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Are family businesses bad news?

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Dan Edwards
Dan Edwards
Dan Edwards has been with Alpha Southeast Asia since 2013 and edits both print and online versions of the magazine. He wrote the award-winning story ‘spotlight on unclarity’ soon as after joining Alpha Southeast Asia. He is based in Singapore. Disclosure: I have no direct investment holding in any stocks or bonds in Indonesia , and no plans to initiate any positions within the next 96 hours. The opinion expressed in this article is my own. I have no commercial relationship with any company cited on this website nor am I receiving any compensation from anyone except from Alpha Southeast Asia, controlling shareholder of www.www.whatinvestorswant.com

FAMILY-OWNED businesses – in which one or more members of a family have a significant ownership interest – are the norm in many parts of the world, but more so in Asia, where such an ownership structure extends to a large proportion of its listed companies as well.

Are family businesses bad news?

Such companies have their unique strengths and weaknesses: the owners might be very dedicated to the family enterprise, but their interests might not necessarily be aligned with the best interests of the company or its shareholders, if the company is a public one.

‘Family-owned companies can be well-governed, but the opposite is also true – and I’ve come across many companies who don’t understand the importance of good corporate governance,’ said Jamie Allen, secretary-general of the Asian Corporate Governance Association (ACGA).

Asia and Indonesia’s predilection for family-owned structures – as well as structures in which one entity, not necessarily a family, is the controlling shareholder – means a host of such concerns.

Janine Canham, head of Investment Legal, Fidelity International, explains: ‘The relevance of corporate governance is higher in Asia given the structure and complexity of family ownerships that dominate the corporate landscape in the region. Family-run or single-shareholder controlled groups facilitate related party transactions. The pitfalls of these transactions can often be a lack of transparency, conflicts of interest and a possible reduction in long-term returns to the investor.’

‘In some countries in Asia, there are often examples of overpayment for an acquisition of an asset from a company related to the chairman, or sale of an asset at an undervalue to a family member; without arms’ length valuations being confirmed or the consent of the minority shareholders being required,’ Ms Canham added.

Chaly Mah, president of CPA Australia’s Singapore Division and CEO of Deloitte Asia Pacific, says: ‘The family-owned business structure does have a greater presence in Asia, and it does impact governance standards. I’ve seen instances where board members, even the independent directors, are there because they are friends of the controlling shareholder.’

Rita Benoy Bushon, CEO of the Minority Shareholder Watchdog Group in Malaysia, shares her views of family-run businesses there. ‘Family-owned companies still account for some 40 per cent of Malaysia’s public listed companies. The competitiveness of family-owned companies lies in their entrepreneurial flair, creativity and innovation – and corporate governance practices must complement and enhance their internal controls to add value to strategic direction, transparency, accountability and thus shareholder value.’

‘Family-owned companies in Malaysia – for example, Berjaya Group, Lion Group, YTL Group – maintain control more by cross-holding structures through their family private companies. One of the major consequences of cross-holdings is that it can make it difficult for minority shareholders to remove directors. Minority shareholders will not have enough support to carry an ordinary resolution to remove directors or any corporate proposals not in the interest of minority shareholders,’ she adds.

Such concerns – of minority interests possibly being oppressed or disregarded in companies with a single controlling shareholder – can be addressed in two regards: if the country has a strong regulator and if the company has good independent directors.

‘You hear of fewer incidents of minorities being oppressed in family-run companies in developed markets, not because they have fewer family-run companies, but because they have better enforcement. The regulatory regime and the penalties handed out for such corporate malfeasance is greater in developed markets than in Asia,’ said Mr Allen.

‘It isn’t so much that developed markets have higher standards of corporate governance; it’s more a case of their regulators having greater political backing. Asia needs better regulators, and governments that support their regulators, to allow for more rigorous enforcement,’ he added.

