Governance Challenges in Family Owned Businesses

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5GovernanCe ChallenGesFoR FAMilY-oWnED BuSinESSES

Motivation

PurposeAlignment

PlanningWhat To Do

FamilyBusiness

Challenges

Implementing

TangibleBenefits


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Practical Guide to Corporate Governance

C pt 5G ver a ce Cha e gesf r Fam y-ow ed B s esses

Key MessaGes

To an extent, amily control yields benefts. Academic research and experience rom manycompanies and investors all show that a certain degree o amily ownership/control provides

positive bene ts to the amily business and its shareholders.

Family-owned frms ace unique challenges. However, many ailures o amily-owned com-panies indicate that such rms also ace a multitude o challenges which risk destroying share-holder value or even the business itsel .

Corporate governance measures lead to long-term success and keep peace in the amily.Corporate governance measures at the amily and business levels provide good solutions to

amily ownership challenges and o ten are indispensable to the long-term success o the amilybusiness and peace in the controlling amily, especially with succeeding generations.

We have two options; there is no right or wrong decision, nor one

that is better than the other. But whatever is to be done, will be de ni-

tive. There is no turning back. We can continue being a amily business,

like in my grand athers and athers days, or become a pro essional

company with a strong and clear capital market strategy.

David Fe er, Suzano, Chairman of the Board,speaking to his relatives after his fathers death


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122 Chapter 5 Governance Challenges or Family-Owned Businesses

Family-owned or controlled companies are the leading orm o business organization in LatinAmerican countries, even among large listed companies: one recent study rom Brazil re-vealed that 51.5 percent o the 200 largest listed companies are amily-controlled. 59

This predominance o amily companies shapes particular corporate governance challengesand opportunities not always considered in markets where ownership is dispersed and manage-ment is mainly composed o external and hired specialists. But or Latin American markets, anydiscussion o corporate governance improvements must address the unique governance chal-lenges that amily companies ace.

This chapter examines:

How investors view amily businesses and the bene ts o amily ownershipfChallenges related to amily controlfGovernance solutions to address investor concerns related to amily ownershipfFirst-hand stories o governance challenges in amily-controlled companiesf

1 Family Business Edge

Family ownership may be seen as an opportunity or a threat, depending on a variety o actors.The amily ownership and commitment to the business may be understood as adding value,provided that the company and the controlling amily can respond to the concerns o the inves-tor community.

Investorsboth shareholders and creditorsmay look with distrust on amily-controlledcompanies, because o the risk that the controlling amily may abuse the rights o other share-holders. So investors likely will scrutinize such companies with care be ore taking the plungeand investing.

There is a long and storied history o amily-owned companies with highly-concentratedownership, poor transparency and absence o accountability and airness principles that led toabuse o minority shareholder rights. 60

From an investor perspective, the key is to establish the right corporate governance condi-tions so that the positive aspects o amily ownership are coupled with assurances that investorinterests will be recognized and addressed.

Investor perception on ownership concentration, and the value associated with it, is re-vealed in a report o emerging market rms published at the beginning o 2007 by Citigroup

Global Markets. The analysis suggests that investors place a three percent valuation premium onrms in which amily insiders wield signi cant, but not absolute, control. Conversely, or emerg-

ing market rms where amilies are majority owners, investors assign a valuation discount o5-20 percent. See Figure 5.1.

59 SILVEIRA, A. DI M. DA, LEAL, R. P., CARVALHAL-DA-SILVA, A. L., & BARROS, L. A. (2007). Evolution and determinantso rm-level corporate governance quality in Brazil. Available at SSRN 60 LA PORTA, R., LOPEZ-DE-SILANES, F., SHLEIFER, A., & VISHNY, R. (2000). Investor protection and corporate gover-nance. Journal o Financial Economics, 58, pp. 3-27. ANDERSON, R. C.; REEB, D. M. (2004), Board Composition: Balancing Family Infuence in S&P 500 Firms. Administra-

tive Sciences Quarterly v.49, http://ssrn.com/abstract=590305, pp. 209-237. CLAESSENS, S.; DJANKOV, S., and LANG, L.H.P (1998), Expropriation o Minority Shareholders: Evidence rom EastAsia, Mimeo, World Bank, Washington D.C., Research Paper 2088, pp. 33.


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Figure 5.1 Relative Valuation by Family Ownership in Emerging Markets 61

-25

-20

-15

-10

-5

0

5

10

R e l a t

i v e

V a l u a t i o n

( % )

Family Ownership

0%-10% 25%-50%10%-25% 50%-70% 75%-100%

Sources: FactSet and Citigroup Financial Strategy Group

Research quantifes the value o good governance in amily businesses. In a study by Pro-essor Panikkos Poutziouris 62 o the Cyprus Institute o Management o 42 companies on the

London Stock Exchange, listed amily rms outper ormed their listed non- amily rivals by 40 per-cent rom 1999 to 2005. But the study also shows that the outper ormance o the Family Busi-ness 63 Index only applies when the interests o shareholders and management are aligned.

Credit Suisse 64 research also showed that amily-owned companies per orm better: overthe long term, such rms tend to achieve superior returns and higher pro tability than com-panies with a ragmented shareholder structure. Credit Suisse analysts compared the stockper ormance o European companies with a signi cant amily infuence to rms with a broadshareholder base. The study uncovered several actors that contribute to the success o amily-owned rms:

Longer-term strategic ocus o thef controlling shareholders and management, instead ooperational ocus on trying to surpass quarterly resultsBetter alignment o management and shareholder interestsfFocus on core activitiesf

Anderson and Reeb ound a similar result when investigating the link between ounding-amily ownership and rm per ormance in large, publicly-traded U.S. rms listed on the S&P

500 in 2003.65

The main nding: amily rms outper ormed non- amily rms and had highervaluations as well.

