CEO non-duality: Is it necessary in family business?

Family businesses contribute about 70% of India's GDP. It is obvious that family firms dominate the Indian corporate sector.

Beginning April 2020, the top 500-listed entities, of which around 60 per cent are family-owned companies, shall have to ensure CEO non-duality, that is, the positions of chairperson and CEO will be held by two different individuals. The chairperson shall be a non-executive director and not related to the CEO, according to the definition of the term ‘relative’ defined under the Companies Act 2013. The term relative is very widely defined in the Companies Act 2013. Members of the Hindu Undivided Family (HUF) are relatives of each other. Relatives of a person are: Spouse, father (including stepfather), mother (including stepmother), son (including stepson) and son’s wife, daughter and daughter’s husband, brother (including stepbrother) and sister (including stepsister). Family-owned companies are jittery about the proposal that the CEO and the chairperson should not be related to each other. We should evaluate the appropriateness of the regulation in the Indian context. 

According to a research report published by Indian School of Business (ISB) in 2018, about 90 per cent of the listed companies are family firms; 64 per cent of the family firms are stand-alone family firms (SFF), and 36 per cent are family business group firms (FBGF). Family businesses contribute about 70 per cent of India's GDP. It is obvious that family firms dominate the Indian corporate sector. The average promoter holding among publicly traded Indian firms in 2015-16, according to Prowess, a database maintained by CMIE, is 55.6 per cent. And the median is closer to 58 per cent. In July 2019, of the BSE 500 companies, 100 had promoter stake above 65 per cent. Families of FBGFs hold shares in group companies through the holding company and cross-holding of shares by group companies. Promoters of SFFs, usually, hold shares through individuals and HUF. This structure helps leverage resources available within the group for the benefit of all the group companies. 

Corporate governance codes in most jurisdictions, including India, are based on the agency theory, which assumes that the manager, irrespective of whether he/she is a professional or a controlling shareholder, is a “self-interested actor”. The agency theory supports CEO non-duality, as it enhances the board’s independence, which monitors the CEO. The other competing theory of corporate governance is the stewardship theory. It assumes that individuals are motivated by the “need to achieve” and gain intrinsic satisfaction by successfully performing challenging tasks, and therefore, the manager is a good steward of corporate resources. It supports CEO duality for achieving the beneficial consequences of “unified command”. 

Credit Suisse in its report, titled The CS Family 1000 in 2018, observes that in the long term (2006 to 2018), family businesses outperformed non-family businesses in every jurisdiction, including India, and in every sector. Research shows: Promoters, who have a high financial and reputational stake in the company, focus on building “sustainable footprint, rather than making a profit”; family values determine how the business operates, deals with stakeholders, and builds trust; and family businesses are resilient. The stewardship theory better explains the promoter’s behaviour. 

There are two strong complaints against family businesses -- one is tunnelling of resources and the other is that the promoter family considers the business as its own and take decisions, which it considers beneficial to the group or the company. The current regulations to protect shareholders from abusive related-party transactions are adequate to address the tunnelling issue. Family takes business decisions and uses the board of directors primarily as a sounding board, and this might not be a weakness. Maybe, because of this, family businesses outperform non-family business over the long term. Professional managers often fail to balance short-term and long-term goals. 

Family firms will be tempted to adopt the ‘tick-the-box’ approach in complying with the new regulation. A professional CEO (not related to the family) of a family firm usually takes non-routine decisions in consultation with the promoter for the smooth functioning of the company in alignment with family values and vision, and also to protect his/her own interest. Companies will not find it difficult to appoint a non-executive chairperson who is sympathetic to the family and will consult the “shadow chairperson” outside the boardroom for every decision -- agenda-setting to conducting meetings. 

Family businesses will continue to be the key driver of economic growth. It is not wise to bring regulations, which might have a dysfunctional effect on their performance. Regulators should seriously consider exempting family firms from the new regulation mandating that the non-executive chairperson and the CEO should not be related to each other. 

The writer is director, Institute of Management Technology Ghaziabad. E-mail id: asish.bhattacharyya @gmail.com