Ms Canham said: ‘Governments and regulators in the region are mindful of these systemic risks and we are fully supportive of their efforts to further enhance current laws and regulations to help enhance the transparency and disclosure of companies in Asia. The key and first step for governance across the region is to have a regulatory framework in place that appropriately protects minority shareholders.’

And then there’s the issue of the company’s independent directors.

Associate Professor Mak Yuen Teen of the NUS Business School says: ‘In family-owned companies or companies with a single controlling shareholder, it means that these controlling shareholders basically own the independent directors. They can appoint or remove them almost at will. Our definition of independent directors does not help. The way directors are appointed, elected and removed needs to be addressed – but this will have to be through listing rules or law changes, not a code of best practice.’

David Smith, head of Asia corporate governance research at RiskMetrics Group, says: ‘The fact that a company is owned by a family or by the state, for example, has no bearing on the quality of corporate governance alone. Some of the best-governed companies in Asia are run by families, and some of the worst-governed companies in the UK and US have no major shareholder. However, where there is a major shareholder, there should be a very strong independent element on the board to counter this.’

Veteran investor Ang Hao Yao agrees that the role of the independent director becomes all the more important in family-owned companies or companies with a single controlling shareholder.

‘And, in order for minority shareholders to be better protected, the method of appointment of independent directors needs to be improved. Right now, most minority shareholders do not feel that independent directors are independent enough, as these directors generally do not have a large stake in the company and the major shareholders have the most say in their appointment and re-election. These two major points make it difficult for minority shareholders to feel that these independent directors have the moral authority to represent their interest.’

It’s a point that Mr Allen agrees with. ‘Every Asian market is more about form than substance when it comes to independent directors. A lot of the independent directors here, save for the ones who sit on the boards of banks, can be linked to the controlling shareholder in some way. There needs to be a stricter definition of independence. Investors want, and need, good independent directors who are truly looking after their interests.’

Mr Ang suggests possibilities to help manage the issue: ‘One is to require major shareholders to abstain from voting on independent directors. This enables the minority shareholders to vote on independent directors based solely on merit. Another is to allow minority shareholders to be able to block an election of an independent director with, say, a 10 per cent vote against. Yet another possibility is to appoint large minority shareholders as independent directors. Being a large shareholder independent of management and the major shareholder, this individual would have the moral authority to represent minority shareholders.’

Mr Smith echoes the sentiment: ‘When it comes to independent directors, some creative thinking may be required. A major shareholder acts as recruitment consultant, nominating committee, and swing vote all at once. Perhaps in such circumstances, large non-majority shareholders can form an ad hoc nominating committee to nominate independent directors? Excluding the major shareholder from voting would unfairly disenfranchise, but there would at least be a process of nomination that involved minority shareholders.’

Institutional investors, like Fidelity, can also play a large part in speaking up at company meetings to ensure that the interests of the minorities are safeguarded.

Ms Canham says: ‘At Fidelity (which manages US$210 billion in assets across Europe, UK and Asia) we expect high standards of corporate governance in those companies we invest in. We actively engage with regulators and with our investee companies to discuss governance concerns we may have. We use our shareholding and our relationship with company management as a positive influence on their governance standards, with our primary aim always to ensure we create and protect value for our fund holders.’

Mr Allen notes: ‘Institutional investors can act as a very good check and balance in companies with large controlling shareholders. And I think they can play an even bigger role in the region than they are now.’

Prof Mak agrees: ‘We need to hear from the local and regional institutional investors – the global ones are doing a fair bit. We need to put more pressure on institutional investors and fund managers to discharge their ‘trustee’ duty to their beneficiaries.’ Ms Benoy adds: ‘Institutional shareholders represent the bulk of the minority shareholders who are normally not represented on the board. They have the necessary clout in terms of voting rights to bring about: a) a greater balance on the board when it comes to the appointment of independent directors; b) greater scrutiny when it comes to corporate proposal and related party transactions, for the benefit of all minority shareholders.

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