INVITED

COMMENTARIES

Is Family Governance an Oxymoron?

Harry F. Martin

Introduction
The short Websters dictionary definition of governance is, to exercise authority over; to influence the action of. The definition of oxymoron is, speech in which antithetical incongruous terms are combined. This paper examines whether successful governance of wealthy families is even possible. Successful long-term family governance only appears to be an oxymoron because relatively few multigenerational businesses and wealthy families are able to achieve it. However, stable family governance is achievable as generations pass and family members multiply. The reason effective family governance is elusive for wealthy families is that it requires establishment and maintenance of the following values and practices: 1. Culture and structure of open family communication 2. Valuing overall family over individual or family branch needs 3. Importance of demonstrated competence in assigning responsibilities 4. Effective generational succession plan for survival of family and its wealth 5. Creation of family conflict management processes 6. Creation and maintenance of an effective family governance plan Families are capable of setting up the procedures required to achieve successful long-term governance. The governance plan can continue to function well through periods of family growth in terms of number of descendants and wealth.

A solid governance plan not only takes into account the need to provide oversight for the family wealth or business, but also considers the need to cultivate and honor the human needs of family members. The human side should not be sacrificed in the interests of maximizing investment return. Over the passage of generations, the family governance model should also be subjected to review if changes are required to keep it relevant. Before moving into the governance process, lets acknowledge the bedrock framework that a family must establish before good governance can occur: good parenting. To demonstrate why solid parenting in previous generations is required before creating a viable family governance plan, consider the following analogy. Imagine trying to transplant our American democratic socialpolitical system to a country with no history of respect for human rights or individual expression, no experience with any form of stable government except chaotic, despotic rule, and no history of working together to postpone immediate self-gratification for longer term mutual gain to society. Without long preparatory effort, our democratic model would never get off the ground in such a country because the cultural-political background required to sustain it is missing. Good parenting in wealthy/business families establishes the framework in which a sound governance model can work. Good parenting means that certain values required to execute a family governance model over time are present, including:

FAMILY BUSINESS REVIEW, vol. XIV, no. 2, June 2001 Family Firm Institute, Inc.

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Martin Valuing the contribution and individuality of each family member while setting high standards of family work ethic and discipline for all Valuing open communication between family members a spirit of transparency Accepting the value of merit in determining roles of family members in governance and business Valuing the concept that the interests of the overall family and its business or wealth are more important than selfish individual or family branch needs Playing by rules established in the familys governance model ing performance of the family company or investments. Such meetings provide an open forum for family members to discuss outstanding matters with each other. The council may have key functional responsibilities, such as nomination of family directors to the company board. The family council can also serve as an educational and mentoring facility for the younger generation. Most important, it helps to create and sustain a culture of mutual trust within the family. The second area of open communication requires a regular flow of information from the family company or investment-philanthropy structure to family members. The closed mode of keeping key financial data from all but a small circle of family members should be avoided. Why should shareholders of a family business receive less information than shareholders of a public company, who get quarterly financial reports? How can a meaningful family governance process be put into place in a culture of secrecy? These two communication processes among the family members and between the family and its business or wealth structure create the knowledge and competency required by family members who will have responsible roles in the family governance model. Along with the accumulated experience of being exposed to financial results or philanthropic grants and discussing them with other family members comes some of the understanding required for good governance. Company and investment performance results become more familiar subjects for the family rather than unknown, distant data. What is really at the heart of this entire communication process is the creation of trust among family members. Openness and inclusion creates family trust, and family trust creates family harmony. 2. Valuing Overall Family over Individual or Family Branch Needs. Few issues are as destructive to effective family governance as emphasizing individual or family branch interests over the greater good of the overall family, its company, or its investments. It is common to observe in multigenerational families that

Lasting Family Governance Plan Process

This section outlines the process required to create a lasting family governance plan. Note that the process does not begin with the family governance model itself; that key stage appears last, after establishment of a number of important prerequisite values and processes. The six steps of the process follow the order of values and practices mentioned above. 1. Culture and Structure of Open Family Communication. A culture of open family communication, reinforced by structured processes, is an integral precondition to creating a successful family governance process. Other key areas of family life must have an open communication culture or process. After all, a viable family governance process cannot survive in an atmosphere of ignorance and distrust. The first place to start is communication between the family members themselves about family matters. In smaller first- and second-generation families, this communication can be achieved through annual family meetings guided by a good communication process for both family and family business matters. Families that have grown to a multigenerational stage may require a formal structure, such as a family council and/or a family office. The council meets several times a year to discuss family issues, includ92