61 CITIGROUP GLOBAL MARKETS. (2007). What investors want: how emerging market rms should respond to theglobal investor. This report examines shareholder patterns among 1,500 largest listed rms in the emerging markets (theEM 1500). The EM 1500 represents the top 1,500 rms by US dollar market capitalization at the end o 2005. It is asubset o the Citigroup/BMI and IFC indices that essentially comprises every listed company with a market capitalizationabove $ 300 million across Asia (excluding Japan), Central and Eastern Europe, the Middle East, A rica and Latin America.All nancial data or the EM 1500 is rom Bloomberg.62 POUTZIOURIS, P. Z. (2004). Views o amily companies on venture capital: empirical evidence rom the UK small tomedium-size enterprising economy. Family Business Review, 14, n. 3 , pp. 277-291.63 A amily business was de ned by the study as one where at least 10 percent o the shares o a company were ownedby the ounding amily and also had a amily member on the board.

64 Credit Suisse Family Index, 2007.65 ANDERSON, R. C., & REEB, D. M. (2003). Who monitors the amily. SSRN Discussion Papers . Available at SSRN: http:// ssrn.com/abstract=369620 or DOI: 10.2139/ssrn.369620.


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The research shows that amily businesses can generate value or all shareholders, basedon several actors, known as the amily business edge. This is what attracts many investors toinvest in amily-owned/controlled companies:

Long-term view in decision-makingfAbility and willingness to adopt unconventional strategies, enabling amily businesses tof

respond rapidly to changing market circumstances and giving them the fexibility to takeadvantage o opportunities and address emerging risksDesire to build a business or uture generations, translating to a ocus onf sustainability andreducing the risk that controlling shareholders will run down company assets and destroyvalueCommitment o amily management to their company, providing continuity in the way thefbusiness is run

I am certain that high ethical standards and good corporate governance

in business generate value and increase the public investors trust.

Eustaquio de Nicols Gutierrez, Homex, Chairman of the Board

A number o Companies Circle members have signi cant experience in the area o gover-nance or amily-owned companies. Here is a highlight.

Homex implements governance practices

With the goal o generating value or all shareholders, Homex has implemented a series ogovernance practices.

Since going public in 2004, the companys controlling amily has held a sizeable stake in thecompany. Still, the amily has relinquished a larger portion o shares or public purchase over theyears: the 2005 IPO launched with 22.2 percent o shares available or purchase. Today, other

shareholders control 64.9 percent66

o ownership, as shown in Figure 5.2.

Figure 5.2 The Ownership Structure o Homex

Float64.9%

Founder Family35.1%

Source: Homex

66 As o October 31, 2008.


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This ownership structure demonstrates the De Nicholas amilys commitment to the Mexicanhousing market, and con dence in the companys continued prosperity and ability to createvalue or all its shareholders. In turn, Homex controlling amily has ound that this approachresonates with other investors, giving them greater con dence in the company.

Homex sought to do its best to ensure all shareholders that their rights and interests willbe properly protected by introducing high corporate standards in its by-laws that ocus on pro-tection o minority investors rights. Moreover, it has never incorporated provisions like anti-takeover practices, diluting schemes or the existence o di erent types o shares that provide

or di erent voting privileges.

Homex leaders see additional advantages o having 35.1 percent o companys ownershipsuch as:

Aligning shareholder interests that leads to better decision processes

Attracting investment and increasing share liquidity

Increasing investor con dence: high percentage o shares in the market gives minor-

ity investors con dence that a dominant group will not make decisions contrary to theirinterests an important actor in Homex success.

Walking the path o true institutionalization and creating value with it

requires a power ul level o commitment, internal control and high cor-

porate governance practices are critical tools to get this job done.

Gerardo De Nicols, Homex, CEO

2 Family Business Governance Challenges

Together with certain advantages in comparison to non- amily owned rms, amily businessesalso ace a set o challenges which they need to address to obtain the trust o investors and, inmany cases, to make the company sustainable in the long run.

Through the years, numerous academic studies have looked at some o these challengesand weaknesses:

In 1988, Holderness and Sheehanf 67 ound that among US corporations, amily rms have alower market value than non- amily rms. 68

67 HOLDERNESS, C. G., & SHEEHAN, D. P. (1988). The role o majority shareholders in publicly held corporations. Journal

o Financial Economics, 20 , pp. 317-346.68 The study measured companies Tobins Q, a proxy or corporate market value calculated as the market value o a

rms assets divided by replacement value o the rms assets.


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In 2001, Prez-Gonzlez ound that the stock market reacts negatively to the appointmentfo amily heirs as managers. 69

In 2004, Villalonga and Amit reported that amily control exhibits speci c weaknesses whenfdescendants are involved in top management. 70

So, even i amily businesses are recognized as a valuable asset, the risks associated withconcentration can drive away additional sources o nance, thereby reducing the companysvalue or restricting available credit terms.

The main challenge in amily business governance relates to the existence o an additionallayer o relationship that the owning/controlling amily brings to the business.- For shareholdersthis complexity includes understanding the various interconnections among the owning/control-ling amily members. These roles include:

Family member/ownersfFamily member/directorsfFamily member/managersf

Family member/employeesf Family members who are not shareholders, but are extended amily and heirsfFamily members who are some combination o these rolesf

Typically, amily businesses in the rst generationand sometimes in the second gen-erationare managed by the ounders and other amily members. These businesses o ten

ace the challenge o attracting good specialists to assume management positions. They aceeven more di culties in retaining such quali ed pro essionals. The relationship between amily/ managers and non- amily pro essionals must be care ully cra ted to maintain a well- unctioningmanagement team and to lead the company to success.

Relations between the amily as shareholders and non- amily investors also present chal-lenges. Non- amily external investors o ten have signi cant infuence over the shaping o the

amily business governance. Their views on corporate governance are converging due to eco-nomic globalization and emergence o global investors.

Despite convergence o governance patterns in the competition or capital, di erences arelikely to remain, rom country to country and rom industry to industry.

