Family Controlled Firms on the Stock Market : Do family-controlled firms show a convergence in corporate governance systems?

I

H

Corporate Governance in

Family-Controlled Firms on the Stock Market

[Do Family-Controlled Firms show a convergence in corporate governance systems?]

Master’s Thesis in Business Administration

Corporate Governance Family-Controlled Firms Authors: Mártires, Miguel Ángel

Sawicki, Kamil Supervisor: Cinzia Dalzotto Presentation Date 2008-06-03

Acknowledgements

We would like to express our deepest gratitude to Börje Boers who devoted his time in order to guide us and give us necessary support with writing this thesis. He was an inspiration for us and made us even more motivated and interested in the subject of our

study.

Moreover, we are very grateful to Mattias Nordqvist for providing us with a list of family controlled companies from his previous study which was a guide and a frame of

reference for us when conducting our research.

Kamil Sawicki & Miguel Ángel Mártires Jönköping International Business School

Master’s Thesis in Business Administration

Authors: Mártires, Miguel Ángel and Sawicki, Kamil

Tutor: Dalzotto, Cinzia

Date: 2008-05-26

Subject terms Corporate Governance; Family-controlled firms;

Convergence; Board of directors; Ownership structure

Abstract

Family-business is considered to be the most frequent and complex form of business organization around the world. However, recently there has been a large number of corporate scandals in such firms especially at the board level (e.g. Parmalat). Within the framework of two corporate governance models characterized by the Continental European and the Anglo-Saxon model, boards of directors hold a central position. This position becomes of great importance when talking about public companies and more specifically in public family-controlled companies. The concentration of ownership is the main characteristic of the Continental European, which is the most workable form of corporate governance for family-controlled business. Nevertheless, family-controlled companies acting under the Anglo-Saxon model have also been able to operate successfully. Therefore, we will investigate if there is a convergence of corporate governance in family-controlled companies across frontiers focusing mainly on boards’ structures and composition as well as ownership, and the sub-committees.

Purpose:

The overall purpose of this thesis is to contribute to the understanding of Corporate Governance in public Family-controlled firms which are in the Swedish and United Kingdom stock market. More specifically, investigate whether the boards’ structures and composition, as well as ownership and the existence of sub-committees show similarities or not in Family-controlled firms acting within the framework of an Anglo-Saxon and Continental model of Corporate Governance

Method:

A quantitative approach was used to fulfill the purpose of this thesis. Furthermore, the top 10 family-controlled companies with highest market-capitalization have been selected from both countries to constitute our sample. The empirical material was gathered mainly from the annual reports of the companies but also by contacting the companies by email or from articles in online newspapers.

Conclusion:

This study found that in some aspects of corporate governance convergence exists while in others it does not. Regarding board structures and composition, there is a convergence to “one tier board” and the presence of family members and employee representation in boards. On the other hand, when it comes to the sizes of the boards and number of independent directors in the boards we argue that convergence is not present.

Table of Contents

1

Introduction ... 6

1.1 Background and Problem... 6

1.1.1 Definitions ... 8

1.2 Purpose... 8

2

Framework ... 9

2.1 Family Business ... 9

2.1.1 The character of Family Ownership on the Stock Exchange ... 12

2.1.2 Corporate Governance in Family-Controlled Firms... 12

2.2 Corporate Governance Theories ... 13

2.2.1 Agency Theory... 14

2.2.2 Stewardship Theory... 17

2.3 Models of Corporate Governance ... 18

2.3.1 The Anglo-Saxon model of Corporate Governance ... 19

2.3.2 The Continental Model of Corporate Governance ... 20

2.3.3 Comparative Analysis of Both Models ... 21

2.3.4 The Case of Sweden and United Kingdom ... 24

2.3.5 The importance of Capital Market, Ownership Structure, Legal Context and Shareholders Control’s Rights ... 25

2.4 Boards Configurations... 28

2.4.1 Board size and composition... 29

2.4.2 Dual board system... 29

2.4.3 The “monistic” board system ... 30

2.4.4 The board as a mechanism for direction and control ... 30

2.5 Summary... 31

3

Method ... 33

3.6 Data Processing & Analysis ... 37

3.7 Reliability and Validity ... 38

3.8 Problems and weaknesses ... 39

4

Empirical Findings ... 40

4.1 Sweden ... 40

4.1.1 Ownership Structure ... 40

4.1.2 Board Structure and Composition... 43

4.1.3 Committees... 47

4.2 United Kingdom... 49

4.2.1 Ownership Structure ... 50

4.2.2 Board Structure and Composition... 52

5

Combined Analysis ... 56

6

Conclusions... 66

7

List of references... 68

Appendix 1: List of Swedish plc’s ... 72

Appendix 2: List of FTSE 100 companies ... 74

Figures

Figure 2.2 A typical corporation; (Neubauer & Lank, 1998). ... 11

Figure 2.3 Governance Roles in the Family Business; (Neubauer & Lank, 1998). ... 11

Figure 2.4 The Anglo-Saxon model of corporate decision-making; (Cernat, 2004). ... 20

Figure 2.5 The Continental model of corporate governance; (Cernat, 2004).20 Figure 2.6 Four Quadrant of Family-Firm Governanc: Dimensions of Market Control; (Lane et al., 2006)... 23

Figure 2.7 Focus of Board, (Hilb, 2005). ... 28

Figure 3.1 The research process ‘onion’; (Saunders et al. 2003, p 83)... 34

Figure 3.2 Indirect Ownership. ... 35

Figure 4.1 Graphic representation capital share and voting rights for each company... 42

Figure 4.2 Graphic representation of independent directors in the boards... 45

Figure 4.3 Comparison of number of independent directors to total number of board members. ... 53

Tables

Table 2.1 Characteristics of the Market and Control Models; Lane et al.,

2006. ... 24

Table 4.1 Comparison percentage in capital share and voting rights... 41

Table 4.2 Supervisory Board in Sweden ... 43

Table 4.3 Illustration of the most important aspects regarding board composition ... 44

Table 4.4 Employees representation on Board of Directors ... 46

Table 4.5 Illustration of the different committees... 47

Table 4.6 Summary of the most important findings regarding the nomination committee... 48

Table 4.7 Comparison of capital shares and voting rights in percentages ... 50

Table 4.8 Presence of Family members in the boards and their positions ... 51

Table 4.9 Illustration of the most important aspects regarding board composition ... 52

Table 4.10 Family members present in particular committees ... 55

Table 5.1 Comparison of Ownership structure ... 57

Table 5.2 Comparative analysis United Kingdom and Sweden... 61

Table 5.3 Family members in the Boards... 62

Table 5.4 Employee representation on Board of Directors... 63

1 Introduction

1.1

Background and Problem

In this chapter the background will be presented to the reader in order to create a better understanding concerning the chosen topic. Further, the purpose and definitions will be addressed.

