In this article, Aastha Maharesh pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, elaborates on issues of Corporate Governance in Family Owned Companies.

Corporate Governance in a Family Owned Companies

Corporate governance is a form of governance applied to business setups or organizations and as such, could include within its ambit all the rules, norms, procedures that operate, regulate and control businesses. The responsibility of governing a business falls upon the management – its Board of Directors, Auditors, Shareholders and any other stakeholder to help the corporate structure achieve its goals with transparency and accountability. The management can take up this responsibility by incorporating provisions to that effect in the key documents governing the company such as the Memorandum and Articles of Association and Investment Agreements. This is important in order to ensure that the investors, employees, and customers don’t lose their confidence in the business and the business runs smoothly.

On looking into the reasons for corporate failures and frauds in a number of large businesses in India, a number of steps have been taken by the Confederation of Indian Industry, Securities and Exchange Board of India, other regulators and even the Ministry of Corporate Affairs to identify, recommend and issue guidelines to ensure quality governance in corporate setups.

Certain provisions of Corporate Governance in a Family Owned Companies have been actively statutorily incorporated in the Companies Act, 2013 such as:

• Independent Directors and Women Directors: To build up the transparency and accountability of the Board of Directors, the Act now requires at least 1/3^rd of the total directors of a listed company to be Independent Directors and have no material or pecuniary relationship with the company or related persons. Public companies with paid up share capital exceeding Rs. 10 Crores or turnover exceeding Rs. 100 crore are statutorily required to have at least 2 directors as Independent Directors.

To ensure diversity on the board, all listed companies and non-listed companies having paid up share capital more than Rs. 100 Crores and turnover exceeding Rs. 100 Crores are required to have at least one woman director on the board.

• Corporate Social Responsibility: Every company having net worth of Rs. 500 Crores or more, turnover exceeding Rs. 1000 Crores or net profit of more than Rs. 5 Crore is required to constitute a Corporate Social Responsibility Committee under Section 135 of the Companies Act, 2013 constituting 3 or more directors with at least 1 Independent Director to formulate policies and recommend activities that the company may undertake for promotion of education, gender equality, health, poverty eradication, environment, employment etc. Again, this measure puts responsibility on the company for the social wellbeing not just of its workforce, but also makes it publicly accountable.
• Audit Committee: The Act provides for the setting up of an Audit Committee comprising of at least 3 directors by all listed companies, majority of which have to be independent directors. The members of such a committee have to be persons who can read and understand financial statements and the task entrusted to such a committee is recommending remuneration and appointments of auditors and reviewing their independence.
• Nomination and Remuneration Committee: The Nomination and Remuneration committee shall comprise of 3 or more non-executive directors out of which at least half shall be Independent Directors. Such committee shall identify persons qualified to become directors of the company and make recommendations to the board of directors regarding their appointment and approval.
• Serious Fraud Investigation Office: Section 211 of the Act provides for the establishment of a Serious Fraud Investigation Office to look into the affairs of the company and investigate incidences of fraud upon receipt of report of the Registrar or inspector or generally in the public interest or request from any Department of Central or State Government.

Governance measures in private companies are a lot more flexible

The level of strictness of norms in case of public listed companies is usually much higher than in case of private unlisted companies. The Securities and Exchange Board of India (SEBI) has issued certain norms on corporate governance that are binding on all listed companies.

Need for Corporate Governance in a Family Owned Companies

Families need governance just as much as any other structure involving multiple persons with their varied, often competing, interests. Family businesses constitute a major chunk of business in India and cannot be put on the back seat. Their contribution to the country’s economy is immense and if they are not disciplined and properly governed, it inevitably affects the national economy. Strong governance measures in a family owned business can effectively act as a prevention mechanism against a lot of tensions that may arise between family members at a later stage. It is also imperative for family businesses to adopt effective corporate governance measures in order to be a tough competition to other players in the global market.

The most glaring characteristic of a family owned business is that all the key managerial positions in such businesses are held by family members. Non-family members may of course be employees of the company, but the decision-making power usually vests with the members of the family. This is probably the reason why a lot of family businesses are not pro-active in taking strict corporate governance measures in their activities – out of fear of losing control over the business. These businesses derive their strength from the love, trust and personal bond that the members share, but at the same time, even slight instability or rivalry in the family could adversely affect the business and project a negative picture of the family firm in the market before prospective investors.

MAJOR CHALLENGES FACED BY FAMILY OWNED COMPANIES

• Investors are often hesitant and distrustful of the company due to chances of the controlling family abusing rights of other shareholders. Therefore, governance measures need to be such that provide reassurance to the investors that their interests will not be diluted in the larger scheme of things.
• Concentrated & restricted ownership – there is always the risk of nepotism and favoritism in a family business.
• Maintaining harmony and establishing a good business relationship between the family and non-family members of the business can often be a very challenging prospect.
• Family businesses are driven more by emotion than by professional ethics.
• Incapacity of the head of the family to run the business or a change in generations – real problems arise when a clear succession strategy is not chalked out. Conflicts arise over the control of the company leading to a trust deficit. As the generations progress, their interests may no longer align and internal competition among family members may heighten and become hostile.

CORPORATE GOVERNANCE MEASURES FOR FAMILY BUSINESSES

Family owned companies are expected to more or less adhere to the same corporate governance measures for their business as any other business. The same principles and practices that apply to any other business are essential for the successful run of a family business as well. Some of these measures include compliance with the Accounting Standards in the preparation of financial statements by a company and its auditors, financial reporting as a measure of transparency and accountability – providing essential financial information about the company to all its shareholders and other stakeholders, regular board meetings and appointment of independent directors along with other directors for an accountable and transparent board of directors, whistleblower policies, etc.

However, there are some measures that family businesses particularly need to lay extra focus on so that they may be successful in the long run:

• Clear demarcation between business and emotions: This is essential for the smooth continuity of the business. This responsibility that entails communicating every member’s clear cut roles to them lies upon the shoulders of the head of the family as at the end of the day, the business should be about competing at a global level with other businesses and not internal clashes among members of the same company.
• Clarity on leadership: There needs to be a clear strategy on choosing the next-of-kin to pass the baton to after the death or incapacity of the previous leader. If there is no such strategy in place, it could lead to confusion and chaos, causing a hit to the roots of the business.
• Democracy – a participative decision making and democratically appointed board of directors is key to a flourishing and disciplined business practice. More so in case of family businesses, since they are ridden with the tendency of nepotism and favoritism.

CONCLUSION

Therefore, corporate governance in any business is the buzz word that attracts investors to invest in it. An outsider to the company would never want to risk his money in a firm that clearly indicates poor governance. Family businesses are no different. In fact, by virtue of being wound up tight due to common lineage, interests, blood and family traditions, family businesses likely need a tighter grip on the proper governance of the business than other non-family businesses to shine in the global market. Family businesses should thereby not shy away from adopting the above-mentioned techniques and preventing any possible damage to the business.

References

Books:

• Avatar Singh on Companies Act, 2013
• SEBI Manual by Taxmann

Other readings:

• https://www.oecd.org/daf/ca/corporategovernanceprinciples/43654301.pdf