There is also a trend toward standardizing understanding o good governance or investorsand international capital markets. Notes one institutional investor in response to a 2006 globalstudy o institutional investors: 71

Global capital markets have become more integrated. Corporate governance becomes a common theme in the global investment community.It can serve as a screening tool to nail down the port olio candidates.Moreover, it can also serve as a benchmark or our investment port olio. Institutional investor 2006

69 PEREZ-GONZALEZ, F. (2001). Does inherited control hurt rm per ormance? Working paper Columbia University .70 AMIT, R., & VILLALONGA, B. (2006). Bene ts and costs o controlenhancing mechanisms in U.S. amily rms. SSRN Working Paper. 71 2006 ISS Global Institutional Investor Study, by RiskMetrics wholly owned subsidiary, Institutional Shareholder Ser-vices (ISS), 2006. Reproduced by permission o RiskMetrics Group, Inc. . 2006-2009 RiskMetrics Group, Inc. All rightsreserved.


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This study, rom RiskMetrics subsidiary, also nds that the majority o investors say thatcorporate governance is more important today than it was three years ago. They also say thatit will become even more important in the next three years including or amily businesses.Investors place a strong value on corporate governance, minority shareholder protection andtransparency. As a result, they want amily businesses to have structures and processes thatare globally recognized as good practices without necessarily considering the amily businessgovernance speci cs.

In addition, amily-controlled rms o ten ace a di cult choice as they con ront the needto und growth by attracting equity: do they cede partial control to external shareholders andchange their old habits and ways o running the business, promoting tangible improvements incorporate governance in exchange or capital or growth?

This discussion shows that amily companies must consider a variety o sometimes con-ficting issues when competing or resources alongside global companies, particularly in coun-tries with institutions, regulatory rameworks and en orcement mechanisms that do not inspirethe con dence o investors. There are additional challenges as well:

Quite o ten, especially during the early, start-up stages o the amily business, the companyfand amily relationships are not clearly distinguished. This is particularly true with respectto nancial relations and accounts the companys and amilys assets are not legally sepa-rated. This causes problems in distinguishing company-owned assets, and how company-owned assets can be used by the amily as a shareholder.Existing governance-related policies are in ormal, as a general rule. This can lead to reliancefon key people rather than on structures and processes. Such common understandingsmay not be as universally-held or understood when situations change. As a result, there couldbe some uncertainty on the part o external investors and non- amily employees.Weaknesses in governance systems o amily businesses are most evident inf internal con-trols, internal audit and risk management. Since many amily businesses are managed bythe ounders or their children, the control environment is largely tailored to their needs. Theproblem: the controls do not grow along with the company, as the business becomes morecomplex. This gap is a primary area o concern or external investors.Governance challenges only increase as the amily and business grow more complex withfeach succeeding generation.

3 Governance Solutions to Family Business Challenges

This section looks at various governance solutions to the challenges unique to amily-ownedbusinesses, and covers a variety o topics:

Distinguishing governance solutions in di erent ownership stages o the amily businessf f Family governance institutions

Family governance documentsfSpeci c solutions to some amily governance challengesf

f Succession planning in amily-owned businessCase study:f Ultrapar

To address the challenges detailed in the previous section, amily businesses have come upwith many governance solutions that are speci c to their ownership structures.


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Research published by IBGC in 2006 analyzed 15 amily-controlled companies and oundthat these companies had ve main motivations or seeking improvements in their governancepolicies and practices: 72

To institutionalize and perpetuate the business modelfTo provide the means to implement the de ned strategic planf

To add value or shareholdersfTo enhance the potential or attracting debt nancing, resources and shareholdersfTo improve the companys image abroad, acilitating globalization and reaching a base of

oreign investors

The study provides clear evidence o the value o good governance to such companies. Thestudy sample was comprised o listed companies with certain liquidity levels. They also met acertain standard o relatively advanced corporate governance practice. The research ound a rel-evant and meaning ul positive correlation between the quality o corporate governance at thesecompanies and their operational and market success.

The analyzed companies are on average larger and are worth more. They have higher mar-ket multiples. They are operationally more pro table, with more liquidity. They pay higher divi-dends. And they are more solvent in the short term and more leveraged than the average o alllisted companies on BM&FBOVESPA. The study also concluded that the analyzed companiestypically ollow better corporate governance practices than an average company listed withBM&FBOVESPA.

Family-owned members o the Companies Circle have aced a similar set o motivations.The stories that ollow provide concrete illustrations o the reasons to initiate corporate gover-nance improvements in amily companies and the bene ts they a ord to the controlling amily,the amily business and outside investors.

I dont know cases o amilies in Latin America that had become more

united because o money, but I do know o many cases where amilies

have destroyed companies because o money. The lesson to be learned

here is that company value is what unites shareholders, irrespective o

whether these are amily members, institutional shareholders or inves-

tors who are external to the controlling groups.

Roque Benavides, Buenaventura, CEO

72 IBGC, BRAZILIAN INSTITUTE OF CORPORATE GOVERNANCE (2006). Corporate governance in amily cotrolled com-panies: relevant cases in Brazil. So Paulo: Saint Paul Institute o Finance. The companies analyzed include Gerdau, Gol,Ita, Klabin, Localiza, Marcopolo, Natura, NET, Po de Acar, Randon, Sadia, Saraiva, Suzano, Ultrapar and Weg..


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Buenaventura transforms from family-run rm to professionally-managed company

In Latin America, as elsewhere, amily ghts have destroyed value and companies to the detri-ment o all. Buenaventura set out on the corporate governance improvement path as a way toavoid this situation, trans orming the company rom a amily-run business to a pro essionally-managed rm. With a ocus on aligning the amilys objectives with those o long-term share-holders and ultimately maximizing value or all shareholders and implementing good corporategovernance, the companys ounders and their successors believe they have avoided the kindso amily disagreements that could have harmed or destroyed the company.

As a listed company on both the NYSE and the Lima Stock Exchange, company leadershave seen that investors really care about corporate governance, and adopting such practicestruly pays o . The company underwent an entire culture shi t, a ecting all shareholders, includ-ing amily members, to ocus on the bene ts or the company as a whole. The amilys objec-tives with respect to the company and non- amily shareholders objectives are the same, as allare interested in enhancing shareholder value.

