Many listed companies in HK are family-controlled businesses. Is proposed regulation to improve corporate governance the way to go or are the rules too stringent? Discuss.
I. Introduction
Family-controlled businesses continue to thrive in the contemporary competitive environment but challenges also emerge, which means that while a number of successful family-controlled enterprises succeed, these also have to deal with many problems linked with the nature of family-controlled firms. Family-controlled business firms have similarities and differences with firms that are not family owned. Similarities include corporate governance, corporate social responsibility, and adherence to regulations. Regulations guide and support the resolution of issues experienced by family-controlled purposes to motivate these enterprises to improve management and operations as well as protect investors and other stakeholders. Differences encompass decision-making, succession, and other facets of management. Family members primarily manage family-controlled business firms so that the decision-making process would likely revolve around the familial culture of the owners. Succession would also follow the family tradition. These differences in the nature of family-controlled businesses created the issue of regulation. The concern is compliance with the management of family-controlled business firms in a manner that balances the interests of various stakeholders and not just the family. The purpose of regulations for family-controlled business firms is to protect the interest of other stakeholders based on the assumption that there is a tendency for family values and culture to overshadow the interest of other stakeholders. The issue of whether to improve regulation of family-controlled business firms involves the balance of socio-cultural factors influencing management with regulations to ensure accountability and transparency of corporate governance.
Family-controlled business firms in Hong Kong are of interest because most business firms in Hong Kong whether small or large are family-controlled companies. Apart from the proliferation of family-controlled business firms in Hong Kong, the familial culture is also clear or distinct. The family culture is traditionally patriarchal with the head of the family also comprising the head of the business and succession in the family aligns with succession in the business. Other family-based practice, quantity translates to networking in business. Socio-political networks of the family likely comprise the business network of the family-controlled business. As such, the proximity or alignment of family culture with business firms creates an environment that would provide insight into whether to regulate family-controlled business firms to improve corporate governance. The resolution of the issue involves an understanding of the operations of family-controlled business firms in Hong Kong, identification of the corporate governance problems encountered by family-controlled business firms in Hong Kong, determination of the appropriateness of regulation in improving corporate governance, and consideration of all the implications that this could have on family-controlled firms.
In this light, the research seeks to look into the issues of regulating family-controlled businesses particularly in relation to corporate governance, which is the area where problems commonly arise. Hong Kong constitutes the jurisdiction in focus because of the unique position of family-controlled businesses providing a context for an insightful investigation. The discussion commences with the definition and conceptualisation of family-controlled business firms, the issues arising from family-controlled business firms, the detailed consideration of the issue of regulation to improve corporate governance, and the conclusions on the implementation of regulation to improve corporate governance in Hong Kong family-controlled business firms.
II. Nature of Family-Controlled Businesses
A. Definition of Family-Controlled Businesses
There remains a dilemma ( 2002) in defining family-controlled business firms because of the differences in opinion on the criteria or elements of conceptualisation. The initial consensus on the definition of family-controlled business firms revolved around demographic factors including the number of members of the family forming part of the management of the firm or the percentage of control or ownership of the family. However, these elements are not sufficient to encompass family-owned business firms. Although, there are many family members involved in the management of the business or majority of control is with a family, these do not necessarily explain issues in family business such as corporate governance practices.
As such, (2005) pointed out the consensus that demographic factors such as the number of family members in the management team or the extent of control are not sufficient to describe the nature of family-controlled businesses. Many elements emerged to describe these types of enterprises. (2005) introduced intention and involvement as elements of family control of a business. Intention pertains to the plan of the family over the management and operations of the business. Even if there are many family members managing the firm, this may not be a family-controlled business when the intention is to offer for public bidding, majority of shares in the company. Involvement refers to the extent, measured by time and effort, exerted by members of the family in the business. A company, although owned by a family, may not fall as family-controlled business with assignment of management to non-family members. However, considering intention and involvement as the elements of the definition of family-controlled business firms led to the consideration of the factors that distinguish family firms as well as the reasons for the existence of family firms.
