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Family Businesses Need to Professionalize Governance Mechanisms

Family Businesses Need to Professionalize Governance Mechanisms

Based on the research of Kavil Ramachandran, Shefali Joshi and Navneet Bhatnagar

Family businesses are the oldest and the most common organizational form of business. They make a significant contribution to the global economy. They are ubiquitous and are found in various sizes that range from a small business to a large multinational corporation. Across the globe, family businesses have been known to have outperformed non-family firms. Most family businesses begin at a small scale with family members in managerial roles. The unique skills and traditional knowledge of family members contribute to the family firm’s resource bundle, called ‘familiness’ that gives it a distinct competitive advantage. However, family firms find it extremely challenging to maintain this advantage across generations. Most of them fail to survive beyond three generations due to the lack of adequate mechanisms to manage complex operations, governance and inter-generational leadership transitions.

Understanding the need for professionalization of family businesses

Typically at inception, most family businesses start off as an extension of the family itself. In most cases, family members are integrally involved in strategic and day-to-day operations of the business. However, as the firm grows in size, the separation of family and business becomes more pronounced. The need for business systems and processes, regulation of family members’ emotions, and creating a separate identity for the business begins to assume greater importance. With the growth and evolution of both the family business and the family, the immense need for professionalization of the family business becomes more and more patent. Often, professionalization of a family firm is believed to be limited to streamlining systems and procedures for operational management activities that only involve coordination of work assigned to non-family employees.

What is amiss in professionalized family businesses?

Kavil Ramachandran, Clinical Professor and Executive Director of the Thomas Schmidheiny Centre for Family Enterprise at the Indian School of Business, and co-authors, Shefali Joshi and Navneet Bhatnagar, point out “Family business professionalization cannot be narrow to only include managerial and operational functions; the scope of professionalization must be enlarged to include governance aspects that were previously ignored”.

Professionalization efforts by family firms have traditionally focused on improving the operational aspects of business. However, in their article titled “Emerging Paradigms of Corporate Governance and Managerial Professionalization in Family Firms” Ramachandran, Joshi and Bhatnagar underscore the need for family firms to progress towards professionalization of governance. Professionalizing family business governance that involves a ‘divorce of ownership and management’ is key to the long-term survival of family businesses, the authors say.

Towards a greater understanding of “Professionalized family business governance”

In their article, Ramachandran, Joshi and Bhatnagar enumerate the key aspects pertaining to the effective professionalization of family businesses. The authors explain that with growing family businesses and complex operational tasks, overwhelmed family members retain strategic decision-making power while delegating operational tasks to non-family executives. At this stage, corporate and board level governance seldom exists —with the board of directors consisting only of family members. With time and growth of the business, the family tree of operating and managing owners becomes fragmented. With the increase of fragmented ownership, diluted stakeholder interests, and strenuous emotional bonding among family members, all strategic decision-making will be undertaken by members of the same family regardless of whether they are active in management or not. In the interest of growing and sustaining the family business, the authors contend that there can be no escape from professionalizing governance that offers umpteen benefits such as enhanced social interaction among family members, development of a shared vision, and improved quality of strategic and objective decisions.

Enumerating what professionalization of a board entails, Ramachandran, Joshi and Bhatnagar point out the following:

  • A professionalized board constitutes an active board of directors with independent directors overseeing executive decisions while safeguarding stakeholder interests. The board strives to working ethically, making the executive accountable to the board, and upholding the interests of the minority stakeholders.
  • Professionalized boards are compact in size. They include a considerable number of independent directors with industry knowledge and expertise; directors harbor no conflict of interest.
  • Professionalized boards are characterized by well-defined norms, codes of conduct, and clear guidelines for board meetings.
  • Professionalized board governance fosters desirable changes in attitude and organizational culture that immensely bolsters the family firm.

Challenges to the professionalization of governance

Professionalization of family firms is no easy feat. Governance professionalization can become a reality, if and only if, family business leaders let go of managerial control in the business. A separation of ownership and management is absolutely essential for governance professionalization to become a reality. Letting go of managerial control may not be easy for family members who might perceive it as a loss of control. Additionally, lack of trust in non-family professionals can further compound governance issues. Members of family run firms generally have a sense of ‘possessive attachment’ and do not brook any interference from outsiders. Thus, maintaining objectivity, consistency in following procedures, transparency, and accountability of executive decisions is hampered by members’ emotional attachment. Ultimately, it is the professionalization of governance that gets smothered.

Approaches to professionalization of governance:

Ramachandran, Joshi and Bhatnagar offer two distinct approaches to the professionalization of governance to enable family members’ detachment from business: 1. Oversight approach 2. Participative approach

Oversight approach

The oversight approach involves family members’ total withdrawal from regular business operations. Family members focus on strategy and governance matters at the board level, while non-family professionals take care of managerial functions. The family members don their ownership hat and occupy board level positions and formulate best governing practices. They are also involved in strategizing, guiding and mentoring the chief executive. Citing the adoption of oversight approach by Dabur, a multi-generational family business in India, the authors illustrate how Dabur’s family members were able to take an independent, unbiased and objective position to improve corporate governance issues in addition to substantially improving family governance initiatives. Dabur’s case undoubtedly showed that family governance cements corporate governance. Family members’ total detachment from day-to-day operations and its beneficial effects on the wellbeing of the business was explained using the case of Merck, a German family business. The total detachment of Merck’s family members from operational activities led to their active involvement in long-term business strategies and corporate governance professionalization that positively bolstered wellbeing of the family and the business at large.

Participative approach

In this approach, family members are not totally detached from operations management. They continue to remain in control of business while taking up more strategic governance roles and establishing clear norms for business management. Most of the operational and management tasks are handled by expert non-family professionals. Ramachandran, Joshi and Bhatnagar point out that this approach allows family members to be emotionally detached from operations, while allowing them to pursue their passion of steering the business in the desired direction. Using the example of GMR group, the authors illustrate how GMR group with relatively young family members reassigned roles based on capacity-job fit to ensure that family members with innate capabilities were assigned roles where they could be most productive. The case of Sudarshan chemicals, also with relatively young family members, demonstrated how assigning operational tasks and managerial roles to non-family executives allowed members of Sudarshan chemicals to focus and involve in the strategic directions of the business that fostered an efficient environment of shared responsibility.

Emotional detachment from business operations is key

Family businesses focused on providing strategic direction to the company can follow either the oversight or the participative approach. Specifically, businesses that are in the growth stage of their life cycle use participative approach that enables passionate family members to be efficiently involved in operational activities. Ramachandran, Joshi and Bhatnagar contend that emotional detachment from operational management and a deeper understanding of professionalized governance will ensure good corporate governance that will go a long way in ensuring the growth, sustenance and longevity of family businesses.

About the Researchers:

Kavil Ramachandran is Clinical Professor and Executive Director of the Thomas Schmidheiny Centre for Family Enterprise at the Indian School of Business, Hyderabad.

Shefali Joshi is an ISB-PGP alumni and worked as a Research Associate at the Thomas Schmidheiny Centre for Family Enterprise at the Indian School of Business, Hyderabad.

Navneet Bhatnagar is Research Associate at the Thomas Schmidheiny Centre for Family Enterprise at the Indian School of Business, Hyderabad.

About the Research:
Ramachandran, K., Joshi, S., & Bhatnagar, N. (2016). 11. Emerging paradigms of corporate governance and managerial professionalization in family firms. Handbook of Contemporary Research on Emerging Markets, 251.

About the Writer:
Catherine Xavier is a writer with the Centre for Learning and Management Practice at the Indian School of Business.

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