Generational shift at Ferreyros

This companys signi cant change in the pattern o ownership and control over time is rootedin amily actors. The rst generation o ounding partners passed on their ownership to thesecond. But not every second generation amily member wanted to participate in the business,since the heirs had other interests or their careers and lives. So the owners opted to turn overthe companys management to pro essional non- amily managers and to create a broad anddiverse base o shareholders. To acilitate the trans er o the companys stakes to new own-ers, Ferreyros registered its shares on the Lima Stock Exchange, an initiative that required theimplementation o corporate governance improvements to attract investment and enhance thecompanys controls and per ormance.

3.1 Distinguishing Governance Solutions in Different Ownership Stagesof the Family Business

Corporate governance solutions that amily businesses can adopt will vary depending on thestage o the controlling amilys ownership. Some structures and processes are adapted tosituations in which there is a single person, the ounder/patriarch o the company, in charge othe company. Other solutions are better suited when the next generation takes over the busi-ness. And a third set o governance solutions are appropriate or companies controlled by amilymembers o later generations.

Harvard pro essor John Davis developed a model to help understand the three-phased evo-lution o amily companies, shown in Figure 5.3. 73 The initial phase, in which all dimensions areconcentrated in one amily, groups o amilies or the individual ounder is known as the ound-ers stage. As time goes by, the company grows and transitions ownership to the next genera-tion, a stage called the siblings partnership. As more time passes, the company transitions to

uture generations, reaching maturity a stage Davis calls the cousins con ederation. Whenthe rm reaches maturity, according to the model, the challenge is to renew and recycle in order

or the company to continue.

73 GERSICK, K. E., DAVIS, J. A., HAMPTON, M. M., & LANSBERG, I. (1997). Generation to generation: li e cycles o theamily business. Boston: Harvard Business School Press.


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Figure 5.3 Development and Transition o Family Businesses Over Time

Family

Business

Family

Business

Ownership

Ownership

Family

BusinessOwnership

Initial Phase Maturity Growth/Development

Source: Better Governance, based on GERSICK, Kelin E., DAVIS, John A., HAMPTON, Marion M., and LANSBERG,Ivan I. Generation to Generation: Li e Cycles o the Family Business. (1997)

f y u C id ti

Remember that what works at one stage o this ownership cycle usually does not workwell at other stages. So controlling amilies should take a care ul look at the governancesolutions recommended or their particular stage o development.

The governance solution you choose or your amily business should depend on theownership stage your company is in.

3.2 Family Governance Institutions

Trans erring the values and business knowledge o the ounders to uture generations becomesmore di cult as the amily grows. The challenge is to keep the generations and all amily mem-bers united and their interests aligned over the years. When amilies reach the third and ourthgenerations, their members may barely know each other. It becomes more di cult to maintainaligned interests within a large amily, especially given that the demand or creation o wealth

or uture generations increases as time passes.

As the competition or resources and power within the amily intensi es, it becomes in-creasingly di cult to maintain a common purpose. How does a amily maintain a shared visionabout the company? All sorts o diverging views can arise: on ownership, on the degree o con-trol that the amily intends to retain, on the amilys involvement in the companys governanceeither through the board o directors or executive management.

The good news: help is available. Family business consultants and groups ocused ongovernance say that several easily accessible publications can help amilies and their busi-ness with nding answers to these and other relevant questions. The IFC Family BusinessGovernanceHandbook, 74 published by the International Finance Corporation, recommends the

74 IFC, INTERNATIONAL FINANCE CORPORATION (2008). Family Business Governance Handbook, http://www.i c.org/


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establishment o amily governance institutions that can help strengthen amily harmony and itsrelationship with the business.

The handbook, aimed at guiding amilies as they initiate best governance practices on thecorporate and amily levels, suggests that allowing amily members to gather under one ormore organized structures, strengthens communication links between the amily and its busi-ness. This approach also provides opportunities or amily members to network and discussissues related to the business and the amily. Table 5.4 highlights the types o governance struc-tures amilies might establish, depending on the stages o the amily companys development.In addition to governance-related structures presented in the table below, amilies might con-sider establishing other structures, such as amily o ce, education committee, share redemp-tion committee and career planning committee.

Table 5.4 Family Governance Institutions

Family Meeting Family Assembly Family Council

Stage Founder Sibling partnership/

cousin con ederation

Sibling partnership/

cousin con ederationStatus Usually in ormal Formal Formal

Membership Usually open to all am-ily members. Addition-al membership crite-ria might be set by the

ounder

Usually open to all amilymembers. Additional mem-bership criteria might be setby the amily

Family members electedby the amily assembly.Selection criteria de nedby the amily

Size Small size since amily stillat ounder stage. Usually612 amily members

Depends on the size o theamily and membership cri-

teria

Depends on criteria setup or the membership.Ideally 612 members

Number omeetings

Depends on the stage othe business develop-ment. When business isgrowing rapidly, can be as

requent as once a week

1-2 times a year 2-6 times a year

MainActivities

f Communication oamily values and vi-

sionDiscussion and gener-fation o new businessideasPreparation o the nextfgeneration o businessleaders

Discussion and communi-fcation o ideas, disagree-ments, and visionApproval o major amilyfrelated policies and pro-ceduresEducation o amily mem-fbers on business issuesElection o amily councilf

and other committeesmembers

Confict resolutionfDevelopment o thefmajor amily-related pol-icies and proceduresPlanningfEducationfCoordination o thefwork with manage-ment and the board

and balancing the busi-ness and the amily

Source: IFC Family Business Governance Handbook

Figure 5.5 shows that once the cousins con ederation stage is reached and the com-pany opts or renewal and recycling, the company adopts good governance practices or thecompany and the amily with the creation o the amily o ce and the amily council. 75 This action

i cext/corporategovernance.ns /AttachmentsByTitle/Family+Business_Second_Edition_English+/$FILE/Englilsh_Family_Business_Final_2008.pd , pp. 31-32.75

The amily o ce is an investment and administrative center that is organized and overseen by the amily council commonly inlarge and wealthy amilies. The o ce is the mechanism through which advice on personal investment planning, taxes, insurancecoverage, estate planning, career counseling and other topics o interest is provided to individual amily members. For more de-tail, see IFC, INTERNATIONAL FINANCE CORPORATION (2008). Family Business Governance Handbook,


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separates the various dimensions and establishes practices that generate greater transparencyand the trust o outsiders. This stage involves the most extensive amily governance institutionsand business governance structures. Good communication between the two sets o structuresis key to business success and amily peace.