(2005) discussed influence and vision as determinants of the family owned firms. Although, these point to different but related aspects,2008) explained that these elements fall under strategic control. Strategic control finds expression in the manner of passing the business through the generations. If succession of business leadership passes from one generation to another member of the family, then the company is a family-controlled business. Succession within the family reflects the involvement of the family in the business as well as the intention for the management of the company. Involvement in the daily operations of the business also comprises an aspect of strategic control. As such, there are also overlaps in the elements comprising the definition of family-controlled business firms so that combining elements could be the key to developing a working definition of family-controlled business firms.
By combining the definitions, family-controlled business firms have a number of elements, which are 1) family ownership, 2) involvement in daily operations, 3) inter-generational transfer, 4) family influence, and 5) family control. As elements of family-controlled business firms, these comprise the determinants of family-controlled business firms relative to firms not controlled by a family. Regardless of whether the business is small, medium or large, these elements determine family-controlled business.
B. Distinguishing Characteristics
There are differences in characteristics of family business between small and medium with large business firms that could be public firms. Since the purpose of the paper is to focus on the imposition of regulation to improve corporate governance, the more important context refers to large public companies. This is because of the inclusion of shareholders have strong implications on corporate governance. This implies that the issue of regulation to improve corporate governance may not be applicable to all family-owned business firms or applicable in varying extents. The distinction of family-controlled business firms below focus on companies that have offered shares to the public.
Strategic control factors such as agency relations ( 2003) and resource control ( 2003) are the encompassing distinguishing factors for a family-controlled business. A number of control factors that differentiate family-controlled from non-family-controlled business firms. First is the control of the top 20 shareholders. This means that looking at the concentration of the top 20 shareholders of public firms determines whether the company is family-controlled. A family-controlled business firm means family members form part of the top 20 shareholders and control majority of the shares. Second is the number of shareholders. If there are only a few shareholders, the ratio of family members to non-family members who are shareholders should be close. This means that many family members are shareholder but even if only a few members of the family holding shares, the percentage of shares held by the family should be substantial. Third is the value of paid up capital relative to share ownership so that the value of paid up capital from family members who are shareholders should be high enough relative to share ownership to imply control over the company. Fourth refers to the spread of shareholders or shares so that the concentration of share ownership to family members makes the company a family-controlled business. Fifth is the chairperson, so that the chairpersons and for the duration of the business should be family members and the extent of influence of chairpersons should be strong to distinguish the company as family-owned. Sixth is the board of directors so that more family members holding positions in the board or family members exercising significant influence in the board make the business family-controlled. Seventh, is the management team led or substantially controlled by family members so that the family exercise influence not only the strategic decision-making but also daily operations. Eight is continuity of control so that the control of the company exerted by family members should persist to make the firm a family-controlled company. Control of shares of the company implies control of resource utilization because controlling interest held by the family enables influence of decisions (, 2003) on the allocation of resources or areas for investment.
III. Dynamics of Family-Controlled Businesses in Hong Kong
A. Historical and Socio-Cultural Emergence of Family-Controlled Businesses
The family constitutes the foundation of Hong Kong society so that the business environment in Hong Kong rests upon the dynamics of the family ( 1995). It is not surprising for most business firms in Hong Kong to be family owned because family relations transcend into business relations so that business practices align with family values and norms. Moreover, life in Hong Kong revolves around the family so that the members of the family commit to upholding loyalty, obligation and respect of the family, the family name, the family’s legacy ( 2004). This explains the majority control of shares in listed companies or majority control of firm decision-making and operations in other types of Hong Kong business format and structure.
(2001) explained that two concepts explain the proliferation of family-controlled business firms in Hong Kong. One is the flexibility in resource management. The establishment of a family business depends on the availability of capital and operating a family business offers flexibility in the area of capitalisation. Many family businesses start with whatever capital the family has and expands depending on the availability of capital. The business strategy is guerrilla entrepreneurship that is very hands on. Another is the minimisation of costs. Family business firms in Hong Kong involve the strong participation of family members and this decreases business costs because during the start-up family members may not receive compensation until after profit comes in. These benefits of operating a family business comprise the competitive advantages of family business in Hong Kong. In addition, (2004) explained that many Hong Kong residents, owing to their socio-cultural roots are hard working, competitive, and with strong commercial instincts resulting to the establishment of many family businesses.