Corporate Governance is an evolving area where in recent years its development has been driven by the need to restore investor confidence in capital market and the desire for more transparency and accountability (Mallin, 2004). Moreover she claims, that “Corporate Governance” is a relatively new phenomenon of the last fifteen years or so, but the newness of the term does not mean that the phenomenon it describes has not always exists.

Defining Corporate Governance is not easy due to the broad definitions of the term. However, based on our purpose we found it more precise to define the term according to the Cadbury report (1992) that describes corporate governance as a system that controls and directs the companies.

Public limited companies, as observed by Berle and Means (1932) cited in Cuervo (2002), brought the separation of ownership in passive owners and consequently concentrated the power in hands of the mangers. Therefore, as it is pointed out by Johanson (2006) the separation of ownership and control creates the need for corporate governance. Consequently agency-theory is perceived as the most influential theory which has affected the development of corporate governance (Mallin, 2004). The central issue is the separation of ownership and control and lack of correlation of interests between owners and managers. Therefore, this separation comprises a mechanism that ensures efficient decision-making and maximizing the value of the firm (Cuervo, 2002).

These mechanisms which solve or reduce the problems arising from the separation of owners and managers can be classified according to Fama (1980); Fama and Jensen (1983b); Turnbull (1997) cited in Cuervo (2002) as internal or external to the firm. The boards of directors, managerial compensation and control by large shareholders are examples of internal mechanisms, while the market which influences corporate control constitutes the external one. Which of the diverse mechanisms mentioned above will be used will depend on the dominant corporate governance system of a given country (Cuervo, 2002). In the economic literature two broad systems of corporate governance are distinguished, the Anglo-Saxon and the European Continental (Rebérioux, 2002).

This European System is mainly characterized according to Cuervo (2002) by concentration of ownership, where the control is exercised by large shareholders, the boards of directors are controlled by internal directors or external directors linked to large shareholders, capital markets are relatively illiquid, the implicit contracting and close personal trust relationships among managers exist, management does not face hostile take-over bids, and banks play a major role in Corporate Gtake-overnance.

On the other hand, the market-based Anglo-Saxon model is characterized by diffused ownership, control is vested in the board of directors, with external directors playing an important role, capital markets are very liquid and where, there is more protection of the Ownership rights of shareholders (Cuervo, 2002).

In the case of Europe according to Collier and Zaman (2005, p.755) “in response to historic and cultural developments, countries have a variety of different corporate governance approaches within the framework corresponding to the Anglo-Saxon or Continental model”.

In recent years the topic Corporate Governance has gained prominence as a result of the large number of corporate scandals at the board level (Hilb, 2005). As an example we can cite the case of Parmalat (family-controlled firm) in Europe or Enron in the United States. Therefore, the structures and operations of boards of directors have received increased interest from both academics and practitioners. In publicly listed companies the final court of appeal is the board of directors and therefore as it is argued by Johanson (2006, p.3) it “has raised the issue of what role the board of directors has played concerning these failures and scandals”. Consequently, the issue is getting the attention and support from international bodies such as the World Bank and OECD. Furthermore a number of member countries have launched significant reform programs domestically in the wake of corporate collapses. Reforms in countries under a market-based model are in board structures and practices that ensure that the board act separately from management and also that the board constitutes a distinct entity, capable of being objective (Lane, S., Astrachan, J., Keyt, A., & Mc Millan, K., 2006). Further, the majority of corporate governance reforms based on the Continental model have focused on the treatment of minority shareholders due to the problems of concentration of ownership. In the case of Europe, during recent years the European Commission has been very active in creating a harmonized regulatory framework. The goal is for national governance models in Europe to converge as a result of this framework. Nevertheless, the most important according to Lane, et al. (2006) is whether family-owned firms should be held to the same guidelines and standards as applied to other kind of firms because as he argued popularized corporate governance practices may be detrimental to family business. Family business is considered the most frequent form of business organization around the world Mallin (2004), Melin and Nordqvist (2007), Leach (2007). Further, as Neubauer and Lank (1998) states, there is little doubt, that family enterprises are the most complex form of business organization.

As it was mentioned above, under the Continental model there is a concentration of ownership in minority shareholders which, with the exception of the United Kingdom, are composed of family-controlled firms. According to Lane et al. (2006) family-controlled firms exhibit characteristics of the Continental model, specifically concentrated shareholder base and where family members are active in management and the board. Therefore, family-controlled firms are expected to adapt similar structures of boards of directors regardless of the country´s corporate governance system.

Hence, the question arises of whether or not Family-controlled firms adopt similar boards’ structures independently of the corporate governance system of the country where they act. Therefore, the analyses will focus on the composition of the board in family-controlled firms in two different countries with different corporate governance systems. Thus, the main task of the development of this thesis is to examine if family-controlled businesses from Sweden and the UK show similarities regarding board composition.

1.1.1 Definitions

Convergence: The similarities as far as corporate governance in family controlled businesses is considered and more specifically the similarities in boards of directors. Thus, the similarities may appear for example, in the proportion of external and internal directors within the boards. Moreover, the size of the boards or employee representatives may be additional factors that show similarities or differences between corporate governance structures of the two countries. Even though the work will focus on convergence in boards of directors some broader aspects of corporate governance will also be discussed.

1.2

Purpose

The overall purpose of this thesis it to contribute to the understanding of corporate governance in publicly limited family-controlled firms in Sweden and the United Kingdom. More specifically, to investigate if the composition of boards of directors present similarities or differences in family-controlled firms acting within the framework of an Anglo-Saxon and Continental model of corporate governance.