Figure 5.5 The Governance Structure o Family-Controlled Companies with GoodPractices

Owners

Management

Boardof

Directors

Independent Auditors

Internal Audit

Committees

AuditingCommittee

FamilyCouncil

FamilyOffice

Source: Better Governance

3.3 Family Governance Documents

Family governance structures and institutions require a certain degree o ormalization i theyare to unction well. As amilies adopt policies on the amilys approach to the business andon governing the business, they will ormalize these e orts with documents that will di erdepending on their ownership stage.

i cext/corporategovernance.ns /AttachmentsByTitle/Family+Business_Second_Edition_English+/$FILE/Englilsh_Family_Busi- ness_Final_2008.pd > , pp. 32-33.


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Typically, in the earlier stages when the company is governed by the ounder or his/her chil-dren, many aspects o amily and business governance are in ormal. Any e orts to ormalize re-late mostly to the business itsel . First attempts at written policies usually are brie documentsthat state a general amily vision and mission with respect to the company.

The next level o ormalization comes with the need to develop a amily employment policy.This becomes more apparent when the company reaches the sibling partnership stage. The

amily employment policy sets clear rules on terms and conditions o amily employment withinthe rm. For some amilies, these rules stipulate conditions o entry, retention and exit romthe business. The policy also should cover the treatment o amily member employees vis-a-visnon- amily employees. 76

In third, ourth and succeeding generations, amily businesses can barely survive unless ullamily governance policies are written and communicated within the amily and the business, as

well as to other outside stakeholders. The document covering all o these policies is commonlycalled a amily constitution. This document expresses the amilys principles regarding the amilycommitment to core values, vision, and mission o the business. It o ten de nes the roles, com-

positions, and unctions o amily governance institutions and the companys own governancebodies, such as the shareholders meeting, the board o directors and senior management .77

f y u C id ti

Creating a amily constitution will codi y all o your amily-related governance policies.

3.4 Speci c Solutions to Some Family Governance Challenges

As companies ocus on maintaining all the bene ts a orded by amily ownership and supple-menting them with good governance processes and structures to enhance competitivenessand oster growth, they will ace challenges.

Solutions used will include mechanisms to:

Separate unctions o ownership, control and managementfCreate amily o ces to clari y the boundaries between the amilys and companys accountsfDevelop the skills and knowledge o heirs so they can become responsible owners, as theyf

can assume various roles as an owner, director or an employee

Processes and structures or decision-making will vary: it is one thing to decide on amilymatters and quite another to tackle company business, with issues such as division o equityand the like. The amily council, created to address amily issues should remain completelyseparate rom the board o directors and rom shareholders meetings, both o which ocus oncompany-related decisions.

76 IFC, INTERNATIONAL FINANCE CORPORATION (2008). Family Business Governance Handbook, , pp. 23-27.77 For more in ormation on amily constitutions, see IFC, INTERNATIONAL FINANCE CORPORATION (2008). Family Busi-ness Governance Handbook, , pp. 24-25.


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It is true that introducing governance measures will not resolve every investor concernabout amily-owned or controlled rms. Still, instituting structures and processes or the amilyand the business can address some key challenges.

Keeping peace in the amily: Keeping peace in the amily is important or inter-personal, socialand business reasons.

The problem

Conficts among the siblings who run the business or misunderstandings between di erentamily branches may spill over to the companys domain and create problems or other share-

holders.

How to manage relations between amily members who work or the amily business andfthose who are only owners and rely on dividend income rom the success o the company:These two groups may have diverging interests and varying degrees o access to companyin ormation, which may lead to an atmosphere o distrust in the amily.

How to manage situations in which some amily members want to work or the company,f and others want to pursue their own interests, possibly leaving the amily business entirely.

Suggested solutions

Family governance institutions can play an important role as places where sensitive issues canbe discussed and solutions ound.

Af amily assembly or amily council can mull over the issues and develop policies on howdividends are determined and distributed to make sure that the amily is satis ed in waysthat are not detrimental to the success o the business. Putting things on the table andopenly discussing contentious issues is o ten the astest way toward nding a solution ac-ceptable to all concerned parties.The amily can create a liquidity und, which could be used by the amily to redeem thefshares o amily members who wish to pursue their own interests outside o the amilybusiness. Some companies even establish special committees with oversight or the re-demption policies.

Presence o outside, non- amily shareholders: This situation poses its own set ochallenges.

The problem

How can the company ensure that these external investors are airly treated? These inves-ftors might have interests and views on the role and results o the business that diverge

rom the controlling amilys point o view. Investors also might have di erent levels o ac-cess to company in ormation. In some cases, external investors have even less in ormationthan non-management, amily shareholders.

Suggested solution

Corporate governance improvements may help.

Empower thef board o directors to arbitrate between the amily and outside shareholders.A board that per orms classic unctions o management oversight and helps managementde ne and pursue the companys strategic direction is capable o aligning the interests oall types o investors.


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The presence of independent directors can rein orce the boards mediating role. Indepen-dent directors can provide an outside, objective perspective or business decision-making.They can act independently to resolve conficts o interest and amily governance prob-lems, such as employment issues.

3.5 Succession Planning in Family-Owned Business

Succession planning is a sensitive issue and involves such dilemmas as:

How to maintain objectivity when amily eelings are involved.fHow to make objective judgments unimpaired by emotions.f

Some use ul steps or dealing with executive succession are presented in the checklist inTable 5.6.

Table 5.6 Checklist: Ensuring Strong Senior Management or the Family-Owned Company 78

Analyze the organizational structure and contrast the current and optimal rolesand responsibilities (compared to peer companies) o each senior manager.

