 index and 40 % of the 250 largest companies in France and Germany are family businesses.” • McKinsey, January 2010

6. Strengths of family owned businesses • Strong set of values: Identity • Long-term view in decision-making: Consistency • Possibility of unconventional strategy: Flexibility • Desire to build a business for future generations: Sustainability • Commitment of family management to their company: Continuity

7. The long-term success of family owned businesses in the UK are bleak • Only 5% continue to create value beyond the 3rd generation* • A study** of inherited family firms and management practices in the UK shows that choosing a CEO by “primogeniture” (selecting the eldest son to lead) tends to lead to extremely bad performance • *Ward (2004). **Bloom (2006).

8. Key Success Factors for FOEs: Define Relationships and Structures within Family and with Outside Stakeholders • Create clarity of roles within the family • Create fair playing field for non-family members • Fair treatment of outside financial stakeholders

9. Create clarity of roles within the family • Family constitution • Family values, philosophy, principles and beliefs • Family code of conduct • Family Assembly / Forums • Family Councils • Family Advisory Board • Family’s long-term role as shareholder (share retention/voting) • Family salary-earners vs. dividend receivers • Self dealing and conflict of interest policies • Strategy for philanthropy and third party foundations • Family training and education strategy • Family employment committee • Wealth management and other family services

10. Create fair playing field for non-family members • Succession planning clear from the start • Family employment policy • Equality of opportunity in recruitment and promotion • Incentives for non-family managers

11. Fair treatment of outside financial stakeholders • Shareholder agreements • Legal structures and tax planning • Disclosure of information • Rights to information • Voting rights at AGM • Control enhancing mechanisms

12. Key Success Factors for FOEs: Set Formal Corporate Governance Structure • Formalities - They Really Do Matter! • Clarify roles and responsibilities between board, management and shareholders • Codify structures and processes for all to see • Create strong Advisory Board • Guarantees non-compromising standards of meritocracy in personnel decisions • Allows clear lines of authority for different areas of business • Ensures the stability and continuity of family policies and values • Distinction made between matters of day-to-day mgmt. and strategy • Allows strategic issues to be properly & objectively addressed • Nominate outside directors • To complement the family’s business skills with the fresh strategic perspectives • Infusion of new ideas due to a broader range of expertise • Ensure equal treatment between family and non-family executives

13. Why List? • Providing a main source of funding • Creating opportunities for the company to finance new investments • Expected future appreciation in the company’s share price and the value of the company • Helping the company to expand domestically and internationally • Sustainability of family owned business

14. Benefits associated with Growth Generated Through Retained Earnings • Maintain full control • Keep core values • Quick decision-making and ability to experiment • Keep balance between profit and commitment to quality and innovation • No restrictions on how to use capital

15. Disadvantages associated with growth generated through retained earnings • Limited access to finance • Slower growth • Absence of external discipline (strategic decision-making and oversight)

16. Benefits associated with growth generated through private equity • Strengthens capital structure • Fewer restrictions on how funds are used than public listing • No scheduled (fixed) repayment (dividends can be deferred and cash can be utilised to address business needs) • Enhances credibility with stakeholders • Introduces private equity culture • Strategic input into the direction of the business by investor • Access to a broader network of contacts • Increased financial management controls and reporting

17. Disadvantages associated with growth generated through private equity • Reduces family share ownership • Difficulty finding strategic investor • Need to identify exit mechanism for equity investor • No means of reversing the transaction • Pressure to produce a high ROI • Costs • More expensive than debt when successful • High cost of capital if company elects to re-purchase shares • More onerous management reporting requirements

18. Benefits associated with growth generated through a public listing • Capital structure • Allows company to pursue acquisitions and strategic growth alternatives • Facilitates access to other financial instruments (debt, preferred shares) • Ability to pursue long term investment strategies • Monetization options • Creates a tool for monetization of members’ equity interest over time • Help secure sustainability • Public equity culture • Fosters ownership culture with employees • Creates long term employee incentives • Visibility • Further raise the public profile of the firm • Enhance credibility with counterparties

19. Disadvantages associated with growth generated through a public listing • Reduces family share ownership • Legal & regulatory compliance • Initial and ongoing compliance with disclosure regimes can be a burden • Increased public scrutiny • Financial and organizational details disclosed to the public • Public reaction may contribute to stock price volatility • Public shareholder base • Public shareholder base requires time, attention and information • Risk of adversarial shareholder base • Potentially less say over operation of the business and strategic goals

20. A Roadmap for Smooth Progression Non Listed Listed 2 1 3 4 Formalize. Create Advisory Board Transition to Board of Directors Strengthen Disclosure & Control Environment Protect Rights of Shareholder & Stakeholders • Formalize the Advisory Board to be a real Board of Directors • Appoint a professional CEO • Define roles and set responsibilities • Form an audit committee, with non-executive members • Form an independent Audit Committee • Form Governance, Nominations and/or Remuneration Comm. • Develop, adopt, and publicly disclose a written corporate governance policy • Establish risk mgmt. internal control & audit • Strive for full compliance with Listing rules and regulations • Create a three to five-member transitional Advisory Board • Appoint a Corporate Secretary • Develop the company’s organic documents (by-laws and charter) Keep an eye on these rules and regulations from day 1

21. Specific Challenges for FOEs Need to distinguish family and company relationships • Dissensions between family members who are actively working and those who are not • Financial relationships Informality of governance policies • “Common” understandings not universally held or understood by outsider (or insiders!) Weakness of control environment • Founder is still is on top of everything … Managing growth: More complex with succeeding generation • Owner / manager equation shifts • Growing number of non-family managers require formal system • Incentivising non-family managers Succession • Who from the next generation is up for the challenge … do they have the same drive?

22. Challenges: Overlapping Roles andResponsibilities Familymember Manager Director Owner

23. Conclusions For the family-owned business, good governance makes all the difference. Family firms with effective governance practices are more likely to do strategic planning and to do succession planning. On average, they grow faster and live longer.

24. We must not be managers. We must be experts in corporate governance.* *Source: A fourth-generation family leader

25. A Self-Assessment and Client Orientation Tool LEVELS PROGRESSION ATTRIBUTES

26. Attribute 1: Commitment to Good Corporate Governance

27. Attribute 2: Structure and Functioning of the Board

28. Attribute 3: Transparence and Disclosure

29. Attribute 4: Control Environment & Processes C. CONTROL ENVIRONMENT AND PROCESSESS

30. Attribute 5: Shareholder Rights

31. Professor Chris Pierce • Global Governance Services Ltd. • chrispierce@ggs.uk.com • (+44) 1689 878399