In order to meet this purpose, the composition of board of directors in publicly limited family-controlled firms Sweden and the United Kingdom will be examined

2Framework

This chapter aims to present the main characteristics of family firms. Further, two different theories and models will be presented in order to generate the necessary framework for our analysis. Finally, a summary of the most important aspects will be put forward to create a clear picture of the theory.

2.1

Family Business

As stated by Sharma (2004) one single definition of family businesses does not exist. Based on the purpose of this thesis, it is important to define family-controlled business. Authors such as La Porta et al. (1999); Faccion and Lang (2002), Anderson and Reeb (2003), Panunzi et al. (2006) cited in Nordqvist and Boer (2007) described the family-controlled business as a company “where a family (that is one person, or two or more persons related through marriage or blood) owns 20% of the voting stock and this firm is represented in the board and /or the top management”.

These definitional parameters of this thesis, which will be further revisited under the research methodology, are consistent with other recent studies such as the investigation of the ultimate controlling shareholders in 27 large companies around the world (La Porta, Lopez-De-Silanes & Shleifer, 1999), or the study of ownership and corporate governance structures of all family controlled firms on the major lists in Sweden (Nordqvist & Boers, 2007).

Family Business is the most frequent form of business organization around the world Mallin (2004), Melin and Nordqvist (2007), Leach (2007). Furthermore, as Neubauer and Lank (1998) state, there is little doubt that family enterprises are the most complex form of business organization.

As it is pointed out by Leach (2007), family firms are the dominant form of ownership of companies in the private sector in the United Kingdom, accounting for around two-thirds of all enterprises and half of the workforce. Nevertheless, the study carried out by Poutiziouris (2006) shows that public family-controlled firms represented only 6.2% of the number of FTSE All-Share index (all quoted companies that meet the FTSE´s eligibility criteria).

According to Neubauer and Lank (1998) the contribution of family firms to GDP as well as employment varies from 45 per cent to 70 per cent through the non-communist world. It was mentioned earlier that family firms are the most complex form of organization around the world (Neubauer and Lank, 1998). Therefore a starting point to explain this complexity is, as Nordqvist and Boers (2007) explain, the overlap of the family and the business, where the family concerns impact the business and business concerns impact the family.

Figure 2.1 Three Circle Model; (Gerscick et al., 1997).

Furthermore, Gersick et al. (1997), Taguiri and Davis (1992), Ward (1987) cited in Melin and Nordqvist (2007) described the characteristics of family business compared to other categories of organizations through the three-circle model (see figure 1). Where the three circles overlap each other the family-business is present. Therefore, they are characterized by three different spheres: ownership, the business and the family itself. These sub-systems are both separated and strongly linked (Poza, 2007). According to Melin and Nordqvist (2007) family businesses are part of a specific category of organizations which show some common characteristics and also face similar problems different from other types of organizations. However, it is possible to find different types of family business within the same category based on the three family business institutions, the ownership, the business and the family.

Considering these three different spheres, as it is argued by Ward (2004), family members will have a different perspective depending on the role they play. For instance they can be owners, managers and family members at the same time and they should be able to balance these three roles. Therefore, we can find a combination of roles, where some individuals can be managers but not owners or others can be simultaneously owners and managers leading to a situation where different people in the family business see things different depending on their perspectives (Ward, 2004). This implication of family members having different or multiple roles is supported also by Mustakallio et al. (2002) cited in Nordqvist and Boer (2007). Consequently, members of the family in family firms can hold different positions (see figure 2.2).

Figure 2.2 A typical corporation; (Neubauer & Lank, 1998).

Moreover, as argued by Neubauer and Lank (1998), the inclusion of the family dimension and the inevitable overlapping of the family with the three circles (see figure 2.3) leads to challenges that no completely publicly held corporation has to face. Thus, this is the conception of family controlled company, where the family has influence in the three circles and therefore, as argued by Neubauer and Lank (1998), this conception begins to explain some of the negative dynamics commonly associated with such organizations.

Figure 2.3 Governance Roles in the Family Business; (Neubauer & Lank, 1998).

According to Hall (2001) there is a strong interrelation between the sub-systems as a consequence of the overlap when some individuals are part of the different systems at the same time. This situation brings conflicts because the individual who acts and has a role in different sub-systems will perceive the business differently. Thus, as indicated by Hall (2001) probably the most difficult situation is to combine the roles of family member, owner and working in the business. This complexity can increase depending on how many roles the same individual holds. Consequently, next chapter will deal with the characteristics of family-business on the stock exchange.

2.1.1 The character of Family Ownership on the Stock Exchange

Nowadays, according to Nordqvist and Boers (2007) nowadays an acknowledgement exists that a majority of firms world-wide can be classified as family firms. Moreover, the presence of family-controlled firms on the stock exchanges around the world is very important, as it was documented in the study of La Porta et al. (1999). Family ownership, as indicated by Nordqvist & Boers (2007), present different characteristics from other form of concentration and dominant ownership such as, e.g. partnership, state, bank, and institutional and pension funds, typically found in the United Kingdom.

Thus, as it was argued above, the family involvement makes them different from other types of firms (see figure 2.3). According to Handler (1989), Litz (1995), Sharma et al. (1997), Chua et al. (1999) cited in Nordqvist and Boers (2007) in family firms the involvement of the family lead to multifaceted goals and objectives. These multifaceted goals could be described as long-term orientation, inter-generational continuity and an unclear governance structure where an overlap of ownership, board and top management exists (Nordqvist & Boer, 2007). Neubauer and Lank (1998) point out that the overlap of ownership, board, top management and the family explains some of the negative dynamics associated with this kind of organizations.

Furthermore, Nordqvist and Melin (2002) indicate that governance structure in family firms might not correspond with the conventional structure because a key characteristic is that family members may hold multiple roles (e.g. an owner, board member and also manager). As it is argued by Nordqvist and Boers (2007, p. 5) “commentators have pointed at family ownership and governance as a “different” way of organizing and running public firms than the managerially governed firms without dominant shareholders”.

Further, Nordqvist and Boers (2007) point out, that private family firms differ from public family firms. They advocate that publicly listed family firms face tensions or conflicts as a result of the simultaneous presence of the family and the public (minority owners, analysts, monitoring agencies, codes of conduct committees). Therefore, private family-firms do not have to address this. Furthermore, as indicated by Miller and LeBreton-Miller (2005) cited in Nordqvist and Boer (2007, p.8) “the controlling families on the stock exchange are more interested in long-term building rather than short-term dealing”

Therefore, according to Nordqvist and Boer (2007) “publicly listed family firms posit unique challenges for governing both the firm and the family”.

