Family-owned firms face a unique set of challenges that are rooted in an organizational structure that prevents these enterprises from attracting and retaining high-quality human capital, obtaining lower cost debt and equity capital, and ensuring long-term competitiveness and sustainability. The recent growth in family-owned enterprises, which are the backbone of Pakistan’s economy, has created a demand for tools will help these companies be more competitive. Corporate governance practices provide a means for ensuring sustained company performance and embedding the values of accountability and transparency in organizations. CIPE partnered with the Pakistan Institute of Corporate Governance (PICG) and the Institute of Chartered Accountants of Pakistan to assess the needs of this particular sector and create the Corporate Governance Guide for Family-Owned Companies.
Family-Owned Companies in Pakistan
In the last decade, Pakistan has experienced a sizeable increase in the number of unlisted companies, particularly family-owned organizations. The rise in numbers of unlisted companies has fueled the growth of Pakistan’s private sector while simultaneously increasing the importance of good governance for businesses. Currently, the Code of Corporate Governance applies only to companies listed on the stock exchanges. However, extending the concept of good corporate governance is vital to the sustainability of unlisted companies.
The controlling shareholders of a family-owned company belong to the same family and participate substantially in the management, direction, and operation of the company. Differing visions and objectives among family members can create conflicts and compromise the governance of the firm. The potential for conflict grows as the family structure shrinks or expands, and as the company changes, particularly with the advent of the second and third generations. Around only 15 percent of family-owned enterprises continue to survive to the third generation. Of those that do, 85 percent either disintegrate or completely vanish before the fourth generation takes the reins.
Challenges stem from the inability of family-owned firms to attract and retain high quality personnel, implement a succession plan, and raise capital. These factors negatively affect a company’s long-term competitiveness and survival. In Pakistan, among the 22 families prominent in business in the 1950s and 1960s, only a few have managed to retain their prestigious position. The shortened lifespan of a family-owned company is mainly due to the following attributes:
- Clear lines of succession do not exist or are complicated by the importance of familial relationships.
- Loose organizational structures do not attract and retain quality human resources.
- Personal interest in the success of the business leads to an unwillingness to take risks such as expanding and diversifying into new business ventures.
Benefits of Good Corporate Governance Practices
Instituting good governance mechanisms can alleviate problems, and help companies sustain growth and overcome short lifecycles. Good governance has a positive impact on the performance of companies and enables them to move into the next phase of the business lifecycle. As companies grow and become more conversant with good governance, their ability to attract capital from external sources also improves, allowing them to expand, diversify, and acquire other businesses in a sustainable manner.
The principles of good corporate governance are as useful for unlisted companies as they are for listed companies. In countries like Pakistan, where a corporate governance code has been established for listed companies, these principles can be practiced by family-owned and unlisted companies as well. Some countries – including Egypt, Turkey, Belgium, and Finland – have also developed indigenous, voluntary corporate governance guides for unlisted, family owned companies.
Good governance directly addresses the issues facing family-owned companies by:
- integrating the strengths of family and business;
- improving shareholder relationships through effective communication and conflict management;
- systemizing wealth distribution mechanisms;
- supporting growth and business diversification;
- managing ownership and leadership transitions;
- developing the next generation of managers, shareholders, and family members;
- improving credibility; and
- attracting lower-cost debt and equity capital.
In Pakistan, family-owned companies are often private, limited companies. Shares are held by a small group of people and there are limits on transferability. When this small group of people, however, is a family in conflict, the company suffers from a lack of objective analysis on the part of independent directors. Creating mechanisms like family constitutions and family councils can manage corporate governance apart from the family so that the business does not suffer. Additionally, good governance practices can assist in creating a more sustainable organization by delineating methods for generational transitions and succession planning.
Corporate Governance Guide for Family-Owned Enterprises
While family-owned companies are the backbone of Pakistan’s economy, these businesses are generally unaware of the principles of good corporate governance, or work in a relatively less open environment. Promoting basic principles of good governance for family-owned companies will support the development of a strong economic sector.
In November 2006, CIPE, in partnership with the Pakistan Institute of Corporate Governance (PICG) and the Institute of Chartered Accountants of Pakistan, organized a seminar on corporate governance aimed at unlisted companies, which was attended by 150 participants including owners of family businesses. Encouraged by the high level of stakeholder interest, the three organizations hosted a roundtable on the subject, which was chaired by the Chairman of the Securities & Exchange Commission of Pakistan. The participants decided to develop a Corporate Governance Guide for Family-Owned Businesses. A focus group, comprised of members of each of the organizations and representatives of family-owned businesses, was formed to develop a framework and prepare the guide based on stakeholder input.
