The word governance originates from the Latin verb ‘gubernare’ meaning to steer. It relates to a framework of policies, laws, and procedures that govern – ensuring citizens, employees, and at times, family members, adhere to the rules of a body, society, or family.
Enterprising families are considered pioneers. They are the backbone of the global economy, making up over a third of the Fortune 500, and offering a blueprint for organizational success. They are often found to be steering financial markets and more commonly than not, sit at the wheel of their governance arrangements. But is family-member involvement in these governance mechanisms causing more harm than good?
Family firms have more at stake than any other. On top of financial capital sits a layer of noneconomic utilities that influence every decision taken by family and non-family members. This is referred to as socioemotional wealth and relates to family values, family legacy, and family relations which must be preserved above all else. This often leads owning families to adopt idiosyncratic forms of governance, characterized by concentrated ownership and the appointment of family members as firm leaders. It also includes distinctive norms, incentives, and authority structures that permeate the firm’s goals and operations. Consequentially, family-intensive governance arrangements are reflected in idiosyncratic behaviors and corporate strategies such as internationalization, acquisition propensity, innovation, entrepreneurial orientation, and risk attitude.
While much research has depicted the role of governance in the family enterprise ecosystem, little has been written about the impact of family-intensive governance arrangements on firm performance. Applying knowledge from a research paper I co-authored with Michele Pinelli and Francesco Debellis, I ask, should business families steer their governance arrangements or have them led by external professionals? And what impact does either scenario have on firm performance?
“They are also more likely to adopt a long-term view while professional managers adopt a short-term outlook due to their shorter tenure.”
Existing theory and empirical data on the matter are extremely conflicting. On one hand, a family-intensive governance arrangement is more likely to reduce conflict of interest between owners and managers, as family leaders with more authority are more likely to share and implement the family’s vision better than professional managers. They are also more likely to adopt a long-term view while professional managers adopt a short-term outlook due to their shorter tenure. This might include taking significant risks when the payout is immediate, and the downside is delayed.
In addition, a family member’s identification with the firm promotes the adoption of pro-organizational behaviors and greater commitment to the firm’s development, such as sales growth, reputation, and profitability. There is also a cost-saving element as families must establish costly monitors and sanctions mechanisms as well as incentive systems to ensure that professional managers make decisions that are aligned with their goals and interests. This cost can be avoided or, at worst, reduced when family members fill this position.
On the other hand, the paper argues that family-intensive governance arrangements can be detrimental to firm performance due to conflicts with non-family shareholders who may fear that family leaders will use their power to divert firm resources to family-centered goals and priorities, thereby harming profitability. Moreover, influential family leaders may harm firm performance by making economically suboptimal strategic decisions, such as foregoing positive net present value opportunities that threaten the family’s socioemotional wealth.
In addition, altruism and paternalism may lead powerful family leaders to reward other family members or long-time employees, regardless of their competence or expertise. They might also give them excessive responsibility which could jeopardize the firm’s economic performance.
For instance, family enterprises with structured human capital plans can avoid granting power to family members in the absence of skillset or expertise.
While the negatives associated with family-intensive governance arrangements need to be carefully considered by owning families, our research touches on several ways to mitigate these risks.
For instance, family enterprises with structured human capital plans can avoid granting power to family members in the absence of skillset or expertise. It can also ensure that compensation is aligned with the long-term objectives of the family and structured in a way that incentivizes performance, values-based leading, and longevity. When hiring external managers, families can also ensure long-term incentive plans avoid the inclusion of stock options so as not to dilute family ownership.
One might argue that decisions taken with socioemotional wealth in mind should outweigh economic consequences as retaining the family and family legacy is paramount, and predominate to preserving financial capital. However, it must also be stated that the two do not need to work exclusively when financial decisions are made with family values in mind, ensuring every investment or economic decision is aligned with the values and objectives of the family.
Another factor that appears to mediate these risks is the long-term orientated culture of the country which houses the family structure.
Long-term orientation refers to how a society reconciles challenges while retaining links to its past. Long-term-orientated countries are thought to exhibit a future-orientated perspective, boast an ability to be dynamic and adapt to changing parameters, and carry the values of persistence, perseverance, and thrift. While family-intensive governance arrangements are most likely to be present in long-term-oriented cultures, their negative impact is weakened in societies with higher levels of institutional trust.
On the contrary, in regions where a strong family culture prevents business families from relegating less competent family members to marginal hierarchical positions, more family-intensive governance arrangements tend to hurt firm performance. This can be found in new family enterprise ecosystems such as Singapore which place talent restrictions on migrating family members and govern that a number of non-family professionals must be employed before being established. In turn, families can overcompensate by playing too much of a dominant role within the governance function.
The paper also finds a correlating link between these arrangements and poor performance, something we believe can be mediated and when done so correctly, even advantageous.
Through the lens of institutional economics, our research calls for the greater relative efficiency of family-intensive governance arrangements, particularly in long-term-orientated cultures.
The empirical results show that the long-term orientation of culture increases the likelihood of adopting more family-intensive governance arrangements, which is attributed to the lower costs of extracting private benefits from the firm, tensions between family owners and professional managers, paternalistic human resource management practices, and legitimacy costs. The paper also finds a correlating link between these arrangements and poor performance, something we believe can be mediated and when done so correctly, even advantageous.
When structured correctly, with risks considered and mitigated, the presence of family-led governance arrangements can reduce governance costs and lead to more positive financial outcomes. They equate to greater control, fewer private benefits being extracted from the firm, fewer resources diverted as well as more value and profitability. Owning families can also lower organizational tensions between the family and governing bodies, preserving organizational functionality but also reducing the need for monitoring systems, contributing positively to the firm’s value and performance.
Family-intensive governance arrangements can be costly, but the cost of not having them is far greater.
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