The combination of socio-economic factors of the Hong Kong culture together with business start-up and management benefits explains the proliferation of family-controlled business firms in Hong Kong.
B. Trends in Family-Controlled Businesses
Statistical data on the number of family-owned business firms in Hong Kong or growth overtime do not form part of the annual statistical research for Hong Kong. This is because of the fluidity of family businesses, especially small firms. Keeping track of statistical trends is highly impossible. However, it is accepted that most of the small, medium and large firms in Hong Kong are family-controlled firms. The leading firms in the Hong Kong Stock Exchange are family-controlled companies. Six of the largest companies in Hong Kong relative to the amount of capitalisation are family-controlled firms. ( 2004)
In relation to family businesses that are also listed companies, (2004) explained that insiders commonly control 51.5 percent of the top 100 family-controlled companies in Hong Kong. This ratio of shareholdings is necessary to influence decision-making and resource control in the company. Among Hong Kong listed companies, the trend is to keep more than 50 percent or majority of shares within the family to continue control. (2006) confirm this by stating that most of the listed companies in Hong Kong that are also family-controlled are controlled by the families by retaining more than 50 percent of shares. This falls within the rules of the Stock Exchange for the minimum free float is 25 percent. As such, many family-controlled firms offer shares enough to reach the minimum but sell more only as needed for investment and expansion purposes. The management of listed family-controlled firms usually falls under the responsibility of the founder of the business or generational successors. Family members also hold strong representation in the board so that family members normally hold the positions of Chairman of the board or chief executive officer (CEO).
C. Role of Family-Controlled Businesses in the Economy
Apart from the fact that the leading large firms in Hong Kong are family-controlled, which means strong influence of families in Hong Kong’s economic growth, (1996) explained that the Hong Kong government also recognises the importance of small family-controlled businesses in sustaining the Hong Kong economy. In fact, the government formed the to take responsibility for the design and provision of management trainings for current and prospective owners of small firms. The importance accorded to family-controlled businesses is because of the impact on the economic growth, employment, and household income. Most of the business firms in Hong Kong are family-controlled, which means that economic growth lies in the hands of family entrepreneurs. As such, the government creates and sustains a business environment conducive to the growth of family businesses as well as implement sufficient regulations favourable to the growth of family-controlled business firms. Growth in family-business firms translates to overall economic growth. Thriving family businesses create employment that in turn brings income not only to the family controlling the business but also to the families of employees. Household income supports greater spending or purchases of the products and services of business firms. In effect, by supporting the growth of family businesses, the Hong Kong government ensures a continuous cycle of growth. This implies that in relation to the issue of regulating family-controlled businesses, this would necessarily consider the impact on sustaining growth of family businesses to support overall economic growth.
IV. Issues in Family-Controlled Businesses
A. Corporate Governance
Corporate governance refers to the policies, processes and systems that address the interests of various stakeholders with application in the direction and control of activities and the manner of doing activities in the company. Corporate governance revolves around good business practice and integrity. (2001) Corporate governance is a result of internal development of management practices. Although developed internally, effective corporate governance find basis on external factors such as market trends, industry best practice, and regulations or laws. The adoption of corporate governance is important because this has implications on the share price of the company as well as cost in raising investments. Corporate governance also applies to family-controlled firms, especially listed companies. Corporate governance issues relative to family-controlled firms focus on the extent that the management practices in the company address the interests of various stakeholders.
(2006) described an issue on corporate governance, experienced by family-controlled business firms in Hong Kong, as the entirety of the concerns of minority or outside investors constituting a challenge to family-controlled business firms to exercise good corporate governance. Family-controlled business firms are prone to enrichment in the interest of the family. As such, decisions are likely in pursuance of activities that would support family enrichment. On one hand, this could also beneficial to stakeholders since enrichment of the family comes from enrichment of the business since the source of income of the family is the business. This means that the interests of stakeholders to ensure business growth coincide with family enrichment interest. On the other hand, even with business growth, the interest of family enrichment could translate into issues such as accountability with the family monopolising the profit to the detriment of the interest of other stakeholders. The emergence of these issues depends on the corporate governance of the company.
