Family Businesses: Risk and Governance Issues

THE RISK WATCH COLUMN: By Dr Alan Waring

Guiding Principles

Good corporate governance aims to protect the interests of shareholders and other stakeholders. National corporate governance codes seek to:

Strengthen the supervisory role of the Board of Directors
Protect the interests of minority shareholders
Ensure transparency and prompt information to board members and others
Selection, appointment and remuneration of both executive and non-executive directors
Safeguard the balance and independence of the board by appointing independent and experienced non-executive directors as a check-and-balance on executive directors
Ensure a comprehensive and effective system of internal controls to manage the significant risks to which the enterprise may be exposed
Ensure that appropriate appraisals, audits, reviews and routine monitoring of internal controls take place at least annually.

Voluntary Codes

Many codes have sections that are voluntary and therefore rely on the integrity and willingness of the particular Board to ensure compliance. For example, codes that recommend a voluntary separation of CEO and chairman role-holders may result in family-owned or controlled businesses ignoring the recommendation so as to retain a dominant position. Others may choose to retain a single person because they genuinely believe that person to be the best available choice. Some have argued in relation to the issue of single joint CEO/chairmen that there is no implicit cause-effect relationship between separate post holders and company performance. However, debilitating conflicts and power struggles involving questionable decisions and possibly reputation damage and financial impact are far more likely where one individual holds too much power.

Family Business Case Studies

Frou-Frou Biscuits (Cyprus – EU)

Alkis Hajikyriakou (Frou-Frou) Biscuits Public Co Ltd is a major food manufacturer in the Republic of Cyprus. The company is listed on the Cyprus Stock Exchange (CSE) Alternative Market and is therefore subject to the Cyprus Corporate Governance Code, which is voluntary for this market. Section A.2.4 of the latter requires a clear division of responsibility between the roles of CEO and chairman. Further, if the two posts are not separated, the Code requires that a justification should be given in part 2 of the Boardâ€™s annual report to shareholders.

The companyâ€™s major shareholder is the joint CEO and Executive Chairman, Mr Alkis Hajikyriakou, who is reported to hold 52% of the share capital. The second main shareholder is the Executive Vice-Chairman his sister Elena (Nora) Dikaiou with 17%.

The Vice-Chairman had been seeking to get the Board to adopt the Code and demonstrate transparency and accountability to shareholders but apparently met resistance from the CEO and Executive Chairman. In response to her attempt to get the topic on the AGM agenda, she reportedly alleges that her brother then sacked her. The companyâ€™s annual report for 2006 apparently cites ten reasons to justify not adopting the Code. In a scathing critique of the Frou-Frou CEO/Chairmanâ€™s actions, Michael Olympios a leading business consultant states (Financial Mirror) that â€˜these explanations not only lack substance but in reality are almost an exact copy of other family firms in the CSE, revealing that this is a symptom of a wider problem of family firmsâ€™. He notes that despite corporate reforms many family firms that are now publicly listed are unable to accept that public companies are accountable to the public. Having executives report to themselves at the Board and without robust independent NEDs is â€˜like having students grading their own exam papersâ€™.

The Institute of Directors of Cyprus has now weighed into the Frou-Frou battle by publicly demanding in June 2007 that the CSE and SEC should make the Corporate Governance Code mandatory for companies listed on the Alternative Market as it is already for the Main Market.

Heavenly Homes (Cyprus – EU)

Heavenly Homes (not its real name) began in the 1990s as a small house-builder, typically with small projects of up to six houses at a time. Owned by the Papacostas brothers (not their real name), the company developed a good reputation within Cyprus for quality and price.

Around 2000 Cyprus started to enjoy a new residential property boom, centred primarily on the growing holiday homes and ex-pat relocation market, some 75% of which involve buyers from Britain. The Papacostas brothers saw the opportunity to grow Heavenly Homes exponentially by building series of apartment blocks, typically 3-6 blocks with 15-30 units per block, in up-and-coming villages in tourist areas. Alongside the apartments, they planned for detached houses, typically 50 per site. Large areas of land were bought, licenses obtained and plans drawn up. As marketing accelerated, many people bought off-plan at a discount. Delivery times were typically quoted as 18 months. The expansion plan got underway.