2.1.2 Corporate Governance in Family-Controlled Firms

As it was already mentioned in the introduction the term corporate governance is a relatively new topic and a decade ago we had hardly heard the term. Moreover, as stated by Neubauer and Lank (1998) the newness of the term does not mean that what it describes has not always existed. According to Neubauer and Lank (1998) the key elements of typical corporate governance structure are the family and its institutions, the board of directors and top management.

For the family-owned business, good governance makes all the difference. Family firms with effective governance practices are more likely to do strategic planning and to do succession planning (Neubauer & Lank, 1998). The stage of development of a family enterprise impacts the governance structure (Neubauer & Lank, 1998). This position is also held by Mallin (2004) who claims, that when a family business is at stage when it is becoming more difficult to manage it effectively impedes its efficient operation and development, it is time to develop a more formal governance structures.

Further, they also stated that once the family business has grown, the glue of corporate governance mechanisms becomes of extremely important. The Cadbury Report described in Jones and Pollitt (2004) states that; “establishing a board of directors in a family firm is a means of progressing from an organization based on family relationships to one that is based primarily on business relationships”. The board of directors is one of the mechanisms of corporate governance, holding especially in public family-controlled companies a central position (Neubauer & Lank 1998). When discussing the boards we must observe and realize that there are legal and managerial reasons for the creation of a board. Around the world, public firms are required by law to have board of directors. Further, as pointed out by Neubauer and Lank (1998) depending on the country where its headquarters are situated a firm may have different board configurations. Due to the importance of it, different board configurations will be discussed in the last chapter.

Moreover, according to Westphal (1998) cited in Anderson and Reeb (2004) when alternative governance mechanisms are weak the boards of directors play an important role in the firm’s performance. As indicated by Shivdasani (1993), Kole (1997), Gomez-Mejia, Larraza-Kintana and Makri (2003) cited in Anderson and Reeb (2004) governance mechanisms based on takeovers on the market make institutional investors and incentive compensation less prevalent in Family firms than in non-family firms. Therefore, as suggested by Anderson and Reeb (2004, p. 214) “because of the relative lack of some governance mechanisms in family firms, outside shareholders potentially rely on boards of directors to monitor and control family opportunism”. This situation is explained because the concentration of ownership among the family leads to a situation where they can have effective control over the firm and use this control to make decisions that create private benefits at the expense of minority shareholders.

Therefore, due to the lack of other governance mechanisms the minority shareholders should rely on the board of directors (Anderson & Reeb, 2004). Consequently, to explain the relationship between minority shareholders and the board of directors as a mechanism for them to protect their interests against family-controlled firms, two theories will be addressed in the next chapter.

One is the agency-theory which constitutes the most influential theory that has affected the development of corporate governance (Mallin, 2004). Secondly, the stewardship theory will be presented providing an alternative explanation.

2.2

Corporate Governance Theories

A single model of Corporate Governance is not suitable for all countries (Mallin, 2004). Corporate governance is a very complex area and depending of the stage of development

of the country in itself, its cultural traditions, legal structure, and ownership it would be more appropriate to accept one model of corporate governance that other. Therefore, one model would not be appropriate for all the countries at any given time.

Consequently, the different theories that have affected the development of corporate governance should be viewed in combination with the different factors mentioned before. These factors will have a big impact on how corporate governance will develop and be accommodated within its own country setting.

The main theory according to Mallin (2004) is the agency theory; however the stewardship theory also represents an important theory in the development of corporate governance within the framework of family firms.

2.2.1 Agency Theory

A substantial amount of research addresses the principal-agent framework. Hence, as argued by Clarke (2004) the agency theory has become in the last decades of the twentieth century the dominant force in the theoretical understanding of corporate governance. As noted by Clarke (2004); Mallin (2004); Jensen and Heckling (1976) in the agency-theory the firms are seen as a nexus of contracts among individual factors of production.

According to Mallin (2004) much of agency theory is related to corporations set in the context of separation of “ownership and control”.

Furthermore, as pointed out by Bartholomeusz and Tanewski (2006) agency theory identifies agency relationship as an act of delegation of decisions. Moreover, Mallin (2004) explains this as a relationship where one party called the principal delegates work to another party, the agent. This leads to a situation in which the agent (manager) should take decisions concerning a productive use of the assets and property of the shareholder. Thus, this relation between the agent and principal is commonly cited as “agency relationship” in the corporate governance context.

As indicated by Mallin (2004) this relationship has mainly two disadvantages. Firstly, the agent may not act in the best interest of the principal and secondly they could have different attitudes towards risk. The divergence of interest between the principal and the agent has associated some cost in order to prevent abuse, which is what has been called “agency costs”. These agency cost are incurred because the agents will maximize their own utility at the expense of their principal (Clarke, 2004).

As a result, according to Clarke (2004), Mallin and (2004), Cuervo (2002) the “Board of Directors” is seen as the essential monitoring device to minimize the problems that may be brought by the principal–agent relationship. Clarke (2004) also pointed out an executive compensation scheme to reduce agency costs and ensure agent-principal alignment.

Therefore, different mechanisms such as boards of directors and executive compensation are built to keep the interests of the agents and the principal in the same line. The board is a mechanism to communicate shareholder’s objectives and interests to managers and also to control them (Clarke, 2004). The establishment of these controls it supposed to imply that managers will attain outcomes favorable for the principal.

A basic assumption concerning corporate governances is that ownership and control are held by different individuals. However, as indicated by Mallin (2004), Bartholomeusz and Tanewski (2006), Nordqvist and Boers (2007) and Carney (2005), family owned firms present the advantage that often ownership and control rather than being split are still one and the same. Though, as stated by Carney (2005), the degree and ownership required to establish effective control will depend upon the “institutional context” in which a firm is located. He further points out that within some contexts, effective control over the firm will require an absolute majority of voting stock while in other contexts the use of dual-class shares may afford affective control with significantly less that an absolute majority of equity ownership. Moreover, he also argues that the control over the assets of the firm could also be also attained with the low ownership levels through the establishment of pyramids and cross-holdings or the existence of covenants that allow the family to appoint the CEO or board member. Therefore, as mentioned above the legal structure as well as tax, political and social imperatives have given rise to numerous adaptations in the formal ownership structures of family firms (Carney, 2005).