Majority control of the family in corporate affairs meant the concentration of power on the family giving them control of decision-making and actions that benefit the family but could be detrimental to minority shareholders (2006). This gives rise to the issue of regulation to obligate family-controlled businesses to comply with regulatory provisions, by integrating these into corporate governance, which extend protection to minority shareholders and ensure that family decisions balance the interest of the family and other business stakeholders.
(2006) also discussed the issue of corporate governance in terms of the pay of company officers or executives. Results of the study made by the authors showed the decreasing trend in the pay received by top executives as their shares or stake in the company increases. This means that an executive director receives lesser pay in accumulating more shareholdings. On one hand, this could represent a compensating process with greater stake in the company offset by the decrease in pay. On the other hand, this could also represent a de-motivation for effective corporate governance. In addition, the pay of top executives are based on profits and not on stock returns so that stock ownership may not actually be an effective offset for the decrease in pay. This is different from the practice in other countries of basing the pay of top executives on corporate performance. This emerges as a corporate governance issue since the performance of the company and the protection of interests depends on top executives motivated to ensure the company’s good performance.
(2004) explained that board structure also constitutes an issue of corporate governance in family-controlled business firms for purposes of accountability. In Hong Kong, the Chairman of the board is commonly the CEO of the company, which means that the person holding the position becomes accountable to himself. This gives rise to the potential issue of abuse of power by the Chairman and CEO. Being accountable to one’s self means holding a position of power with limited checks. This could create issues in effective corporate governance since accountability forms part of regulations for family-controlled corporations.
(2004) also mentioned transparency and disclosure as corporate governance issues in family-controlled firms. Since majority of control rests in the owner family in many Hong Kong business firms, disclosure and transparency could become an issue, especially on the part of minority shareholders. Since family-controlled business firms follow the patriarchal family system, it can happen that not all members of the family know the decisions of the head of the family. The same applies in business firms. There is a risk that other stakeholders of family-controlled business firms may not know about decisions. Most Hong Kong firms rely on positive reputation in selecting auditing firms since this increase the semblance of transparency. However, this does not guaranty the extent of disclosure since the code for best practices are not mandatory in application to Hong Kong firms. This could become a deciding issue in regulating family-controlled businesses to improve corporate governance.
B. Succession
(2001) defined succession as the process involving the transference of managerial control of a family-controlled business firm from a member of the family to another. This encompasses the period in between the time when the dominant coalition of the family expresses the intent to go about succession until the period when the incumbent family member holding leadership position actually relinquishes the position to the selected successor. The dominant coalition could be only one person, siblings, or other family groupings. Succession has an impact on the leadership and management of the family-controlled business since a change in leadership could mean a change in corporate governance and other policies. Since succession is predominantly a family matter in family-owned business firms, the process of succession and the selected successor could operate to the detriment of the interests of other stakeholders.
(2008) discussed problems in intra-family succession that are primarily due to the lack of consideration or preparation of succession. This is especially so when the succession happens because of catalysts such as decline in firm performance or loss of key investors or business partners. These trigger succession that in turn leads to the problem selecting successors. The failure of intra-family succession is commonly due to lack of determination of the qualities, expectations and roles of the successor together with poor assessment of the needs and abilities of the successor. This becomes an issue of corporate governance because of the need for the development of policies on succession as part of corporate governance. This is necessary in order to operate in case of immediate need for transitions in leadership or management. However, the process of succession could also lead to problems, especially when other stakeholders do not agree with the process.
(2008) also explained that conflicts in selecting the family member to succeed the incumbent family member could lead to problems such as when a number of family members compete for the position. This could divide the family-controlled businesses and division does no good for the business or the interests of stakeholders. As previously mentioned, the selection of a successor should fall under the ambit of corporate governance. This means that there should be a formal process of selection and screening even if the succession is also a family matter. In the case of listed companies, the actions of the family affecting the business also affect stakeholders so that to prevent unfair practice, corporate governance practices known and acceptable to various stakeholders become necessary.
Succession constitutes a separate issue from corporate governance but this is also linked to corporate governance in terms of the composition and cohesiveness of top executives since the board may not favour the successor, decision-making with a different composition, and accountability practices among the top executives. Succession, especially intergenerational change in leadership could cause conflicts in corporate governance ( 2008). As such, the issue of regulation to improve corporate governance necessarily considers the development of internal policies on succession based on regulations or laws and best practices that considers the interests of various stakeholders.