Design a ormal organizational structure that clearly de nes the roles and re-sponsibilities o all senior managers. This should be based on the companyscurrent and uture business operations needs.

Evaluate the skills and quali cations o the current senior management based onthe new organizational structure.

Replace and/or hire senior managers.

Decentralize the decision-making process and approval levels as necessary. De-cision-making powers should be linked to the roles/responsibilities o managersand not to their ties to the amily.

Establish a clear amily employment policy and make its content available to allamily members.

Develop an internal training program that allows skilled employees to be pre-

pared or taking on senior management assignments in the uture.

Establish a remuneration system that provides the right incentives to all manag-ers depending on their per ormance and not on their ties to the amily..

Over the years, the Companies Circle members have con ronted the succession issueshead-on. Here is a sampling o their approaches to resolving the problems.

78 IFC, INTERNATIONAL FINANCE CORPORATION (2008). Family Business Governance Handbook, , p. 47 .


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The times we live in, where competition or capital is erce and glo-

balization orces us to compete globally, the international competitive

scenario requires companies to be experts in adapting to ever-changing

scenarios. The preparation o an advance succession plan will allow or

the transition rom one stage to another to be carried out smoothly,

avoiding interruptions.

Roque Benavides, Buenaventura, CEO

Buenaventura separates board and management

This rms initial succession process involved separating the position o chairperson o theboard rom that o general manager. This was a controlled and natural process, approved bymost shareholders.

The next stagesuccession planning at the general manager and other senior manage-ment levelsis a topic o requent discussion at Buenaventura s board meetings. Now, thecompany is in the preliminary process o identi ying and evaluating potential in-house candi-dates, with the idea o developing new capabilities. The search also will extend to consideroutside candidates.

As a company and as a amily, Buenaventura seeks to ensure continuity o the corporatevision. The executives who are appointed to manage the business in the uture must be thecandidates best equipped to continue generating growth and increasing value or the sharehold-ers and stakeholders. The board is playing an essential role in this succession process, ensuringthat competent pro essionals are involved in the selection process and that the decision criteria

t with the companys vision, mission, values, and strategic choices. The board also can exer-cise its ull powers to resolve any internal conficts that might arise during the process.

Non-family professionals take the helm at Marcopolo

Non- amily pro essionals took the management helm or the rst time at Marcopolo in 1995,with the appointment o a team o executive directors who were not shareholders. Ten yearslater, although this executive team was still young, it became apparent that the company need-ed a succession plan. Since 2005, the company has ocused on managing succession.

Currently, Marcopolos senior executive succession plan looks like this:

Retirement policy: At age 60, with possibility o a ve-year extension period in special

casesRetirement preparation plan: Policies or potential continued relations between the

company and the retired executives, such as consultancy, or appointment as a boardmember in controlled companies


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Board role: Regular ollow-up on the succession plan, mainly through the companys

human resources committee

In addition to the succession o business leadership positions, amily businesses shouldpay close attention to ownership succession and preparing uture generations o owners.

For Marcopolo this meant developing a ormal ownership succession plan. Currently, thetwo potential candidates or succession attend in-house and external training programs. Themain theme o these courses is the enhancement o knowledge, skills and technical know-howto become competent company shareholders the successors at Marcopolo decided that theywould only assume the role o shareholders, with seats on the board. They leave the role omanaging company operations to external management pro essionals.

E eme ts f Marc p s Tra g f r Fam y ow ersh psucc i C did t

In-house training: Lectures on speci c characteristics o industrial, engi-

neering and manu acturing areascommercial knowledge-building emphasizes sales and marketing strate-giesadministrative and nancial knowledge-building ocuses on strategicplanning, budgets, accounting, cash management and company nance

External training: Courses and seminars given by institutions that are highly

regarded in the academic world and the corporate community

This was an outstanding process, brilliantly planned and executed ac- cordingly. Succession was success ul and created room or new execu-

tives to join our group.

Ana Maria Igel, wife of Pery Igel, son of Ultrapars founder

Succession process for Ultrapar

At Ultrapar , Pery Igel, the son o the companys ounder, viewed some o his hired executivesas allies who could help protect the company rom the uncertainties that a business dependenton amily management and capital could ace. In the 1980s, Igel drew up a process or his suc-cession based on two key elements:

Pro essionalization o Ultra Groups management

Shared control o the company between heirs and key executives

To carry out this plan, Igel distributed bene ciary shares to his heirs and trans erred sharesto executives. A shareholders agreement, ormalized in the mid-1980s provided or recipro-cal rights o rst re usal in the event o sale o controlling shares. It established two separate


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holding companies with a de ned li e span o twenty years and control over the umbrella rm,Ultra S.A:

Igel Participaes: held by the heirs o the amily

Avar Participaes: held by Ultrapar executives

During this period, new management leaders were trained to prepare them to lead thecompanys growth. These executives who were now also owners had their interests alignedwith those o the amily. In the transition stage, a new group o executives received shares, butwith a shorter time horizon in which to dispose o the shares.

In late 2004, the two holding companies were dissolved, and the corresponding shareswere passed on directly to Ultrapars heirs and executives.

Two years later, in 2006, a new succession process took place. This time the CEO one othe executives who received shares rom Igel as part o the original 1980s share trans er wasreplaced by a pro essional groomed internally by the company. The ormer CEO retained his

position as chairman o the board o directors yet another step in the companys evolutiontowards better governance.

Suzano Restructuring

In 2002, as the Fe er amilys third generation began to assume more leadership, the companyinitiated a thorough restructuring process. The goal: to ensure that the businesses in whichthe Group had decided to invest pulp and paper and petrochemicals would be su cientlycapitalized or long term sustainability, able to grow, with competitive costs o capital throughits partnerships with the capital markets. E orts also were designed so that the businesses didnot depend excessively on the controlling shareholders capital.

Case St dy: S za a d 83 Years a Fam y-C tr edC mpThe path to good governance requires a tailor-made approach that addresses the particularchallenges, vision and purpose o each company. It also must be understood in the con-text o the level o maturity o the controlling amily, its shareholders and the controlledcompanies.