Is Family Governance an Oxymoron? long, simmering real or imagined grievances suffered by one family branch translate into that branch regarding its governance role as a struggle for power against other branches. Once well entrenched, these fractional attitudes are hard to eradicate. The essence of successful governance of any entity is that the shareholders do not represent their own narrow interests, but the interests of all of the shareholders to ensure the best future for the organization. It is important to emphasize continually this theme of focusing on the stewardship of the entity being governed rather than on ones immediate needs. The addition of outside, independent directors to the family company, investment process, or philanthropic endeavor can also be helpful in educating family members in their broader responsibility as directors. The most powerful argument against selfish interests is that they can kill the goose that laid the golden egg. For example, what is the good of a family business furnishing jobs for or promoting unqualified family members if this results in a steady erosion of the companys value? 3. Importance of Demonstrated Competence in Assigning Responsibilities. Any sound governance process requires demonstrated competence in its directors, at least in a majority of the board members, concerning issues confronting the entity. Whereas family representation is important, without competence in the governing body, an entity will falter. The family culture required to recognize this truism must be developed. The principle of competency or best to the top should affect not only which family members are selected to a governance board, but also whether independent, nonfamily directors are required. There are structural ways in which a family can reinforce the culture of required competency, including written requirements of experience and skill for family member participation on boards. The same principle can be introduced into the family company, investment process, or philanthropies by creating written standards of employment and advancement applicable to family members. All of this is valuable in creating a culture that recognizes that a family members role in governance is subject to certain competency standards required to ensure the effectiveness of the governance process. One educational process should precede the effort to ensure that family directors have the competency required: a continuing effort to educate family shareholders in their responsibility to follow and understand their companys or investment funds challenges and ongoing performance. Informed, participating family shareholders will build the foundation for competent family directors. So far, we have discussed family governance as it applies to entities like a family business, investments, or philanthropy, where professional skills and experience are required. An equally important part of the family governance process includes governance of the family itself. This is an area where other competencies are crucial, including the ability to deal in a fair, balanced manner with family issues, including conflicts. A spirit of maturity and sensitivity in dealing with family members, particularly those from other branches or generations, are additional valuable traits. The wisdom of the seniors is extremely helpful here, and family councils and offices may have required retirement dates that are much older than those of business boards. The family should endeavor to create a culture and practice that recognizes the importance of choosing family members with these useful character traits for boards where family, rather than business, issues are the main focus. 4. Effective Generational Succession Plan for Survival of Family and Its Wealth. No family governance plan can be successful over time without the creation of a meaningful generational succession plan. It seems that more havoc is wreaked in families and their businesses by the lack of such a plan than by any other negative force. The origin of a lack of a meaningful generational succession plan is usually a controlling patriarch or matriarch who has dedicated his or her life to the business with good results, but cannot contemplate, much less provide for, shar93

Martin ing his or her power and control. Sons and daughters are played off against each other or discouraged until none of them may be actually prepared to run the business or investments. Succession plans advanced by consultants are ignored or toyed with to allow the passage of time without results. A controlling family CEO can, thus, prevent the creation of an effective family governance simply by failing to invest genuine power in the governance board. All of the meaningful responsibility remains with the patriarch or matriarch. Family members or outsiders may serve on the board, but the controlling senior deliberately limits their role. The family wealth is then at risk when the family CEO is disabled or finally passes on. Family members suffer personally, particularly the children, who are never allowed to develop the competencies and confidence required for future leadership of the family or its wealth. The situation is aggravated when the family CEO holds a controlling block of stock and the family must suffer in silence or simply leave the scene. One constructive approach to address this problem is for the family to appreciate that the company has become the entire world of the family CEO, who put so much skill and effort into building the company. Perhaps the family can assist in finding alternative vehicles for the founder/builder to use his or her energies and talents in later life. A well-established solution is to have mandatory retirement ages for the CEO and board members. Mandatory retirement at age 65 for a CEO and 70 to 72 for board members is common. Often, the best way to select the most qualified family member or other candidate for the top spot is to form a board committee comprised of nonfamily members to make the eventual selection. The process can take several years of careful consideration of candidates, including nonfamily members. The family governance role in the crucial succession process will be important even if family board members themselves do not choose the next CEO. Family values of work ethic, best to the top, and employment standards focusing on 94 ability and competence can set the stage for a future family members secession to the CEO role. The governance process can also provide promising family members in the company with the advantage of constructive mentoring from key company officers. Another important issue is the need for a succession plan for rotation of family and other members on the family council, family office board, or company board. Provisions should be made for younger and middle family members to be eligible and prepared for membership on these boards when appropriate. Without such a process, there is no meaningful overall family participation in a governance role that is reserved solely for a few senior family members. Suppose the younger generations are admitted to key family boards only when one or two key senior family members die. How can they perform their governance roles well with no preparation over the prior years? In a culture that excludes younger and middle-generation family members from the governance process, such members become cynical or disinterested, losing interest in the familys future. Let me now share a special message with my consulting colleagues. We family practitioners do a pretty good job of helping functional families establish and carry out workable family governance plans. We often have considerable trouble doing so with dysfunctional families, particularly those where an autocratic patriarch or matriarch controls the company and/or family. One of our limitations here is that many of us may need to be liked and find open confrontation with an overbearing personality difficult. This position can lead to a powerful family member merely using us to postpone indefinitely the sharing of power or control. We can be led and may ourselves lead codependent family members through futile processes where decisions are postponed forever, obviously unprepared successors are appointed who can never succeed, or no successor is ever adequately prepared. Our mission is not to be liked; our mission is to help our clients change their behavior. I believe that we have a professional responsibility in