C. Conflict Management and Decision-Making
(2008) discussed the issue of the cognitive and relation-based conflict emerging during decision-making among family members. Family members making business decisions are caught in the intertwine between familial obligations and business duties that could affect decisions and outcomes for the various stakeholders. Again, regulation emerges as a concurrent issue by providing guidelines in corporate conflict resolution and the degree of family participation or influence in decision-making. In Hong Kong, where family obligation is strong, conflicts of this nature often emerge with concurrent strength that challenges the role and sufficiency of regulations to ensure effective corporate governance based on the context of family-controlled business firms in Hong Kong.
(2008) explained the maintenance of trust among the family as an issue for family-controlled business firms. There is a positive relationship between the degree of trust among family members and business growth. However, a number of conflict also arise because of the duality of the relationship of the family members as family and as business owners involving different although linked interests and perspectives. These complex problems affect trust. This has an indirect impact on effective corporate governance since issues of accountability, disclosure, and transparency fall under the ambit of trust.
D. Corporate Social Responsibility
(2008) explained that the corporate social responsibility practice of family-controlled companies depend on three factors including commitment to the community, support of the community, and sense of community. These three factors then determine the corporate social responsibility practice that matches community expectations and creates a positive perception of the family and the company in the community. This then benefits the company in terms of social and business networks. This means that family-controlled firms usually developed a sense of good business practice based on community culture.
Nevertheless, this could also give rise to the issue of inconsistency between the developed sense of good business practice and regulations or standards. The dilemma relates to the issue of corporate governance because of the conflict that could arise between the good business practice developed by the company based on community culture and the regulations for corporate governance.
E. Performance (Profitability)
(2005) explained that family ownership affects performance following a pattern of ‘entrenchment-alignment-entrenchment’. This means that family-controlled companies primarily managed by proxies could negatively affect performance because of problems in balancing interests in the achievement of goals. When the role of the family is balanced, the impact on performance strengthens. If the role of the family on the firm becomes stronger, then the effect on performance declines. The implication on family-controlled business firms in Hong Kong is to enhance effective corporate governance practices with strong control of the business in order to address entrenchment.
(2008) discussed strategic planning as an issue for family-controlled business firms. Many family-controlled business firms have informal structures, which mean limited focus on strategic planning and management as means of facilitating performance. Lack of strategic planning explains some of the problems experienced by family-controlled business firms that adversely affect performance. This affects effective corporate governance indirectly since strategic planning has close links with corporate leadership.
IV. Regulation of Family-Controlled Businesses (15)
A. Assessment of Family-Controlled Business Regulations
(2000) discussed the regulatory framework of Hong Kong for corporate governance as comprised of statutory and non-statutory provisions. The statutory provisions include the Companies Ordinance, Takeover Codes, Securities (Insider Dealing) Ordinance, and Securities (Disclosure of Interest) Ordinance. The non-statutory regulations include all provisions under the Listing Rules encompassing the composition of the board, independent and non-independent directors, items for disclosure, disclosure processes, and other related issues.
Assessment of these regulations in terms of impact and effectiveness would provide insight into regulations on corporate governance for family-controlled business firms.
B. Proposed Regulation
This section provides a discussion of the proposed regulation for family-controlled business firms in Hong Kong particularly the provisions and the areas of corporate governance affected.
C. Advantages or Benefits of Regulation
This section discusses the benefits of regulation to family-controlled business firms.
D. Disadvantages or Downsides of Regulation
This section discusses the drawbacks of regulation to family-controlled business firms.
E. Weighing Options and Alternatives
This section provides an analysis of issues felt by family-controlled business firms in Hong Kong together with regulatory options and alternatives in the context of Hong Kong as well as in the general business context.
V. Conclusion
A. Summary
This section summarises the discussion including all pertinent points raised in the paper.
B. Conclusion
This section considers implications for family-controlled business firms in Hong Kong together with generalisations for all family-controlled business firms.
C. Recommendations
This section provides recommendations on the limitations in scope of the discussion and areas for future study.
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