Co-cre­at­ing the Fu­ture: The Dawn of Sys­tem Lead­er­ship

Rotman Management Magazine - - FEATURES - By D. Kiron, N. Kr­uschwitz, K. Haanaes, M. Reeves and S. Fuisz-kehrbach and G. Kell by P. Senge, H. Hamil­ton and J. Ka­nia

The sys­temic chal­lenges we face are be­yond the reach of ex­ist­ing in­sti­tu­tions. We sorely need

more sys­tem lead­ers.

Af­ter more than 10 years of mea­sur­ing and rat­ing board ef­fec­tive­ness in widely-held Cana­dian pub­licly-traded com­pa­nies, the Clark­son Cen­tre for Board Ef­fec­tive­ness (CCBE) pub­lished a re­port in 2013 about the per­for­mance of fam­ily-con­trolled cor­po­ra­tions. Our key find­ing sur­prised many peo­ple: over the 15-year pe­riod from 1998 to 2012, Cana­dian pub­licly-listed fam­ily firms out­per­formed the S&P/TSX Com­pos­ite In­dex by a to­tal of 25 per cent.

Given that fam­ily-firm boards are run quite dif­fer­ently from those of widely-held com­pa­nies, this out­come en­cour­aged us to re­con­sider some of our core as­sump­tions about what con­sti­tutes ‘good cor­po­rate gov­er­nance’. We wanted to un­der­stand how that im­pres­sive per­for­mance was achieved, and we now be­lieve the an­swer is that a longer-term per­spec­tive is quite lit­er­ally baked into fam­ily firms’ DNA.

Pub­lished an­nu­ally, our Board Share­holder Con­fi­dence In­dex (BSCI) mea­sures boards’ adop­tion of rec­og­nized best prac­tices and trans­par­ent com­mu­ni­ca­tion. BSCI scor­ing met­rics are chal­leng­ing for even the most cut­ting-edge is­suers; but for fam­ily firms—whose ap­proach to gov­er­nance is so dif­fer­ent—it is sim­ply not pos­si­ble to achieve a high rat­ing. For ex­am­ple, us­ing the 2014 BSCI cri­te­ria, hav­ing a ‘dual class share struc­ture’ and a few (but not a ma­jor­ity of) non-in­de­pen­dent di­rec­tors — typ­i­cal for fam­i­ly­owned firms — loses a can­di­date up to 17 points right off the bat, au­to­mat­i­cally ty­ing them for 50th place on the rank­ing.

In 2014, the high­est ranked fam­ily-con­trolled cor­po­ra­tion in the BSCI was Maple Leaf Foods Inc. (MFI), which ranked 46th out of 242 is­suers. MFI did rea­son­ably well be­cause it has adopted prac­tices more typ­i­cal of a widely-held is­suer than a fam­ily firm. For ex­am­ple, the only non-in­de­pen­dent di­rec­tor on its board is the CEO and con­trol­ling share­holder, Michael Mccain. Af­ter MFI, the next high­est ranked fam­ily firm was Sa­puto Inc., in 101st place.

Given that Cana­dian fam­ily firms are among the best per­form­ers in the coun­try — and also ap­pear to be rel­a­tively re­sis­tant to ma­jor blow-ups — the fact that they were con­sis­tently rank­ing to­wards the bot­tom of our rank­ing de­served ur­gent at­ten­tion. The re­sult: the world’s first fam­ily-firm board rat­ing.

In 2014, we in­ter­viewed di­rec­tors and ex­ec­u­tives rep­re­sent­ing 21 fam­ily-con­trolled and pub­licly-listed is­suers, and found enough ev­i­dence to sup­port the cre­ation of a new fam­ily firm board ef­fec­tive­ness in­dex, which we named The Long View — re­flect­ing the clear ad­van­tage that fam­ily firms have in avoid­ing the temp­ta­tions of short-term gains. The Long View will mea­sure fam­ily firms against cri­te­ria that are specif­i­cally tai­lored to their gov­er­nance re­al­i­ties, pro­vid­ing a frame­work to com­pare them against each other, rather than against the norms of wide­ly­held is­suers.

The process of de­vel­op­ing the rank­ing be­gan with a philo­soph­i­cal ad­just­ment, as many BSCI cri­te­ria re­flected gen­er­ally ac­cepted gov­er­nance con­cerns, in­clud­ing the be­liefs that:

• Highly in­de­pen­dent boards and com­mit­tees help to en­sure ap­pro­pri­ate and im­par­tial over­sight of strat­egy, oper­a­tions and man­age­ment;

• En­hanced dis­clo­sure of ex­ec­u­tive com­pen­sa­tion leads to

a level of rigour that can with­stand ex­ter­nal scru­tiny; and

• Ma­jor­ity vot­ing poli­cies pro­vide mi­nor­ity share­hold­ers with greater in­flu­ence over the com­po­si­tion of the board of di­rec­tors, who are their key rep­re­sen­ta­tives.