Consequently, Bartholomeusz and Tanewski (2006) have, as mentioned before, arrived at the conclusion that family-firms adopt different corporate governance structures which are not in line with maximizing the value of the firm. Hence, family firms have different characteristic than non-family firms in order to reduce or increase agency-cost. This overlap of ownership and control support the argument that family-controlled firms either reduce or increase agency-costs.

According to Jensen and Meckling (1976) cited in Nordqvist and Boer (2007) family-firms represent a kind of organization where the agency costs are low. The argument that family-firms reduce the agency-costs is also introduced by Bartholomeusz and Tanewski (2006), because the more concentrated ownership the greater the degree to which the benefits and costs are borne by the same owner. Others found the explanation that the well being of the family is strictly related to the welfare of the company, hence family firms have further incentives to reduce agency-costs. Family- firms also have an additional incentive to prevent atomized shareholders, ultimately reducing agency-costs (Bartholomeusz & Tanewski, 2006).

Nonetheless, Morck and Yeung (2003) argued that this is certainly relevant in economies where most of the large firms are widely held, as in the case of the United States and the United Kingdom. However, it seems to be different in other countries such as Sweden where it is common that most large firms are parts of family groups. Moreover, other studies indicate that agency problems seem to have different origins than usual agency relationship in non-family firms (Voordeckers, Van Gil & Van Den Heuvel, 2007).

Therefore, these structures give rise to their own set of agency problems. The overlap of ownership and control can create an opportunity for family members to expropriate the wealth of outside shareholders. In family firms groups, the managers may act for the controlling family but not for the shareholders in general (Morck and Yeung, 2003). This appreciation is also reinforced by La Porta (1999); Family-firms control other firms through pyramid structures but also have problems with separation of ownership and control, although not the ones we have been dealing with until now. The problem lies in a fact that firms are run by controlling shareholders and not by professional managers without equity ownership. Because of this, controlling shareholders have a seat on the boards which allow them to monitor the management and sometimes also be part of the management team.

As it is pointed out by Bartholomeusz and Tanewski (2006) the family members have an opportunity to expropriate the wealth of outside shareholders through excessive compensation, for instance, dividends, and risk avoidance and through control blocks. Family-firm groups control other firms, each of which controls other firms, which in turn control yet more firms, but are never allowed a majority of the votes in any firm in the group.

As a consequence of these characteristics Bartholomeusz and Tanewski (2006) discovered the following: they have lower proportion of independent directors than non-family firms, little proportion of outsiders on family boards and they are more likely to allow the CEO and the chair-person roles to be occupied by the same person. Nevertheless, this study was made with medium-size and not publicly held companies.

According to Anderson and Reeb (2004) under the agency-theory framework an effective board structure will require an appropriate balance between family directors’ interests and independent directors’ objectivity. Therefore, for the minority shareholders the influence of independent directors may represent an important line of defense in protecting themselves against opportunism by large shareholders (Anderson & Reeb, 2004). Consequently, as pointed out by Anderson and Reeb (2004, p.214) in family-firms “independent directors remain one of the primary lines of defense that outside shareholders can employ in protecting their rights against the influence and power of large, controlling shareholders”.

Therefore, as indicated by Anderson and Reeb (2004) family board representation increases the conflicts between family shareholders and the minority shareholders. On the other hand, too little representation of family members on the board affects the managerial monitoring and the board´s effectiveness due to the lack of the firm-specific expertise of insiders and family members. Hence as mentioned before an effective board structure will require a good balance between insiders and outsiders (Anderson & Reeb, 2004).

According to Tsai, Hung et al. (2006) cited in Nordqvist and Boer (2007) the agency-theory is not the most suitable for analyzing governance structures within family-firms. The reason, according to Mustakallio et al. (2002) cited in Nordqvist and Boer (2007), could be that family members hold different or “multiple” roles in the business. This overlap of roles leads to a situation under the framework of agency-theory, where the minority shareholders see the board of directors as a mechanism to protect themselves from the opportunism of family members. Furthermore, the explanation could be found in the overlap of owners and managers dealing with a situation in which both interests are aligned.

Consequently, according to Anderson and Reeb (2004) even though agency-theory can be used to explain the relation between founding families and boards of directors from two different perspectives, as a mechanism for the minority shareholders and also as a mechanism to align the different interests between the principal and the agent, the stewardship theory provides an alternative explanation.

2.2.2 Stewardship Theory

According to Clarke (2004) business policy and organizational theory have received strong influence from agency theory. As he argued, agency theory is mainly based in economics and simplistic human behavioral which will always try to maximize his or her utility.

Agency theory relay on the different interests between the principal and the agent. Therefore, the both interests are not aligned and such situation is not present under the stewardship theory. Under this theory, executives are motivated to act in the best interest of the corporation and owners. Thus, as indicated by Clarke (2004) a priority towards organizational rather than personal objectives exists. Consequently according to Donaldson (1990); Davis et al. (1997) cited in Nordqvist and Boer (2007, p.11) the “aim of corporate governance should thus be to find an organizational structure that makes it possible to achieve coordination in the most effective way”

Consequently, according to Davis and Schoorman et. al. (1997) cited in Norqvist and Boer (2007) the interest of both, owners and managers are aligned, seeing the managers as team players that will act in the best interest of the owners. Thus, the agent under this theory, act in a collective way seeking to attain the objectives of the organization. Contrary to the agency-theory, his/her utility is maximized through the maximization of shareholder wealth.

Therefore, the stewardship theory focuses more on structures that facilitate and empower rather that those that monitor and control (Clarke, 2004). This view is also shared by Donaldson (1999) cited in Nordqvist and Boer (2007) emphasizing that the aim of corporate governance should be to create an organizational structure in order to achieve effective coordination. As indicated by Anderson and Reeb (2004) the firm´s health is an extension of their own well being and therefore, family members will identify closely with the firm.

