Family and business dynamics: the relationship between family governance and business governance

In most countries across the world, family businesses employ more than 60% of the workforce and contribute in excess of 70% to the respective nation’s gross domestic product. They constitute the economic backbone in both old and new economic regions.

However, only a small number of family businesses survive the third generation after being established. Two-thirds of all family-owned companies are liquidated by their founders or sold, while fewer than 15% are still run by a family member in the third generation (see the IFC/World Bank publication IFC Family Business Governance Handbook (2018) for more information on this).

Following the publication of studies conducted by INSEAD on the Institutionalization of Family Firms in Asia-Pacific and the Middle East (2017) as well as Latin America (2019), we are taking this opportunity to discuss some of the underlying reasons for family companies’ failure and to demonstrate how closely family and business governance are actually intertwined.

The studies by INSEAD make a distinction between what they refer to as ascendants and champions. Ascendants comprise family businesses that are no more than three generations old, while the champions are already in their fourth generation or later. The INSEAD authors set out the following reasons for the failure of family-run firms in the first three generations:

• Lack of succession planning and arrangements – this aspect is the most frequent reason for family businesses going under. Many business founders refuse – either implicitly or explicitly – to put succession arrangements in place or to allow any discussion whatsoever within the family of this emotionally charged issue. Differences in priorities, values and experience between the founding and subsequent generations are not discussed. Successors from within the family are installed by the business founder without these individuals having the necessary qualifications or backing from within the family and the firm.
• Inadequate promotion of talent – it is frequently the case that the second generation does not bring forth any personalities who could take over the running of the family business. Alternatively, there may be no programmes in place to identify and foster talent within the family from an early age. At the same time, family businesses may not be able to attract highly qualified external talent as these individuals consider the career opportunities, options for participation and compensation to be too limited.
• Lack of leadership and governance – companies run by their founders often lack institutionalised management layers and functions. Seats on the board of directors or management positions are filled by individuals who simply nod through decisions made by the business founder. A seat on the board is often seen as a family birthright regardless of the person’s qualifications.
• Weak decision-making mechanisms – at companies run by their founders, decisions are often taken by the founders themselves or are subject to their approval. In addition, the family’s financial interests may come before the company’s commercial interests, negatively impacting the firm’s attempts to build up capital over the long term. This aspect is exacerbated over the course of the generations as the number of family members wishing to share in the success of the business grows.

The INSEAD studies recommend addressing the four shortcomings outlined above via a better long-term, sustainable organisation both within the family and between the family and the business. They encapsulate this in the term «institutionalisation», differentiating between six areas of action:

The action areas with a green background relate to family governance issues; the fields in blue refer to corporate governance considerations. Both family and corporate governance have to be developed and put into practice together. In particular, in the absence of long-term family governance it is almost impossible for family businesses to establish and implement stable corporate governance.

Conclusion: the INSEAD authors examined a total of 254 family businesses across the respective global regions in producing these studies. The results demonstrate that for a family firm to survive beyond the third generation, the family has to take a long-term approach to planning its internal structures via family governance and, at the same time, professionalise the leadership and organisation of the company by means of corporate governance. The figures show that champions, i.e. successful family businesses that are in the hands of the fourth or subsequent generations, have done their homework when it comes to these considerations.

Dr. Christian Rockstroh, Partner
christian.rockstroh@swisspartners.com

14 October 2019