The New Development Era of Sri Lanka
Welcome to the forty eighth edition of this regular column.
Here in this column, we discuss a wide range of topics around Information and Communications Technology (ICT) and Business Process Outsourcing (BPO) as well as about Business in general, Education, Entrepreneurship and the Society at large.
Last week we talked about one of the most fascinating organisations in the world, ‘Semco’ which is a delightful organisation to read about as it breaks traditions and norms, and provides a completely ‘out-of-the-box’ experience. We will move out of that world this week and focus our attention on a more academic study. It’s about corporate governance specifically in the family business sector. It is always claimed that corporate governance in family businesses (and small and medium sized companies in general) is poor. But any organisation, even a company like Semco that has a completely different culture needs some kind of governance in place.more
What is corporate governance?
International Financial Corporation defines it as:
"Corporate governance refers to the structures and processes for the direction and control of companies. Corporate governance concerns the relationships among the management, board of directors, controlling shareholders, minority shareholders and other stakeholders. Good corporate governance contributes to sustainable economic development by enhancing the performance of companies and increasing their access to outside capital"
What is a family business?
Family business is a common concept in Sri Lanka, although how exactly you define a family business can be subjective. Therefore it is important to define what a family business is in the context of this analysis. One way to define a family business is a one with a dominant shareholder. By this definition, Microsoft is a family firm, although Bill Gates hasn’t indicated an intention to pass control on to his children. Another way to define them is the companies run by heirs of the people previously in charge or by families that are clearly in the process of transferring control to heirs.
In family settings, Bartholomeusz and Tanewski carried out a research in 2006 and found out that family firms adopt significantly different corporate governance structures to non-family firms. There was evidence to suggest that these ultimately impact on firm performance. The practical implications of these findings indicated that in order to improve firm performance and maximise firm value, the owners need to adopt more transparent corporate governance structures and be controlled by greater discipline of independent monitoring. This also involves better disclosure.
In my personal experience, some family firms have almost no independent monitoring from a governance perspective. This is even true when one close family (e.g.: husband and wife) owns 100% of the shares.
Bartholomeusz and Tanewski also found that both shareholders and investors believe that executive compensation is a key board-performance indicator. The way a family firm remunerates its executives is a test of whether the board is working in the interests of shareholders or not. The researchers suggest the Company Board takes more ownership in family business settings regarding the executive payment. However, the real problem would be the lack of proper board activities in a typical family business as decisions on direction are taken in a more informal manner. This is the usual Sri Lankan scenario, where most family businesses don’t maintain professional Corporate Board activities.
These researchers also found evidence that family firms are likely to have a lower proportion of independent directors on their boards. Furthermore, family firms are considerably more likely (than nonfamily firms) to allow the same person to hold Chief Executive Officer (CEO) and Chairman roles. These findings suggest that families maintain a close control with little opportunity for external discipline. Further evidence was produced to suggest that the compensation of family firm CEOs is less sensitive to prior performance.
As the wealth of the family is directly tied to the future of the company while decision making is on much longer term basis compared to other firms, researchers such as Chami and James have indicated that family businesses more strictly adhere to wealth maximisation than their counterparts. Family controlled businesses usually work in tandem with families having longer time horizons than public shareholders or professional managers, which from a vision based governance perspective, is a positive. These together with the benefits of selflessness suggest that family control is a cost-reducing mechanism. This is fairly correct because owners always pick the lowest cost option in family business although as an employee someone would have picked the more comfortable solution simply because it’s someone else’s money.
A few researchers studied Swedish businesses and found out that family firms do take risks while they are engaged in entrepreneurial activities. However they take risk to a lesser extent than their non-family counterparts. They also found that risk taking in family firms is negatively related to performance. From a governance perspective, this is a key concern. This could be because of a lack of risk management in place and I suggest we consider doing this even in small setups.
In another perspective on organisational performance and family control, in 2001 Yeh, Lee and Woidtke researched Taiwanese businesses and found family-controlled businesses with low levels of control have weaker performance than family-controlled firms with high levels of control. The results suggest that high levels of family ownership and low levels of family board representation are effective ways for family controlled businesses to mitigate the separation of cash flow rights and control. This is a good recommendation for implementation and I see it also as a good way of training young family businessmen. Usually, the father hands over the business to his son/daughter at a young age and they wouldn’t have had proper training on governance. So, increasing external board representation could help in teaching these inexperienced ones who wouldn’t have that exposure otherwise.
To improve business performance and firm value, we need to adopt more transparent corporate governance structures and bring in a higher level of independent monitoring. The boards of our businesses need to take more control over executive remuneration. Risk taking seems to be less in family businesses. As most of the investments going into business are actually family wealth, they take extra caution when investing which decreases the risk appetite. This may slow down the business growth, and the opportunity here may be to consider bringing in more external investors. This has the added benefit of increasing the independence of the Board. Implementing a risk management framework under the guidance of the Board is important. Lower representation for the family on the board is better while keeping the control at a higher level. For matured family businesses, all these can be underpinned by a clearly documented board charter.
Research in Sri Lankan Universities
Let’s move to a bit of a different topic now.
One of the topics we discussed in this column over the last few months has been around the university sector. The week before last, I wrote about the need to liberalize our university system and that had attracted attention and comments. I have always been advocating that research activities in Sri Lankan universities need to be improved. If research doesn’t take place, technically it can’t be a university as new knowledge is not generated in that establishment.
Minister of Higher Education S.B. Dissanayake has said at the Sri Lanka Economic Summit 2011 organised by the Ceylon Chamber of Commerce (CCC) in Colombo, last week that Sri Lankan universities should research to increase our high tech products’ share in exports as it is only around 1.5 percent of our total exports, said. The value of the world tea trade is only $ 8 billion, while figures for coconut and rubber are $ 20 and 25 billion. On the other hand, the value of the world electronics industry is $ 1,800 billion, while trade in products such as IT, telecommunication, nano-technology, and bio-technology products generate $ 2,000, 2,500, 200 and 100 billion respectively.
Sri Lanka exports a large quantity of vital minerals that are used in high tech industries in raw form and universities should focus on research to add value to these products, he said. Today, we need new high yield seeds, machinery for agriculture, pharmaceuticals, marketing and administration systems. University academics should carry out research in these areas as there are ample opportunities in these areas, he said.
Sri Lanka ranks 82nd out of 140 countries in the latest Knowledge Economy Index (KEI) published by the World Bank which indicates the extent we need to progress. University education in Sri Lanka is dominated by the State and it is unable to meet the demand and the quality required by the labour market.
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See you next week!
Yasas Vishuddhi Abeywickrama is a professional with significant experiences. He was recognised in 2003 by CIMA (UK) as an up and coming business leader for the future. In 2009 he was named the Young Professional of the Year by Professions Australia. Yasas has a bachelor’s degree in Computer Science from University of Colombo and a Masters degree in Entrepreneurship & Innovation from Swinburne University in Australia. He has worked in the USA, UK, Sri Lanka & Australia and being trained in the USA & Malaysia. He is currently involved in the training organisation, Lanka BPO Academy (www.lankabpoacademy.lk). Apart from this column, he is a regular resource person for ‘Ape Gama’ program of FM Derana. Yasas is happy to answer your relevant questions – email him at email@example.com. Courtesy - The Island