Working with strangers who are managing your company and sitting in your boardroom

or the rst time might be an uncom ortable experience at rst, especially when you arenot sure o its value. This challenge was experienced thirty years ago at Suzano by MaxFe er, son o ounder Leon Fe er and ather o current board chairman David Fe er. Thedi erent stages experienced through the years helped make it possible or the organiza-tion to react in a ast and e ective way when Max Fe er died, creating a model to survive

amily uncertainties.

The Suzano Group designed a structure based on amily control and on maintaining a closerelationship with capital markets. The arrangement allows heirs o the ounders to exer-cise control through the board o directors, while management is comprised o non- amilyexecutives. The amily acknowledges that this move has enabled more potential develop-ment and expansion o the company, and protects the business rom possible intra- amilyconficts.


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O course, the extent o governance processes and structures that the company ollowsdepends on the development stage o the company and the controlling amily. It requirescare ul and gradual introduction and implementation o governance measures, which canbe improved and enhanced over time.

A big picture o the phases o Suzanos company development as shareholders involve-ment in the company evolved is shown in Table 5.7.

Table 5.7 Suzanos Development Phases

Phase Benchmarking Process

First phase (1920s-1970s) Founded by Leon Fe er at the age o 20.fHe maintains leadership until his death in1999.Management highlighted by his entrepre-fneurial style and centralization

Second phase (1970s-2001) Max Fe er joins executive management infthe 1970sDevelopment o executive managers andfheirsFirst executive president and rst non- ami-fly board director

Third phase (2001-present) Max Fe er diesfNew model o governance and manage-fment

David Fe er presides over the board withfexecutives in management

The timeline in Figure 5.8 shows the milestones in each phase o company development,the impact and next steps. On the right-hand side one can see the most recent phases othe process, culminating in the installation o a new governance structure and the sale oone o the units, generating signi cant value or the shareholders

Details o the Restructuring. In 2002, as the Fe er amilys third generation began to as-

sume more leadership, the company initiated a thorough restructuring process. The goal:to ensure that the businesses in which the Group had decided to investpulp and paperand petrochemicalswould be su ciently capitalized or long-term sustainability, able togrow with competitive costs o capital through its partnerships with the capital markets.E orts also were designed so that the businesses did not depend excessively on the con-trolling shareholders capital.

For this to happen, the two companies, Suzano Papel e Celulose and Suzano Petroqumica,had to comply with corporate governance standards consistent with best market practices.

In 2003, the Group implemented a new business model based on three pillars:

Family control: For the Groups long-term vision, reputation and values


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Pro essional management: For capital discipline and a ast decision-making processPartnership with the capital markets: To assess company per ormance on a perma-nent basis, promote the continuous practice and enhancement o corporate governancestandards and ensure business growth and development

A rst step in the Groups restructuring process: Suzano Holding began to run SuzanoPapel e Celulose and Suzano Petroqumica subsidiaries through a pro essional manage-ment team, recruited in a search that considered internal and external candidates rom themarketplace.

The new pro essional management team, comprised o highly-quali ed executives,streamlined corporate operations spread among the subsidiaries. Their e orts have re-sulted in 30 percent cost reduction, improved management per ormance, implementationo appropriate subsidiary control mechanisms, and management accountability or results.The team also implemented a new monitoring model allowing or improved monitoring oand reporting or subsidiaries.

These successes have enabled members o the controlling amily to step aside rom theirexecutive role in these subsidiaries and assume a more strategic position, minimizingsuccession-associated risks to the continuity o the Groups businesses. Some memberso the amily began to participate in the strategic management o Suzano Papel e Celuloseand Suzano Petroqumica through appointments to the boards and related managementand strategy committees, along with other Suzano Holding executives. So, the Group cre-ated processes to ensure a better balance between greater management independence

or the subsidiaries and long-term strategy or the controlling shareholders.

These improvements have marked an important change in the behavior o the controllingshareholders. A ter decades o a hands-on approach to the businesses, the controlling

amily withdrew rom day-to-day management, delegating to pro essionals and assuminga more strategic role. For members o the amily who had truly grown up in and with thecompany, this represented a huge paradigm shi t.

In the Words of the Entrepreneur: David Feffer Tells the Suzano Story 79

Understanding the enhancement o corporate governance practices in Suzano Group

demands, at rst, the rebuilding o the path since its oundation in 1924 by my

grand ather, Leon Fe er.

The implementation o the Brazilian industry in the early 1950s, more concentrated

in the state o So Paulo, was the scenario o the beginning o our industrial activi-

ties. This movement was led by important entrepreneurs, who set up amily-owned

conglomerates strongly responsible or the development o Brazilian industry.

The beginning o our activities was in the pulp and paper industry. In the 1950s,

we developed the technology or the production o pulp rom eucalyptus and be-

came the rst company in the world to produce it on an industrial scale. For that,

79 Written or UPsides, FMO quarterly magazine, Number 2, Netherlands, April 2007.


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my ather, Max Fe er, and a group o Brazilian scientists spent some months at the

University o Gainesville, Florida (USA), studying alternatives or pulp production us-

ing native Brazilian trees, since all the pulp produced at that time was based on pine

trees, common in European countries.

In the 1970s we diversi ed our activities towards the petrochemical industry since

we identi ed an important growth trend in the use o plastic in the packaging seg-

ment, an important market or the paper industry, thus seeking to keep our presence

in that segment.

My grand athers management ended with his death in 1999, at the age o 96, leav-

ing behind entrepreneurship as his legacy, which enabled the substantial growth o

our business.