By 2005, Heavenly Homes had at least six major sites at various stages of build and with further projects planned. However, from 2002 onwards there were growing customer complaints about major defects, poor quality, (very) late delivery and reluctance to close-out snagging lists and deal with complaints. Heavenly Homes soon acquired the tag â€˜Hellish Homesâ€™ among dissatisfied buyers. George Papacostas, the CEO and Chairman, candidly admitted in 2005 that the company had suffered huge damage to its reputation that would take a long time to recover. Nevertheless, major new capital projects including properties at golf complexes are in hand that will dwarf the companyâ€™s previous experience. As one of the largest privately owned land developers in Cyprus, Heavenly Homes may well apply for CSE listing despite their continuing problems.

The root cause of the companyâ€™s problem lies in a combination of greed fuelled by the property boom, the inexperience of the owners in running major capital projects, their lack of knowledge of basic management methods, their tendency to cut corners and their unwillingness to buy-in the necessary expertise. The board of directors lacks both numbers and expertise, including strong independent NEDs. The lack of professionalism coupled with a fear of accepting new expertise and a reluctance to let go typifies many family-run businesses of all sizes in Cyprus and many other countries.

The Cyprus property boom has slowed down sharply over the past 18 months, with over-supply, over-pricing and under-demand. Whereas in 2004 properties were snapped up off-plan, now many built properties remain unsold after more than 12 months. Despite all the warning signs, many developers (Heavenly Homes included) continue to gamble on an upturn and continue to build relentlessly. If the property bubble bursts, their survivability is in doubt.

Asian Conglomerate

The Triple A Asia Group (not its real name) is a privately owned conglomerate employing over 10,000 people across Asia in activities including finance, insurance, manufacturing and distribution. It has a solid reputation and, in some areas, it is the market leader. It has been operating for approximately 100 years.

Although family-owned, Triple A Asia took the decision some 20 years ago to recruit professional managers, specialists and technocrats to ensure that all the existing businesses had the necessary skill resources to adapt and grow in the global marketplace. Further, long-term strategic planning ensures that new businesses are started that will become significant revenue generators in the years to come. A considerable amount of time, effort and money is invested in selecting the best human resources.

The various Group company boards are required to show transparency and accountability and appoint Independent Non-Executive Directors. This policy is regarded as a necessary part of protecting the interests of all shareholders and stakeholders. Protection of corporate reputation is regarded as an imperative. This policy position presages a recent study (Shea 2006) of the Hong Kong family firm Hutchison Whampoa Limited which concurs with previous studies that good practice in corporate governance and social responsibility is not an optional extra for any family firm wishing to put themselves at a competitive advantage both inside and outside Asia.

Key Issues

From the foregoing, key issues for success in protection of shareholder and stakeholderÂ interests, and especially for family-controlled businesses, appear to be:

Whether relevant CG Codes are mandatory or voluntary
Whether CG Codes are strict or laisser-faire
Whether CG Codes are comprehensive or narrow
CEO/chairman split and how this affects Board decision-making
Knowledge, experience, quality, integrity and risk appetite/aversion of Board directors
Independence and authority of INEDs and ED/INED balance
Ownership structure, including significant institutional investors
Boardroom culture and power relations

Conclusions

All publicly listed businesses need to consider the benefits to corporate reputation, brand, shareholder protection and public confidence from implementing corporate governance codes and the damage that may result from ignoring them. A robust approach to long-term implementation may require firms to buy in expertise they lack. It is especially important for family businesses to address the issue of CEO/chairman split with common sense.

Dr Alan Waring, is a risk management consultant and is Adjunct Professor at the Centre for Corporate Governance & Financial Policy, Hong Kong Baptist University School of Business. This article is abridged from his paper at the 2^nd Asia-Pacific Corporate Governance Conference, 23-24 August 2007.

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