Independent directors play an important role in helping family business boards transform into high performance boards. Indeed, one of the key benefits independent directors can bring to a board is a greater understanding of how outsiders view the company. Prof. Didier Cossin, Director of the Global Board Center at IMD, Switzerland, describes a 3-stage model of how independent board members progress towards promoting transparency, efficiency and innovation in family businesses and companies from emerging economies.
The recent increase in attention toward corporate governance is not surprising, given the prolonged economic crisis, rising social difficulties, dramatic increases in market volatility and high-profile corporate collapses. One approach, which has attracted considerable interest, involves looking toward ‘closely held’ business models to discover new best practices in governance and leadership. This strategy has significant merit. Family businesses are particularly compelling, since they have demonstrated an incredible ability to outperform widely held (i.e. traditional western exchange-traded) companies, by more than 150% over a 10-year period, according to studies. Yet, this performance is not fully reflected in the value of firms, which, curiously, often trades at a discount to fair market value. Even when family businesses are well-operated, outsiders typically do not value them appropriately.
As a result, many family businesses are at a significant disadvantage when additional capital is needed, and lack the social trust, which is becoming more and more important in recent years. One explanation for why outsiders seem to be biased against family owned businesses can be concern about the lack of transparency, failure to respond to the outside environment, or not enough innovation in either the business model, management skills or technology. A similar prejudice is felt by businesses from countries outside of the most dominant market economies. Combined, this provokes a situation wherein family-owned businesses based in rising economies, including the Middle East, still do not receive enough consideration from outsiders, even when business is booming, and companies have strong potential to enjoy continued growth into the future.
The main question is Why? Family businesses need to consider important follow-up questions, such as ‘how can good companies provide externally visible signals of legitimacy and good management practices?’ and ‘how can good companies distinguish themselves from local peers, which may be less worthy of consideration?’.
Family businesses from emerging economies can benefit greatly from looking to mainstream models, in order to understand exactly how to increase perceptions of legitimacy in the eyes of the public, of shareholders (notably extended family) and other stakeholders (notably government and society). Of course, major changes to address these problems directly – such as changing a firm‘s region, or overhauling the ownership structure of a company – are unrealistic. In fact, even if this were possible, these changes would be a big mistake.
Significant, and far less disruptive, changes can be made through focusing on improving firm governance. One of the current hot topics in research involves the role of independent directors, within businesses from Norway to China. Some progressive firms work hard to empower independent directors, even adjusting structural aspects of governance to help enhance the impact non-executive directors can have on the performance, capability to innovate, and risk management of a company. This could boost public confidence, sending a strong signal to the market through revising board processes and composition.
One of the primary roles an independent director is expected to serve, within a widely held company, is to reassure stakeholders that an impartial, objective presence is sitting in the ‘decision room’, possessing sufficient knowledge and expertise to intervene and question decisions that are excessively risky, overly focused on short-term gains, or aimed at benefitting management, instead of the long-run best interest of shareholders and general public. While this represents a response to a different kind of governance challenge, adding the right independent directors to a company‘s board can promote reassurance (of an equally important kind) for stakeholders of family businesses as well.
The important role of non-executive directors
Independent directors play an important role in helping boards transform into high performance teams. Indeed, one of the key benefits independent directors can bring to a board is a greater understanding of how outsiders view the company. In most businesses, there is a strong motivation to project a positive impression, yet inside board members may not have any idea of how to accomplish this feat. This is especially true within family businesses, where individual and company reputation are more closely linked. Here, independent board members can not only provide an external view of the company, but also first-hand knowledge of the innovative management and governance practices needed to increase collective knowledge, and activate the board and the company‘s true potential.
A second way independent directors represent a major asset, is their heightened ability to influence how outsiders view the firm. The mere presence of an independent person on a board of directors can build social trust and become a strong signal of legitimacy, with the independent director recognised as a public representative and advocate, able to address a wide range of public interests. Company boards with the right independent directors are perceived as more objective and fair both by society and stakeholders alike.
A third impact of highly effective independent directors is enabling a transformation of the business itself. Here, diversity is critical. A truly diverse board is comprised of people from different backgrounds, with a broad portfolio of views, enabling problems to be approached from multiple angles.
Typically, independent directors can then be pooled from other regions, other industries, and other environments including practical academics. Most importantly of all, a diverse board should have a broad range of thinking styles, in order to be as flexible and innovative as possible. Family businesses often reflect the opposite of diversity, since a common culture surrounds most members’ professional and personal lives. Here, independent directors can provide an interesting addition to the mixture, adding some spice to the soup.
How independent directors enhance board processes: a 3-stage model
The right kind of contributions from an independent director can help a family-owned business progress toward a more advanced and far more effective form of corporate governance. This evolution can be observed across three stages of development:
In the first stage, boards are still dominated by their controlling families. The primary problem at this stage is disconnection from the external world, which can lead to insufficient recognition of external threats. Another symptom is a lack of innovation, in terms of strategy, internal management practices, or technology. Success will be limited within these firms, as creativity is stifled, in favour of continuation along a predictable linear path.
The next stage in the evolution of a company‘s board is contrarian in nature, with freedom of expression rising noticeably. Reactions improve, allowing better responses to external events including: broad markets trends, actions of major competitors, and changing consumer tastes. A key benefit independent directors provide at this stage is new information, which can reduce the risk that small stakeholders and major competitors will know something that the board has not yet recognised. However, while this stage is an important step, there can be growing pains. Sometimes boards at this stage become dysfunctional, lacking common focus and the ability to engage in productive dialogue, which can hurt business development. It is not uncommon for this to be disruptive at first, before the new power has been fully harnessed.
Finally, after reaching the third stage, a board becomes more effective. It is at this stage that a board can look ahead, to become a co-creator of change with management, both inside the company and on an industry-wide basis. Not only do boards at this stage typically include several highly active independent directors, these organisations also have board processes to help empower these directors, and invite their positive influence to inspire innovative new ideas, improve access to new markets, and question activities to serve as an additional form of risk management. While the Middle East has seen substantial development in regulations as a driver of governance change, there are strong reasons why a business should proactively drive this change internally, and many rewards awaiting the ones that do.