Figure 5.8 Progression o Suzanos Leadership Succession and New Governance Model

Foundation of the firm byLeon Feffer in So Paulo

Leon Feffer acquires a lotof paper that remainedfrom the fire

Max Feffer joins the company

Max Feffer assumes executivemanagement

Preparation of managers

3rd generation begins to beprepared

External executive CEO

Growth, development ofexecutives and

preparation of heirs

Sale of SuzanoPetroquimica

David Feffer only inChairman role

Hired managers at bothcompanies

Improved governance:independent committees

Improvement in SuzanoPetroquimicas Board

Suzano PetroquimicaLevel 2 BOVESPA

New management model Liquidity and remuneration for

shareholders Suzano Papel e Celulose Level 1

BOVESPA

Max Feffer passes away 3rd generation in command

1924 2007

2006

2005

2004

2003

2001

1929

1950s

1970s

1980s

Source: Better Governance with Suzano data


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Then, my ather, Max Fe er, assumed command and marked his management by

preparing the Group or the strategy towards the capital market. Under his com-

mand, the Suzano Group de ned its growth plat orm, divested rom non-core assets

and ocused investment on our main businesses, which were separated into two di -

erent companies, Suzano Papel e Celulose and Suzano Petroqumica.

With my athers unexpected death in 2001, a ter little more than two years lead-

ing the group, the controlling shareholders my brothers, my aunt and my mother

unanimously invited me to assume command o the Group. I accepted and we

discussed how we would ace the uture. I said: We have two options; there is no

right or wrong decision, nor one that is better than the other. But whatever is to be

done will be de nitive. There is no turning back.

We could continue being a amily business, like in my grand athers and athers days, or become a pro essional company with a strong and clear capital market strat-

egy. In the rst case, I explained, Suzano could per ectly serve the current genera-

tion o our amily, but the uture would be uncertain because it would probably be

di cult to access the necessary resources or modernization and growth o the busi-

nesses. We need to always keep in mind that we participate in two capital intensive

companies. There ore, we could begin to ace serious di culties to invest, reinvest

and compete in the marketplace.

On the other hand, pro essionalizing the companies and rein orcing the partnership

with the capital market, would allow us to leave the 21st century better than how

we started it, also having access to competitive unding to success ully ace uture

investment challenges.

Both options were correct. The second one, however, presented another advantage:

the perspective o solid value generation, business sustainability and the mainte-

nance o the values and belie s o the ounders, who did not just think about the

present, but also the generations to come. Everybody was conscious that taking the

capital market route would entail having to live rom the results o the businesses

rather than directly rom them. Between the two options, the second one prevailed.

Despite all the changes this process has brought, the transitional phase was very

smooth and, in act, represented an enhancement o our way o doing business.

We had very sincere and realistic conversations. We closed the door to the past and

opened the gates to the uture. The basic oundation was that Suzano should belong

to all shareholders, including the Fe er amily. When we made that decision, the

di culties started to be elt. First, we requested to be dismissed rom our positions.

We needed to create a meritocracy criteria in the Group, paving the way to promote


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stronger development, to re ormulate assessment parameters and, particularly, to

treat all shareholders equally.

All these changes were very challenging. I had grown up getting ready to be the

president o the Group one day. Suddenly, I was orced to commit a kind o hara-

kiri. I le t managements ront line to take over as chairman o the board o directors

o both companies, which are responsible or de ning business policies, long-term

global strategy and or the supervision and management o executive directors. It

was not easy. The process progressed. We hired executives rom the marketplace.

We began to de ne and align strategic actions or the pulp and paper and petro-

chemical businesses counting on the support o a pro essional senior management.

In 2003, we implemented the new management model with the adoption o high

standards o corporate governance practices, based on three pillars: amily control,

pro essional management and partnership with the capital market.

Independent members are also part o the board o directors o both companies,

trans orming them into an important place or debates ocused on adding value

or the businesses. Suzano Papel e Celulose and Suzano Petroqumica are listed in

BOVESPAs special o corporate governance segments, which ensure a air, transpar-

ent and reliable relationship with the shareholders and the capital market. We cre-

ated the Audit, Sustainability and Strategy, and Management committees, which are

responsible or discussing these subjects in depth, with the goal o better support

or the board o directors in its decision making. The boards o directors at the Suza- no companies have internal rules de ning their operating procedures and guidelines

or per ormance, quali cation and assessment o their members.

We launched our code o conduct based on the ethical principles that always guided

our activities: integrity, equality, transparency, pro essional recognition, corporate

governance and sustainable development.

The bene ts o better corporate governance and the capital market strategy became

evident when we realized that the access to capital was bigger and easier, coupled with lower sensitivity to market volatility. The capital market has an additional impor-

tant role o permanently evaluating the per ormance o the company and its manage-

ment. I the results do not meet expectations, they are criticized by analysts, and in-

vestors tend to step back. It is a matter o coherence between what is promised and

what is done. I there is good management, what was promised is delivered and the

capital fows. Otherwise, the market penalizes the company. There is no way to hide

this reality. Management is either positive or negative. The capital market, naturally,

is practical, very clear and pragmatic.


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When a company adopts high standards o corporate governance, it should have

greater responsibility or results. The balance between right and wrong has a higher

importance since the control systems acquire a wider perspective, with respect to

detailed and clear rules. For Suzano Group, corporate governance is a guarantee o

the sustainability o what the ounders created. It is the evolution o a dream. We may ace di culties along the way, which are natural. But good corporate gover-

nance practices contribute to the continuity o the Suzano companies, and make its

oundations resistant to this irreversible movement called globalization. And, thanks

to these good governance principles and the good per ormance o our businesses,

the capital markets have learned to value and respect our controlling position.

David Fe er, Suzano, Chairman of the Board

Suzano Group sold its petrochemical operation to Petrobrs in 2007, creating value or itsshareholders. This would have not been possible without key improvements in corporate gov-ernance.

This chapter addressed the unique corporate governance challenges acing amilybusinesses.

F r F rther Th ght a d D sc ss

Are you a member o a amily that owns a company? I so, identi y some o themain challenges acing your company and your amily.

Are you a non- amily senior executive in a amily-owned company? List some othe main challenges acing the frm.

Based on the discussions in this chapter, name some specifc steps towards re-solving these challenges, using suggested corporate governance practices. Re-member to frst identi y the companys ownership stagestill led by the original

ounder? Are direct heirs in control? E ective actions will depend on peggingthem to the right phase in the companys li ecycle.

Governance Challenges in Family Owned Businesses

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