In order to do this, according to Anderson and Reeb (2004, p.211), family firms “will place outside directors on the board to provide industry-specific expertise, objective advice, or generally advocates for corporate health and viability”. Therefore, under this theory the emphasis is put on the counsel and advice that outside director can offer as opposed to their monitoring and controlling activities (Anderson & Reeb, 2004). Thus, the inclusion of independents directors provides external expert advice and different backgrounds, creating new visions and positive effect in the firm´s performance (Anderson & Reeb 2004).

Another important aspect when it comes to large companies and especially publicly listed firms is the process through which the directors are elected. Therefore, as it is point out by Anderson & Reeb (2004) the election of directors in large companies is delegated by the shareholders to a subcommittee of the boards of directors, which is the nominating committee. This committee has an important role because it must find the right balance in the composition of the board (Anderson & Reeb, 2004). Consequently, as it is indicated by Anderson and Reeb (2004) under the agency-theory the family will have influence on the nominating committee in order to maximize the family control of the firm resources and also limit the independent directors’ representation. On the other hand, under the stewardship theory the family will elect independent directors with different expertise and experiences and also the influence on the nominating committee will be positive for the company, not as in the other case (Anderson & Reeb, 2004).

Finally, the approaches based on the main two theories of the development of corporate governance have been discussed in order to explain the existence of boards of directors as a mechanism of corporate governance. The boards of directors constituted just one mechanism of corporate governance. Therefore, the two prevalent models of corporate governance as well as the different mechanisms under each model will be presented next.

2.3

Models of Corporate Governance

In the previous chapter the introduction of the agency theory was explained as a situation in which the owner and control is not held by the same person. As a consequence of this theory which has influenced most of other, the term corporate governance emerged. It comprises mechanisms to ensure efficient decision-making and maximizing the value of the firm. Furthermore, it was argued under the agency-theory that the board of directors is seen as the mechanism to deal with the situation of principal-agent and minimize the problems it creates. On the contrary, under the stewardship theory the behavior of agents are aligned with the interests of the principals and therefore, the board of directors is seen as a structure to achieve coordination in the most effective way.

Cuervo (2002), pointed out that to solve this problem two mechanisms can be used. These mechanisms can be viewed from two perspectives, mechanisms which are either: internal or external to the firm. Internal is found among others in the boards of directors or managerial compensation. External, however, are the market for corporate control, managers, and products and services (Cuervo, 2002). Furthermore, these mechanisms are strictly related to the corporate governances systems.

Corporate Governances systems can be market-oriented or large-shareholder oriented. As we can expect, market-oriented systems relay more on the market for corporate control while shareholder-oriented tend to use control by large incumbent shareholders (Cuervo, 2002).

According to Lane et al. (2006) as corporate governance is embedded in the cultural, legal, and financial framework of various countries, these frameworks have given rise to these two models.

Indeed, both systems constituted the two main corporate governance systems. The market-oriented control is the Anglo-Saxon model and the shareholder-market-oriented control is the Continental European system (Cuervo, 2002). Also these systems are called outsider and insider systems (Lannno, 1999). An outsider system is found in United Kingdom and United States, where the main characteristic are that; the economies have a liquid market where ownership and control rights are traded and have little concentration of shareholding. Therefore it involves companies with widely dispersed shareholder base and a majority of independent, outside board members (Lane et al., 2006).

Opposing is the inside system which is characterized by small number of listed companies, illiquid capital market and very high concentration of shareholdings in the hands of corporations, institutions, families or governments (Lanno, 1999). Therefore, one system relies on the market and outside investors for corporate control while the other uses an interlocking system of networks and committees. The family-owned business exhibits characteristics of the control model which involves companies with a concentrated

shareholder base and family members active in management and the board (Lane et al., 2006).

However, these mechanisms depend on the corporate governance systems presenting in the different countries. Nowadays, there is a wide diversity of national corporate governance models and multiple decision making procedures across Europe. Further, as argued by Collier and Zaman (2005) this diversity response to the historical and cultural development of Europe. Countries have a variety of different corporate governance between the frameworks of the two models mentioned above. However, in reality the systems do not differ to such great extent and usually the differences are in elements that one country posses and the other does not (Collier & Zaman, 2005). Furthermore, the systems classified as insider are too divergent to be just considered in one category (Collier & Zaman, 2005).

Furthermore, according to Cernat (2004) corporate governance constitutes a very complex area, where many of the variables and concepts used to describe it can fall in two main categories: capital-related and labor-related. Different ownership structures, corporate voting and the role of institutional owners among others fall in the category of capital-related, while in a labor-related we find that the main aspect is the stake holding position of labor in corporate governance.

Therefore, based on these two main categories the two different types of corporate governance will be presented.

2.3.1 The Anglo-Saxon model of Corporate Governance

The Anglo-Saxon model of corporate governance is mainly based on the market capitalism or in other words it is a market-based system (Cuervo, 2002; Lane et al., 2006). This model is mainly found in United Kingdom and United States. Consequently, as argued by Cernat (2004) looking at this model from the perspective of the capital-related features, the model can be characterized by equity holding (ownership diffuse) and a broad delegation to management of corporate responsibilities leaving the influence of the shareholders very weak. Moreover, in the aspect of the boards, configurations, there are mainly a one-tier board found under this model (Cernat, 2004).

Another important characteristic pointed out by Cernat (2004) is that minority shareholders enjoy protection because the market-oriented system develops capital market which is also supported by the legal infrastructure.

With regard to the labor-related aspect, the most important characteristic is found in that labor is not allowed to participate in strategic management decisions. The organized labor within this model is characterized by a relatively high level of heterogeneity and fragmentation.

Moreover, he also argued that employee participation has a financial aspect. Many companies within this model offered stock ownership plans, or discounted purchase of stocks in a firm (Cernat, 2004).

Figure 2.4 The Anglo-Saxon model of corporate decision-making; (Cernat, 2004).

