By Suresh Vaidhyanathan
A well-conceived corporate governance plan for family businesses can help them sustain the business viability over generations, says Suresh Vaidhyanathan
The harrowing stories of corporate failures and scandals over the last decade made corporate governance a raging topic all over the world. The regulators worked overtime to stipulate a raft of reactive legislations in the US and elsewhere, seeking to achieve better accountability and transparency in corporate affairs.
The corporate world is highly dynamic as the business considerations change dramatically driven by regional and global economics. Whilst there is no one universal prescription for better corporate governance, the West seems to have restored a decent level of the public confidence in the regulatory authorities, corporates, rating agencies and financial institutions.
The implementation of rigorous regulations and complex procedures followed the advent of the global recession that was a rude wake-up call for most boards around the world. Boards and executives were made more accountable than ever. Executive remuneration and bonus packages were put to severe scrutiny by activist shareholders and regulators. Companies closed down or were taken over. Governments bailed out banks with taxpayers’ money and thereafter subject them to onerous supervision.
Corporate governance in the region
The MENA region has been a late starter in the governance game — the need for best practices in corporate governance was perhaps not seen as a major priority by the predominantly family-owned business houses, shrouded in a typical lack of transparency. Foreign investors and financial institutions had to contend with incomplete financial reporting and absence of comprehensive insight into the business, in a region where “name lending” has been an accepted financing model for decades.
The regional capital markets suffer from a lack of critical mass in listings and investments, and at certain times from unpredictable inflows and outflows of capital. International funds and investors are unable to tick all their boxes to engage in any material long-haul investment exercise in the region. Again the reasons cited are transparency, regulations, reporting, board practices, protection of shareholders rights... the list goes on.
Dominance of family businesses
There is no doubt that family businesses in the region have built a solid foundation for economic growth and prosperity. Family patriarchs dedicated their lives to build substantial conglomerates, navigating new business areas and building teams based on trust and loyalty. They built a robust private sector, on the back of their rulers’ vision and initiatives. However, there are some structural changes in the business scenario that are impacting their long-term sustainability.
As the world gets smaller with technology and easier market access, there is increasing competition from international players. Secondly, the next generation is often not inclined and sometimes incapable of running affairs with the same vigour as the patriarch. The next generation represent an exponential multiple of stakeholders with diverse capabilities and expectations, making it complex for the business to be directed in unison.
A well conceived and implemented corporate governance plan for family businesses can indeed help them sustain the business viability over generations, whilst reinforcing the family values instilled by the patriarch they undeniably respect. Global statistics point to a dramatic fact — 70 percent of family-owned businesses do not survive into their third generation. The region should actively seek to buck this phenomenon and thrive for the long term.
Awareness and regulations
Thankfully, the region is making progress in establishing the importance of good corporate governance as a value proposition to family businesses. Recent regulations by governments has also emphasised the need for better-regulated corporates and banks.
In the UAE, The Commercial Companies Law No 02, 2015 was issued by His Highness Sheikh Khalifa Bin Zayed Al Nahyan, The President of the UAE and Ruler of Abu Dhabi. Significantly, the new law will stipulate standards expected from listed companies and banks in the area of corporate governance, moving the country more towards international standards. Amongst other things, there are expectations that the law will govern transactions between the company and its directors. As a consultative process was followed, one can expect a comprehensive framework to be articulated in the detailed provisions of the law.
Encouraged by the stipulation that a minimum of only 30 percent (earlier 55 percent) of equity can be floated on the capital markets, several companies may be forced to consider improving their governance standards in a bid to raise new equity.
In Saudi Arabia, where corporate governance standards are relatively higher, efforts seem to be on to intensify compliance as preparation for the onset of FDI into the markets. The Capital Market Authority has been severe on defaulting companies, charging hefty fines and administering suspensions to ensure compliance, strengthened controls and improved transparency. As a result, listed corporates and banks are exercising more diligence in managing their affairs.
Seeking to help the region develop rapidly from its relative infancy, the Hawkamah Institute for Corporate Governance was set up in 2006 in Dubai. The Institute was founded in partnership with international organisations including the OECD, the IFC, and the World Bank GCGF, and regional organisations including the Union of Arab Banks and the Dubai International Financial Centre Authority.
Hawkamah has published the ESG index, which measures the environmental, social and governance (ESG) attributes of publicly traded companies in the MENA region.
The report says: “The region is also generally overlooked by global long-term investors largely because of the region’s poor track record in transparency, disclosure and reporting”. It further says: “the benefits of good corporate governance have been typically seen by companies in terms of better strategic decision-making and regulatory compliance rather than being associated with better and cheaper access to credit and capital or improved valuation of companies.”
Areas for improvement highlighted in the region include reporting on related party transactions, conflicts of interest, information asymmetry, and the need for independent non-executive directors, board composition and evaluation amongst other things.
The ESG index is indeed a laudable initiative, providing a broad assessment matrix to potential investors and at the same time potentially encouraging the indexed companies to perform better.
One key area of concern is the inclusion of truly independent directors in company boards. An independent director should not have any other relationship with the company and is tasked with a duty to provide unbiased and independent contribution to the board. However, boards in the region have inadequate representation from independent directors. There is also a shortage of qualified and competent independent directors — in this context, organisations like the Mudara Institute of Directors, Dubai run director development programmes to train and certify professionals to act as competent board directors.
Corporate governance priorities
Elsewhere in the Western world, the high priority areas in corporate governance hover around enhancing diversity by gender, age, education and background. The imperative need for diversity at the board level has never been so prominent, with companies aspiring to increase their percentage of women in their boards. Companies have started to realise the benefits of having a diverse board and its resultant contribution to company performance.
The MENA region is also coming to the realisation that most boards are male-dominated. Now with a conscious initiative women are being slowly inducted into boardrooms, and it seems a definitive trend for gender diversity is emerging.
Furthermore, there is a massive push towards better awareness at the board level in the specialised areas of technology and cyber security. In today’s world, companies that operate in a highly technology oriented environment like banking, retail, logistics and others, are threatened with imminent possibilities of interruptions and organised cyber attacks. Boards are therefore required to ensure that the systems are well structured and risks are proactively managed.
In conclusion, the benefits of sound corporate governance in companies far outweigh the associated costs in the long run. Shareholders, board members, regulators and other stakeholders in MENA should keep the momentum going in order to ensure long term sustainability of businesses, robust regulatory framework, healthy capital markets, attraction of FDI and fruition of other key benefits.
A judicious complement of regulation driven measures (tightly monitored) and creation of better awareness for corporate governance as a value proposition is the need of the hour.