The Politics of Family Boards

By Peter Davis

One of the boards I serve on engages regularly in a kind of ritualistic jousting with the founder and CEO. We try to show him that he can't continue to violate the most basic of management principles and survive; he tries to show us that we don't know the first thing about the real world. Most of the time he is being defensive; most of the time we are beating up on him, believing that if we don't, the game may soon be over.

We play this game at the invitation of the CEO, who has hired us to hold his feet to the fire. He has to delegate, hire better managers, and establish controls, goals, and accountability, we tell him. He realizes that to survive, his company has to go through a culture change, but he's so immersed in the business that he can't be objective. In our crazy debates, he does pick out a few things he's willing to listen to, but progress is frustratingly slow.

I see a great deal of unhappiness with the boards of family firms — which means that a very valuable resource is being mismanaged. In most privately held family businesses, the board is a legal fiction; it never meets. There is deep resistance from family members, especially founders, to establishing the kind of structure required for a useful board. To many entrepreneurs, boards get in the way of creativity. As one owner told me, "If we had a board, they would have told us not to do the outrageously risky things we did to become successful."

Making sure a board succeeds requires hard work on everybody's part. Board members need a mission and a mandate. They need clearly defined boundaries to set off their responsibilities from those of the shareholders and management. They need managers and a CEO who realize that by sharing power, they gain power. In turn, outside directors have to appreciate that family companies are different — and sometimes impose special demands on board members.

If properly managed, a board can be a vital source of insight and support, providing an unemotional forum in which issues too hot for the family to handle alone can be thrashed out.

Many CEOs of family companies are tired of the loneliness of flying solo. Many are sick of being picked on by their families, and see the board as an island of sanity in a sea of troubles. By creating a board with outside directors, moreover, a family CEO will significantly increase his power over the nonbusiness oriented family shareholders.

The best decisions to share, of course, are the unpopular ones, especially the no-win ones like succession planning. The CEO who has children in the business may be unable to face the emotional. consequences of choosing among them. Not only can the board help him make a more objective choice, but by taking some of the responsibility for it, the board can make it more palatable to those who lose out and others affected by the choice.

Boards are also established when power has shifted in significant measure to shareholders, who need a body to represent their interests to management. In family businesses, this situation can prove to be more than a little sticky.

Boards of public companies have a hard enough time determining the criteria for judging company decisions. Should they be maximizing shareholder value, whatever that takes? Or do they have a broader responsibility to other "stakeholders" — employees, suppliers, customrs, and the public?

In practice, boards have considerable latitude to set their own policy and goals. But what happens in a family business when there are only three or four shareholders and their opinions on the direction the company should take differ widely?

That is when board members frequently get drawn into efforts to mediate share holder differences, putting themselves squarely in the middle of a family conflict. To avoid that position — invariably a nightmare — some boards may decide to ignore the shareholders and attempt to make decisions purely on the basis of "what is good for the business." That course, however, is sure to incite stockholding members of the family because it appears that the board is taking the side of management.

I recently had firsthand experience with this dilemma in a company owned by two brothers. They had taken over the business from their dad about 30 years ago and built it as partners, each performing a variety of jobs in sales and management. The younger brother had gradually become the stronger force and in recent years served as CEO. This arrangement worked because the older brother had no interest in day-to-day management and didn't feel threatened.

The older brother did, however, want to be consulted on key decisions, particularly those affecting his children in the business, and he wanted to be paid the same as his brother, as he always had been. Although his younger brother worked harder, he argued, the CEO's salary is considerably augmented by his perks. To pay him less, he thought, would relegate him to the status of a junior partner.

The issue was raised only after the brothers appointed a board of directors to help with the transition to a third generation. Through the years, the brothers had agreed they wanted to pass on the business to their children and that the company would have to adopt a "business-first" philosophy which, among other things, meant that their children could not work as equal partners, as they had; one of the new generation would be the boss and be paid more than anyone else.

The brothers appointed a board with three outside businessmen to serve not merely as an advisory body, but as a statutory board with responsibility for insuring that family issues did not interfere with good policy-making. Since the younger brother had better business contacts he, in effect, chose the board members.

The members took their mandate very seriously. One of their first acts was to set up a compensation committee, made up solely of outside directors, which soon proposed a rigorous new compensation system covering all salaries, including the brothers'. Since the younger brother works harder, his salary under the new plan would be higher than that of his older brother, whose total compensation would be cut in half.

For all his support of a business-first approach, the older brother felt betrayed, as did his kids. To this day the argument threatens to break up the partnership. If challenged in their decision, board members reply that they are simply being logical: If anyone, including a brother, works less, he should be paid less.

Yet is this correct? For the sake of the company, the board should make a distinction between the second and third generations. The two brothers came into the business as equal partners and should leave it as equal partners, with the same pay. For the next generation, however, the business-first approach has to prevail: The board, and the brothers as controlling shareholders, must affirm that their children will be paid according to their contributions, just as other employees are.

Outsiders appointed to the boards of family companies should be free to carry out their valuable role as a highly principled body providing insight and discipline for top management. But they must also know something about the values the family deems important in operating the business. It is the family's job to forge a consensus on values without involving the board, and then to give members of the board a clear mandate which, in turn, enables them to work together with the family as a team. In the long run, a board cannot function without a family consensus, and perhaps the company can't either. FB

Peter Davis, chairman of the "Family Business" advisory board, is director and founder of the Division of Family Business Studies at the Wharton School, University of Pennsylvania, where he and his staff educate and advise family firms on critical issues.

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May 1990


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