Comparative Corporate Governance
2.3 The future of the OECD guidelines
Although the principles of the OECD are non-binding, it is ultimately a matter of self-interest for countries and corporations to assess their own corporate governance regimes and to take these principles to heart. In an increasingly integrated world characterized by highly mobile capital, investors’ expectations for more responsive corporate governance practices are something that governments and companies cannot afford to ignore.
This is not simply an issue relevant to foreign investors. Strengthening the confidence of domestic investors in a country’s own corporations and stock markets matters contributes greatly to the long-term competitive- ness of corporations and to the overall health and vitality of national economies.
2.2.2 The inefficiency of the six OECD principles
The OECD corporate governance principles, as amended in 2009, would not prevent futures’ crises. The principles are broadly stated and the comments did not provide sufficient detail to cope with all aspects of corporate governance. Their implementation remains problematic. The OECD would better integrate the core financial accounting and risk management principles as the three constitute a triad of a single reality.
For instance, requiring the board to tailor its remuneration to the cor- porate strategy and risk appetite could incite to a riskier strategy detri- mental to stakeholders. It would be recommendable if the OECD teamed up with the Committee of Sponsoring Organizations of the Treadway Commission (COSO) to explicitly link the principles with the funda- mentals of risk management and adequate financial accounting. Unless such an effort is made, the principles remain impressive on paper and illusory in practice.
2.3.1 Partnership structure
A partnership is not a taxable entity per se. That is, there is no taxation whatsoever, at the level of the partnership entity. Profit realized by a part- nership is taxed in the hands of the partners, whether there is distribu- tion or not. Treasury regulations known as the ‘check-the-box-election’
allow unincorporated entities to choose to be taxed as a partnership or a corporation. Entities which are characterized as a ‘per se corporation’ or which are actually incorporated under state law are not allowed to make such an election. Under the US Internal Revenue Code 1986 (IRC) (26 USC) Section 701 and the regulations thereunder, each partner must file an annual tax return at the end of the partnership fiscal year as agreed under the partnership agreement. The agency problem, heavily discussed, seems to have a different meaning for professional partnerships. There is no separation of ownership and control within these large accounting firms (i.e. Deloitte, Ernst &Young, KPMG, and PwC). The OECD corpo- rate principles do not fit with such business organizations. A proper set of rules would be appropriate for auditing and accounting firms, and law firms, as they are still perceived as gatekeepers protecting shareholders.
2.3.2 Family businesses
Governance in family business is just as important as in any other corpo- rate entity. Whereas the OECD principles analyze corporate governance under the lenses of shareholders and management – the agency problem – and the assumption that corporate governance is salient as it tends to reduce the cost of capital does not fit with the structure of family-owned business for at least two reasons: (i) the agency problem is or can be in existence, and (ii) the capital issue can be solved by the founding or fam- ily members providing needed cash without any market interferences.
However, family-owned business still need a sound corporate governance structure in order to promote family harmony, and operate in a transpar- ent structure where functions are properly assigned. That is, the reasons for a family-owned business to embrace corporate governance are quite different from those argued for market or shareholder-owned undertak- ings. Family-owned or controlled firms are the leading form of business in many parts of the globe: Latin America, Asia, Africa, and even Europe.
Several studies have almost concluded that family-owned firms outper- formed their listed counterparts.
A study conducted by Professor Panikkos Poutziouris over 42 com- panies on the London Stock Exchange concluded that listed family
firms outperformed their listed non-family rivals by 40 percent from 1999–2005. 4
Anderson and Reeb also concluded that family firms outper- formed non-family firms and had higher valuations also. 5
The reasons for such outperformance are:
1. Longer-term strategic focus of the controlling shareholders and man- agement, instead of operational focus on trying to beat the market’s quarterly expectations;
2. Better alignment of management and shareholders’ interests;
3. Focus on core activities. 6
Despite their role and significance in the global economy, the OECD devoted no particular principle to family-owned businesses. The OECD states that the corporate governance principles adopted in 1999, and revised in 2004, should apply to family-owned businesses irrespective of their features. The International Finance Corporation (IFC) has filled the vacuum with a Family Owned Business Handbook (2008), which provides specific corporate governance principles or solutions to family-owned undertakings. By and large, a family-owned business can meet its corpo- rate governance challenges by adopting a governance structure which is made of: (i) the family council and the other shareholders; (ii) the share- holders’ gatherings; (iii) the board of directors; and (iv) the management.
Advisory or special committees for audit, recruitment and family mem- bers’ exit remuneration could also assist the board in achieving for the firm values, mission and vision.
(i) The family council
The family council would have to develop policies for the long-term busi- ness and avoid any undue interference by family members with the man- agement. Family issues unrelated to the business per se should also be dealt at the family council.
(ii) The other shareholders
The other shareholders (minority shareholders) should be represented in the shareholders’ gatherings with equal voting rights and freedom to express their views on the course of the business. Both the family council and the minority shareholders should be vested with the power to elect the board of the directors.
(iii) The board of directors
The establishment of a board of directors in a family-owned business offers a means of safeguarding the stability and continuity of the firm. 7 The duties and responsibilities of the board must be clearly defined in the firm’s by-laws. It is also salient for the board to include non-exec- utive experts and delegate whenever necessary some tasks to ad hoc committees.
Family Council
Advisory Committee
Recruiting Committee
Board of Directors
Management Shareholders’
Assembly
Remuneration Committee
Audit Committee
Other shareholders
Figure 2.1 Structure of family-owned business
(iv) The management
The management shall emanate from the board or the shareholders’ vote.
The best practice would be to hire professional managers from outside the family circle in order to gain or bring in needed skills of a professional manager. That is not to say that family circles lack necessarily such skills.
They are too close to the business so that sometimes they miss the whole picture in terms of potential or future growth. Figure 2.1 provides a rep- resentation of a family-owned business structure.