For our inau­gu­ral rank­ing, we se­lected 24 cri­te­ria against which we scored 37 Cana­dian fam­ily firms. Some cri­te­ria from our orig­i­nal rank­ing were in­cluded with­out any ad­just­ment, while oth­ers were in­cluded with slightly dif­fer­ent def­i­ni­tions or thresh­olds; still more were de­vel­oped specif­i­cally for The Long View. The full method­ol­ogy can be down­loaded from our web­site: rot­ Fac­ultyan­dresearch/re­search­cen­ters/clark­son­cen­tre­forBoard­ef­fec­tive­ness

Fol­low­ing are three key ar­eas where the The Long View is cri­te­ria dif­fers ma­te­ri­ally from our orig­i­nal rank­ing for pub­licly-held firms.

1.Ceo/chair Split is Not Re­quired. The trend of split­ting these roles has pro­lif­er­ated across Canada over the past 20 years, but as in­di­cated, it is not the norm with fam­ily firms: ap­prox­i­mately 65 per cent have ei­ther cho­sen not to split these roles or have ap­pointed a non-in­de­pen­dent fam­ily mem­ber to serve as Chair of the board. Our in­ter­views re­vealed that this is be­cause they be­lieve a fam­ily mem­ber — as a rep­re­sen­ta­tive of the con­trol­ling en­tity — is best po­si­tioned to guide the board in its strate­gic de­ci­sion mak­ing. Although they are less likely to split these roles, fam­ily firms are deeply con­cerned about the in­her­ent con­flict-of-in­ter­est that this struc­ture presents. As a re­sult, most have ap­pointed an in­de­pen­dent Lead Di­rec­tor, and have em­pow­ered this in­di­vid­ual to fully mon­i­tor and en­sure the in­de­pen­dent op­er­a­tion of the board.

2. Di­rec­tor In­ter­locks Are Ac­cept­able. A ‘di­rec­tor in­ter­lock’ oc­curs when two di­rec­tors sit on two dif­fer­ent public boards to­gether. Both of our rat­ings al­low for no more than one di­rec­tor in­ter­lock per board, in or­der to re­ceive full marks; but in the case of The Long View, there are no lim­its on in­ter­locks be­tween af­fil­i­ated public is­suers. For ex­am­ple, if two di­rec­tors sit on the board of a fam­ily firm as well as the board of its pub­licly-listed sub­sidiary, this does not count against their rat­ing. Only those firms with more than one di­rec­tor in­ter­lock with non-af­fil­i­ated cor­po­ra­tions re­ceive a de­duc­tion in The Long View.

In our in­ter­views, fam­ily firm board mem­bers ex­plained that it is of­ten of great ben­e­fit for them to have a small num­ber of di­rec­tors who sit on mul­ti­ple af­fil­i­ated boards. This ar­range­ment helps to en­sure that the strate­gic and fi­nan­cial in­ter­ests of each en­tity are suit­ably aligned. It also en­ables a more ef­fi­cient flow of in­for­ma­tion through­out the group of com­pa­nies. As op­posed to in­ter­locks be­tween widely-held cor­po­ra­tions — which can present the risk of de­ci­sions be­ing made in the in­ter­ests of an en­tirely sep­a­rate en­tity — in­ter­locks within a fam­ily firm’s larger cor­po­rate struc­ture can present a gov­er­nance ben­e­fit.

3. Reg­u­lar Meet­ings With­out Man­age­ment. Al­low­ing di­rec­tors to meet with­out man­age­ment present is a sim­ple yet highly ef­fec­tive gov­er­nance mech­a­nism. Ac­cord­ing to many peo­ple we spoke to, it may be the sin­gle-most im­por­tant prac­tice to en­sure that fam­ily firm boards make ef­fec­tive and in­de­pen­dent de­ci­sions. For The Long View, credit is given as long as in­de­pen­dent di­rec­tors meet with­out man­age­ment at ev­ery full board meet­ing. If the board holds a strictly trans­ac­tional meet­ing — i.e., to sim­ply ap­prove a sin­gle item that has al­ready been dis­cussed — we do not ex­pect the board to hold an ‘in cam­era’ ses­sion with­out man­age­ment.

In clos­ing As with our first BSCI rat­ing in 2002, the inau­gu­ral Long View scores will not be pub­lished, in or­der to pro­vide suf­fi­cient op­por­tu­nity for us to com­mu­ni­cate fur­ther with fam­ily firms and de­ter­mine how to im­prove the rat­ing. In Jan­uary 2016, the re­sults of the sec­ond Long View sur­vey will be pub­lished on the CCBE web­site.

Over time, The Long View will evolve, as the BSCI has, to in­clude new and more nu­anced cri­te­ria that rep­re­sent the ev­er­chang­ing land­scape of cor­po­rate gov­er­nance. In com­ing years, it is our hope that fam­ily firms will no longer be frowned upon with re­spect to their cor­po­rate gov­er­nance. We also in­tend to in­cor­po­rate the lessons we learn from these or­ga­ni­za­tions into the broader dis­cus­sion of cor­po­rate gov­er­nance for the ben­e­fit of all busi­nesses.

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