Is Family Governance an Oxymoron? these cases either to resign and/or to inform junior affected family members that their future opportunities are limited until the controlling family member actually dies. The best options for their developing lives may be either to confront the controlling family member in a group or simply to move on elsewhere to achieve their potential. 5. Creation of Family Conflict Management Processes. To be successful over generations, a family governance process must be able to survive the inevitable points of family conflict that arise. Therefore, it makes sense to anticipate these conflict areas while creating family values and processes designed to avoid or minimize them. The following are some of the troublesome areas along with accompanying solutions. Angry, isolated family members. This is a classic risk area in wealthy families. These are the people who tend to bring lawsuits against the family, its trusts, or its company. The family value of treating each family member with respect and listening to their complaints goes a long way to alleviate these risks. When people feel included and can voice their complaints, it is often possible to work out solutions. The family governance model should provide for long and open processes of communication when any major family decision is required, such as selling the family company. Everyone should be encouraged to attend these meetings, especially those family members who may oppose the action proposed. However, the greater family should not be held hostage to a distinct minority in moving the family, its company, or its investment process forward. The open communication process should not allow one or a small minority of family members to hold up indefinitely a decision for needed change. After appropriate due process, a family majority, or supermajority, should be able to approve the change and have it enacted. No liquidity available for family shareholders. This is another constant risk point. The family governance process should provide for a transparent liquidity procedure with fair independent appraisals. If the family company or its investments limit the amount of liquidity that can be provided at any one time, then these limits should be explained to the family. The key is to have a predictable liquidity process informing the family when and how they can obtain needed cash from their shareholdings. Anger regarding why certain family members were appointed or promoted within the family governance, company, investment, or philanthropic structure. We previously considered some of the governance standards effective in dealing with this normal human reaction of jealousy, particularly virulent in family situations. Here we need clearly established family values and written standards favoring competency and merit. It also helps if the governance structure, either directly or by approving recommendations by family company management, acknowledges regularly that certain family members demonstrate the qualities required for more responsibility. This information can be appropriately communicated to the family at venues such as family council meetings, thus avoiding surprises that fuel family jealousy. Anger regarding family company dividend policies. The need for and interest in dividend flow can be vastly different between a nonworking shareholder and a shareholder in a responsible family business position. A process of education regarding the companys need for retained earnings to sustain its growth and competitiveness adds helpful balance to this issue. Outside advisors can add credibility to such family discussions. Use of skilled, trusted family advisors to mediate family conflict. Family conflict is unavoidable no matter how prudently a family prepares its governance. At times of inevitable difficulty, family advisors who have built credibility with a wide range of family members over the years can be invaluable. They can move between family branches and generations with calming advice in a manner that would not be possible for involved family members. Wise families recognize this and not only give their trustees, consultants, lawyers, and family office heads the status to oper95

Martin ate effectively within the family, but also request their help in sensitive situations, where appropriate. 6. Creation and Maintenance of an Effective Family Governance Plan. Applying the earlier dictionary definition of governance, we see that by the governance process, the family both exercises authority over and influences the action of the groups it governs, i.e., the family, its businesses, wealth, philanthropy, and so on. This process of control is the whole shebang; this governance process covers just about every overall family activity and every communal family asset. It even reaches into individual family behavior. No wonder it is so important. Effective family governance consists of and requires for its success so many distinct family value models, so many family structural procedures, so much persistent hard work and selfless commitment from many family members over succeeding generations. Why, then, is there no universally applicable family governance model? The fact is, you cant simply push a button on your PC and obtain the model that will be perfect for your family. What you can and should do is follow the good parenting practices required for a solid family base and then work through the six values and practices described above to create your own family governance model. The effort to establish a family governance plan for a receptive, highly functional first-/second-generational family will be quite different from the effort required to help a difficult multigenerational family (which may have ignored many of the above suggestions) create a meaningful governance plan. The examples of two great American families continuing their legacies well into their fifth and sixth generations illustrate how good family governance can perpetuate a familys wealth and values for well over 100 years. The CargillMacmillan family continues its role shepherding Cargill, the largest privately owned company in the United States, not by positions in senior management, but by its governance responsibilities on the Cargill board. Similarly, the Rockefeller family continues its key role in its philanthropic foundations and investments through its influence as directors of these varied entities. A lasting family governance plan can, therefore, prevent the shirtsleeves-to-shirtsleeves syndrome while creating family harmony. It demands enormous commitment, patience, and hard work from the family. Whatever the effort, it is worth it.

Harry F. Martin is the founder of Family Advisors, LLC, of Mystic, Connecticut, consultants assisting wealthy families in effectively dealing with issues of governance, succession planning, conflict resolution, parenting, and how to create a family office. This article was originally commissioned by Peter A. White of Citibank Private Banks Family Advisory Practice. 96