2.3.2 The Continental Model of Corporate Governance

The continental model is rather different and the framework is based on the stakeholder theory of the firm. Therefore, this model, as argued by Cernat (2004) considers not only the interests of shareholders but also the stakeholders. In contrast to the Anglo-Saxon model, at a corporate level, the employees through trade union representations or works council take participation in the strategic decision-making process. Even though the presence of work council and trade union are aspects that could be found in some countries, as it was mentioned before, systems classified as insider are too divergent. Another remarkable aspect is that many Continental European countries provide a two-tier board. This includes the board of directors and the supervisory board. Therefore, as argued by Cernat (2004), such Continental corporate governance deals with shareholder-manager (agent) problem mentioned in the last chapter. It ensures insider supervision through different channels as it is represented in the graph:

According to Cernat (2004) this model in relation with the capital-related aspect presents an extensive cross-ownership links in corporate finance and control. Moreover, dividends are less prioritized that in the Anglo-Saxon model, the ownership is concentrated and banks play a very important role. As indicated by Cernant (2004) it is very common for banks to own significant proportion of shares as a way of controlling their major client´s economic activities.

The labor-related aspect is very important in a macro and micro-level (Cernat, 2004). As it is represented in the graphic above, the board enters into consultation with workers and the supervisory board before any important decision.

A basic assumption could probably be that there are not conflicts among the different parts, but despite these institutionalized links between workers and management, the board of directors maintains its dominant position and sometimes acts without taking into consideration the stakeholders (Cernat, 2004). Therefore, even though employee participation is promoted, the interaction is not without friction.

2.3.3 Comparative Analysis of Both Models

Under market model, independent boards play a very important role in both the level of financial and business disclosure (Lane et al., 2006). Therefore, it is of extreme importance that under a market-based model there is a monitoring approach towards the board because such monitoring of management influences the value of extrinsic motivation. According to Lane et al. (2006) the market-based model practices have a lack of two important and potentially key elements. Firstly, it does not address the board’s ability to monitor management which involves managing appropriate amount of monitoring and collaboration. Therefore, there should be a balance of both and it is this collaboration among governance actors that allows for an effective governance system. This collaborative approach is based on the stewardship theory that operates on the assumption that managers are able to personally identify with the firm, its mission and obtain satisfaction from intrinsic motivation (Lane et al., 2006).

Secondly, market-model practices also fail to address the interests of companies with concentrated ownership. Moreover, in market-based model the focus is on dispersed and inactive shareholders based on public companies, seeing the family business governance as lacking objectivity. However, as stated by Lane et al. (2006) even Family-controlled firms have a strong influence on management and the board since they have been able to successfully operate within the control model of corporate governance. Further, even in the United Kingdom and United States where the market-model is prevalent, family businesses with owners who act as managers and board members have shown to be successful (Lane et al., 2006).

Therefore, the competitive advantage of family business lies in its long term investment philosophy. Under a market-based model the shareholders tend to maintain a short-term perspective of their investments but totally the opposite happens in a control-based model where the investor value the non-financial return and long-term business health (Lane et al., 2006).

The control-based model could be for a family-owned business the most workable form of corporate governance but the focus must be on accountability. Therefore the board should have competences in order to ensure accountability. Hence, according to Lane et al. (2006) accountability in the family firm’s context involves making-decisions processes that do not sacrifice the long-term health for short-term personal corporate gain. Thus, as indicated by Kets de Vries (1993); Taguri and Davis (1996) cited in Lane et al. (2006, p.151) “family firms generally have the benefits of a strong identity and sense of unity that enable them to carry on a long-term view of the business and its sustainability”. On the other hand, there is an overlap of business, family, ownership, management and board. These are main characteristics of family firms and this may consequently damage the economy by not targeting the interests of minority shareholders which can cause the failure of the company. Therefore, the important aspect of accountability of the board in family-firms resides here.

Furthermore, based on two important dimensions; the number of shareholders and the activism of the family members on the board and management identify the process from which family firms can start to move closer to the market model (Lane et al. 2006).

Looking for the perspectives of number of shareholders in the firm and the activism of them, it is found that a typical family owned-firm present a very low number of shareholders and very high activism, as it is shown (figure Quadrant 1). Therefore, for a typical Family-owned firm in order to achieve accountability under the control model there should be a focus on achieving a competency-based board (balancing monitoring and collaboration).

Once the ownership becomes more widespread, family-business begins to move closer to the market model. Therefore, it is in this moment that control mechanisms such as independence, discipline and objectivity are needed, because otherwise family-controlled companies will lack the ability to align management with ownership. In such situation the identities of the family and the business can become distanced and therefore, the company may start to loss one of the strategic advantages (Quadrant 4). This is probably the situation in public family-controlled firms, where the ownership becomes widespread but the family is still active in the business.

Moreover, according to Lane et al. (2006) there are two other ways how family businesses migrate from the control model of corporate governance. One is when the family becomes passive investor and it does not have an active participation in management. Secondly, when family remains active in the management or board, but the family expands and become less unified. This type as it is described by Lane et al. (2006) is very unstable, because this lack of unity can derive in a high risk of failure or can create the sale of shares of the company.

Figure 2.6 Four Quadrant of Family-Firm Governanc: Dimensions of Market Control; (Lane et al., 2006)

As a final point, the conclusion is that no single corporate governance can account for the many configurations of families, shareholders and business conditions (Lane et al, 2006). Moreover, one of the main characteristics of a control model is the concentration of ownership. Consequently this might be the main reason of why this model is more suitable for family firms.

Nevertheless, there are other aspects very relevant which have an important role in the concentration of ownership and as a consequence the different ownership structures. The main aspect probably is found in the different legal systems within countries and different mechanism which can be employed within these legal systems. As pointed out by Mallin (2004) the key element which has direct influence on the type of ownership and control structure is the legal system. These aspects will be discussed in the next chapter together with the ownership structures and the capital markets.

Finally, to leave this chapter with a clear picture concerning the main characteristics of the two models discussed before the main aspects are summarized below.

Table 2.1 Characteristics of the Market and Control Models; Lane et al., 2006.

Control / Continental Model Setting Setting

Prevalent in UK, US Prevalent in continental Europe, Asia, Latin America More reliance on public market More reliance on public market

High ownerhsip liquidity Illiquid ownership Shareholders are anonymous investors, not managers

Widely dispersed shareholders

Shareholders only have financial connections to the company

Elements of Governance Elements of Governance

High level of disclousure Secretive

Focus on shor-term strategy Focus on long-term strategy

Independent board members Shareholders with control rights in excess of cash flow rights Shareholders view company as one of many aspects held Shareholders have connections to the company other thatn fiancial Ownerhsip and management are separate and at arm´s length (i.e., managers,board memebers, family)

Inside board members

Ownership and management overlap significantly

Concentrated shareholders base often overshadows minority shareholders

Shareholders view the company as more that an asset and as interested in financial and non-fiancial returns

Market / Anglo-Saxon

2.3.4 The Case of Sweden and United Kingdom

Nowadays, there is a wide diversity of national corporate governance models and multiple decision making procedures across Europe. This diversity, as argued by Collier and Zaman (2005) responses to the historical and cultural development of Europe.