After a round of deliberations, which took place at five focus group meetings, a framework was prepared. The framework was then discussed at two roundtables: one in Karachi, attended by stakeholders from Sind and Baluchistan and another one in Lahore, attended by a large number of stakeholders from Punjab, Khyber Parkton Khawah, Azad Kashmir, Gilgit Baltistan, and Islamabad. These efforts led to a draft guide, which was then published on the three organizations’ websites for two months to solicit stakeholder input. The comments and suggestions received were incorporated and the final version of the guide was approved in June 2008.
To mark the launch of the Guide, CIPE invited Abdul Razzak Dawood, the former federal commerce minister and Chairman of the Pakistan Business Council, to be keynote speaker at an event where heshared his views with 100 business leaders of family-owned enterprises. Dawood manages his own businesses in the engineering, chemical, and power sectors and is chairperson of Pakistan’s first family-owned multinational company. In his keynote address, Dawood observed that:
“Corporate governance is necessary for the creation of human, intellectual, and financial capital. I am a strong believer that good corporate governance is not a cost, but rather a value addition, an investment in the future of the company.”
The Corporate Governance Guide for Family-Owned businesses is the first guide of its type in Asia. It provides in simple language a corporate governance framework, based on the OECD’s internationally recognized principles, which is practical and adaptable for both listed and unlisted companies. The publication contains recommendations applicable to enterprises of different sizes, ages, types of business, composition of shareholders and family dynamics, and is a resource for progressive, medium to large sized, unlisted, family-owned companies in Pakistan and internationally.
Adoption of the Guidelines by National Foods
National Foods is an example of a family-owned company that has placed an emphasis on improving firm governance. It has maintained an annual growth rate of at least 20 percent since its founding in 1971. At first, National Foods was a spice business, but it now supplies more than 700 food products. The company has become a household name in Pakistan as a result of a successful marketing strategy combined with an array of quality products. Since its founding, National Foods has employed good governance and management practices, which established a good working relationship among the founders and prevented conflict. The first generation owners structured the organization into departments and identified human resource functions, roles, and responsibilities. These undertakings provided the foundation for the further professionalization and increased competitiveness of National Foods.
Under the leadership of the second generation, National Foods increased the number of its shareholders and listed the company on the stock exchange. Corporate governance allows a greater level of freedom for professionals while providing them with standards to follow and key performance indicators to achieve. In order to grow a business, family managers need to delegate responsibility and authority to professional managers. Today, the company’s governance structure is also complemented by the Code of Corporate Governance issued and enforced by the Securities and Exchange Commission of Pakistan. In the words of Abrar Hassan, CEO of National Foods, “corporate governance has helped National Foods with better access to capital and finance through investors by imparting confidence in the company through transparent practices.”
Corporate governance guidelines address one of the major weaknesses of family-owned firms, which is successfully managing family succession. National Foods treats family employees and non-related employees equally and recruits leadership based on merit. Successful companies master the art of attracting the best and brightest people through a professional human resources team. National Foods’ strategy centers on continuous recruitment of recent graduates and developing the company’s reputation as a professional working environment. The family does not expect that the third generation will lead the company but instead encourages interested family members to play a role in business development.
National Foods’ experience shows the advantages of listing large family businesses on the stock exchange. Listing a company creates exit mechanisms while freeing up capital to invest in other ventures. Becoming a public limited company has enabled National Foods to develop a culture and reputation that allows them to compete with multinationals. Adherence to the Code of Corporate Governance has also helped the board develop a vision of its roles and responsibilities.
In conclusion, National Foods has successfully undertaken the process of diluting ownership through public listing, divesting to new shareholders, and delegating management functions. Its experience exemplifies the positive outcomes that eventuate from transforming family owned enterprises into public limited companies. The adoption of these guidelines has guided the company on a path of growth and professionalization.
Lessons Learned and Conclusion
Corporate governance is crucial for defining the respective roles of shareholders as owners on one hand, and managers on the other. By establishing good corporate governance practices, companies are able to reduce conflicts, motivate employees to perform at higher levels, and strengthen accountability mechanisms—thus stimulating the company’s growth and ability to profit. Companies that adhere to a Code of Corporate Governance are better able to respond to the demands of an ever-changing business and political environment, with increased accountability and transparency. Above all, well-governed companies are best positioned in the global marketplace to attract more equity and low-cost debt capital.
This case study was published in CIPE’s “Strategies for Policy Reform Volume 3: Case Studies in Achieving Democracy That Delivers Through Better Governance,” click through to download and read more.