The Early Succession Stage of a Family Firm: Exploring the Role of Agency Rationales and Stewardship Attitudes
(Authors: Oliver Meier and Guillaume Schier)
Research Applied précis prepared by Ken McCracken, KPMG LLP, London
This paper recounts the early stage (2000 – 2012) of succession between G2 and G3 in a highly diversified, publically traded French family business in which 51% of the voting rights were controlled by two closely related family branches. It provides a fascinating account of how decisions in the early stages of succession planning can help a transition unfold over time in a way that addresses the competing interests of key parties.
At age 55 the CEO from one of the family branches in G2, who had been in post for 20 years, decided to start preparing for succession. After discussing ideas with a non-family advisor, he built support with the founder and others in G2 for the task of passing the business to the next generation.
The family’s values made it important to build consensus about the way forward, which also presumably made practical sense given that each family branch was a minority shareholder and could not impose its preferred outcome on the other. The two branches also wanted to ensure that no harm was done to the family’s reputation when dealing with the interests of their non-family investors.
After making an early start, planning the first decision in this case was, in a sense, not to make any decisions. Instead time was taken to identify the conflicts of interest that could undermine achieving the ultimate goal of continuing family control into G3. While pursuit of continuity motivated the family to work together, it also created potential for conflict with the legitimate economic interests of the non-family investors. For example, these investors could understandably feel frustrated with the family’s attitude toward risk and investment being driven by the longer-term goal of continuity and not by maximising return in the shorter term.
Although the two main family branches wanted to work together to achieve their goal, they did not assume that their respective interests, and those of various other minority family owners, would always cohere and they identified where there was scope for further conflicts of interest. For example, under French tax law the needs of non-working minority family shareholders for dividends ran counter to the interests of family shareholders working in the business who would pay more tax on these distributions.
The various conflicts of interest in this case from the perspective of G2 are helpfully summarised in Table 1. This will be a useful reference guide for practitioners who agree with this family that it is wise to identify potential conflicts in the early stages of succession planning. The authors suggest that agency theory is a helpful way to identify these conflicts, but go on to argue that the characteristic agency theory approach of addressing them through financial incentives and various control mechanisms that are intended to align competing interests does not provide a full explanation of how this family dealt with these challenges.
Instead, they suggest that a more cogent explanation lies within the domain of stewardship theory. This theory accommodates the commitment many families have to achieving non-economic goals – in this case the main goal was continuity – and can explain how this motivates them to act altruistically, meaning to do what is needed to achieve the goal even when this is not in their own economic interest.
The family owners working in the business in this case agreed that the way to resolve conflict with the minority non-working family shareholders and the non-family investors was to buy them out:
- This enabled these other investors to cash out at a fair price, which helped preserve the family’s reputation.
- The share buy-back programmes were spread over ten years and involved careful divestiture of assets so that the family was not forced to sell more treasured assets.
- Pruning the ownership tree in this way, however, increased the stake of one of the two main branches over the other.
- The latter’s willingness to accept this apparent lop-sidedness is explained as an act of altruism to achieve continuity of the business under family control.
However, in return, the controlling branch agreed to important changes in governance:
- Representatives of the smaller branch had to be in a position in the business where they could monitor and oversee their interests.
- This involved a new two-tier board structure comprising an executive board that would run the business and a non-executive board that would oversee or monitor the executive board.
- The executive board was chaired by a representative from the family branch with the larger stake, while someone from the smaller branch chaired the non-executive board.
The authors describe this as an ‘organisational innovation’ that combined the family’s stewardship attitudes with the monitoring and control mechanism that is more redolent of agency theory. They describe this as a hybrid form of governance that had time to develop and convince the continuing family branches that it represented a workable balance of interests for their future in business together.
This organisational innovation is a good point to mention how the next generation became involved in succession planning. Four of them – two from each branch – were appointed to the non-executive board, where they were joined by seven independent members who could help educate the next generation as well as establish the role of this new board. The next generation was also kept engaged with the developing succession plan through a series of discussions, formal and informal, that actually allowed them to influence decisions about the shape of the future business that they would one day own. This inclusion helped to mitigate the risk of intergenerational conflict about business strategy.
The strategy included selling some businesses and, by the end of the process, the turnover of the business had been reduced. This commercial consequence of the family’s planning will make sense to those who respect what families are willing to do in order to maintain family cohesion and family control into the next generation. On the other hand, it might not make sense to those who fail to grasp the sophisticated interplay of economic and emotional returns on investment in a family business, which are well illustrated in this paper’s analysis of the conflicts of interest.
The authors describe this family’s relatively informal approach to planning as a ‘permanent collaborative process.’ There was no formal plan as such and instead matters were ‘…progressively discussed among the incumbent generation’ and with the next generation. Clearly, the shared vision for the future was vital in directing these discussions, holding the family together during the inevitable ups and downs of the planning process and allowing the family to react flexibly to whatever events arose.
It may seem daunting to practitioners to consider starting a client assignment by reaching for one theory of governance – agency – to identify conflicts of interest and then using another – stewardship – to quiz clients about their capacity to act altruistically in order to resolve the conflicts, but, on the other hand, the paper provides evidence of this being an effective way of forming a plan for a family business. There is no doubt that conflicts of interest that are often latent, naturally come to the fore during the succession planning process, and identifying them early has to be important to managing them well.
Apart from repeating the mantra that it is wise to start planning early, what else can advisors and families learn from this research?
- Agree as a priority the bundle of financial and non-financial reasons why the family wants to continue in business together and do not take this for granted. Had this family’s goal or vision been to sell the business and create a family office, they would have had different conflicts of interest to manage and their planning would have followed a very different course.
- Identify the conflicts of interest that could arise among different stakeholders in pursuit of this goal. Starting early will provide the time that may be needed to resolve these practically.
- If consensus decision making matters, involve the next generation in making some of the decisions that will affect their lives.
- Look for innovative ways to develop governance that will help to create a balance of interests among those who are going forward in business together.
- Use this governance to introduce the next generation to the business and to bolster their business education.
- Such governance innovations can also strengthen a planning process that otherwise needs to be collaborative and flexible in order to cope with the complexities of succession planning.
Where and when to start succession planning and then how to proceed are highly practical issues for advisors and their clients, and there is much to learn from how this family navigated its course. I highly recommend reading the following two sections of this article: The Clayron Succession: Contextual Background and Findings. The Tables and Figures in this article also provide very good summaries of the findings with great quotes from the interviews that were conducted with various participants in this case.
About the contributor
Ken McCracken is head of Family Business Consulting at KPMG UK. An FFI Fellow, Ken is the recipient of the 2001 FFI Interdisciplinary Achievement Award. He can be reached at [email protected].