As we pointed out before, the different corporate governance systems must be viewed in conjunction with the legal system, the capital market and the ownership structures. In Europe, as it was introduced before, countries use different corporate governance between the frameworks of two models.

Therefore, our intention is to present some ideas about these three aspects and not go deeper into it because they constitute a very complex area which is not our primordial focus. Furthermore, it is important to headline how these factors interact in the two countries since that constitutes the purpose of our analysis within the two models of corporate governance.

2.3.5 The importance of Capital Market, Ownership Structure, Legal Context and Shareholders Control’s Rights

According to Lanno (1999) the problem is that the “systems” are not different to a big extent and therefore, the differences in reality are only in the degree or in elements that one country possesses. Moreover, the systems classified as insider cannot be considered in one category because they are very divergent. Therefore, in Europe each of the continental European systems has to a different extent some elements of the outsider system. Depending on which point of view is used, some countries, in the legal aspect for instance, are very close to the Anglo-Saxon but very different in the development of the financial markets.

Therefore, as indicated by Lanno (1999), Sweden has a relatively large number of domestic listed companies and high stock market capitalization, which are characteristics of the outside system. The United Kingdom, as it was expected, is the country within the European Union with most domestic companies listed on the stock market. The capital market constituted a very important side of how corporate governance is developed. This constituted one way in which firms can finance investment, e.g. through the issue of equity capital (Lanno, 1999).

As we defined before an outside system relies on the markets and outside investors for corporate control while and insider model uses a system of interlocking networks and committees (Lanno, 1999). This perspective was also explained by Cuervo (2002) where he emphasized that a market oriented system relies on the market for corporate control to solve the corporate governance problems. In the other way the “inside system” tends to use large shareholders to align the behavior of managers and owners. Ownership and control are infrequently traded and high concentration of ownership and control are in hands of corporations, institutions, families and government (Lanno, 1999). This position is also defended by Reberioux (2002) who emphasized that equity holders are normally in a weaker position because of the different mechanisms that large shareholders tend to use in order to keep control over firms, reflecting an insider control.

The main differences are found in the level of capitalization and the ownership changes in the companies. According to Lanno (1999) despite the integration of the European markets, the side of the stock market in terms of capitalization falls far below the levels in the United State. The only countries which reach the Anglo-American standards are United Kingdom, Sweden the Netherlands and Switzerland.

A part of this difference in the market capitalization is influenced by ownership changes in the companies constituted another important point to consider. In a market where many companies are quoted and the shares are traded, the level of take-over will be high and therefore, it ensures that shareholders´ and managers´ interests converge. On the contrary is the situation in an “inside system” where the level of take-over is very low. In the European Union the British companies dominate in the take-over market (Lanno, 1999). Therefore, the market can exercise control over the companies if it is an open system, but as in the case of Sweden, Denmark, Finland, France and the Netherlands, there are some mechanisms that management can employ to prevent hostile take-over and therefore, it may limit the role of the market in the exercise of corporate control. These mechanisms together with the structure and concentration of shareholding constituted the elements that limit the control of the market, especially in those countries. Regarding the structure and

concentration, in the case of UK the largest share owners of quoted companies are institutional investors (pension funds, insurance companies, banks while in Sweden family-controlled firms dominated the stock exchange (Nordqvist & Boers, 2007).

As pointed out by Mallin (2004) the key element which has direct influence on the type of ownership and control structure is the legal system. This is reinforced by the study carried out by La Porta, F.; Lopez de Silanes, F.; Vishny, R. (1998) where they found that the strongest protection of shareholders is found in common-law countries while the civil-law countries showed the weakest protection. Scandinavian countries’ civil-law are situated in the middle.

They have observed that these differences in laws among countries are consequences of the legal origin. The civil law is the oldest and it has been the most influential, therefore, it is the most common to be found around the world (La Porta et al. 1998). The common law system builds on England´s medieval laws while the civil law system is based on Roman law. However, in many countries, especially where there is a civil law code as opposed to common law, the protection of minority shareholders is not effective and so there has been less impetus for a broad shareholder base (La Porta et al. 1998).

In the case of Scandinavia, as argued by La Porta et al. (1998), these countries posses some similar characteristic to other countries with civil-law but also they keep some elements that make them different from the rest. On the contrary, “the common-law includes the law of England and those modeled on English law” (La Porta et al. 1998 p.1119).

Under a law legal system such as in the United Kingdom, there is a better protection of minority shareholders’ rights and therefore, shareholders are very well protected. On the contrary, in a civil law system there is not protection of shareholder minority. Thus, it encourages another type of shareholder base and therefore, environment is more conductive to fewer family owned firms.

Therefore, the differences in ownership structures found an explanation in the differences in the legal protections of the investors (La Porta, 1998). In countries with a civil law system there is more codification but weaker protection of rights, hence there is less encouragement to invest. Therefore, the legal system is very important because when investors provide external financing to a firm they receive control rights in exchange. According to Shleifer and Vishny (1997) the main differences between corporate governance around the world are found in the nature of legal obligations that managers have to the financiers, as well as how courts interpret and enforce these obligations. Further, as he pointed out the most important legal right shareholder has is the right to vote on the important matters but the exercise of this right will depend on the legal extent and the court protection of shareholders rights.

This view is also shared by La Porta et al. (1998) where in their study they showed that some legal systems present in some countries favor minority shareholders through different mechanisms while other countries posses a package of laws more protective for shareholders. Within these mechanisms one can find: accumulative or proportional voting for directors; deposit of shares before shareholding meeting; if the shareholder must show up in the general meeting or not; the percentage of share capital needed to call for an extraordinary shareholding meeting; one share-one vote rule (La Porta et al. 1998)

Concerning the management mechanism, which is very common in Sweden, it reduces the control of shareholders in public limited companies since it is the establishment of voting