Trust in Governance
Would a family business choose to base how it is governed on the general assumption that the key players are not to be trusted?
If you are likely to answer this question ‘no’ then would it possibly change your mind to know that distrust underlies the model of corporate governance that is often recommended to family businesses as a good model to follow?
The Anglo-American model of corporate governance – the version that applies to listed public companies in the UK – is trying to solve the problem of how to motivate one party (a director) to act on behalf of another (the shareholder). It is assumed that the director cannot be entirely trusted to act altruistically in the interest of the shareholder and is more likely to act in the director’s self-interest. Therefore, rules, codes, guidelines and formal enforcement mechanisms are needed to mitigate the type of opportunistic management behaviour that could result in reduced shareholder returns.
Members of a business family who have problems trusting each other will be attracted to the methods that this model of governance adopts to resolve problem over trust; for example, board committees and the presence of outside or non-executive directors to police the executives who are in charge or running the enterprise. However, what about families who prefer governance structures and practices that reflect relationships of loyalty and trust?
The pertinent question for every family is, ‘who do we trust?’ In broad terms[1], some will answer that they prefer to trust people who are like them, while others will adopt a generally trusting attitude to everyone and not just people with whom they have some shared characteristics. This difference will have a profound effect on how their business will be governed.
Who do we trust? [2]
Types X and Y mentioned below are different descriptions of a family’s basic attitude to trust. It is important to stress that one is not better than the other; they are just different. Knowing which one is the more accurate description of a family’s attitude makes it easier to build trust into governance in a way that fits with the family’s innate feelings about who they can trust.
Type X – “We trust people we know or who are like us.”
This attitude to trust naturally limits the scope of who can be trusted to direct family and, in the absence of a familial relationship, might include trusted advisers, close friends and members of the same cultural, ethnic or social group as the family In other words, the family trusts people they know or who have something in common with them.
This approach to trust generates an insider/outsider mentality. Insiders are those who can be trusted and outsiders are treated as strangers who should not be admitted to positions of trust unless they are very carefully vetted or can be controlled, but even then the family might still feel that there is a gap in trust that cannot quite be bridged.
This type of trust is usually slow to develop beyond immediate kith and kin because it is based largely on the personal experiences and social networks of family members. Bad experiences involving breaches of trust tend to be treated as setbacks that make the family more wary. An outsider who is deemed to have breached the trust placed in him or her, reminds the family of their view that outsiders should not be trusted in the first place. Violations by insiders who it was assumed were trustworthy might be punished by rejection and the breakdown of relationships, so that an insider becomes an outsider and the overall attitude to trust among the insiders is reinforced.
Type Y – “Treat others as you would wish to be treated by them.”
This view describes people who believe that if they adopt a trusting attitude, it will be reciprocated rather than abused. Unlike Type X, it is not based primarily on personal experiences or relationships and is rather a belief or statement about of how people ought to behave.
As a result, the group that can be trusted is wider and the family is likely to find it easier to contract with outsiders without the same level of checking or controls that would be needed to convince Type X that an outsider can be trusted. The intrinsic optimism in Type Y usually means that setbacks are absorbed without sacrificing the view that people are generally trustworthy and that this is the right way to live and conduct the affairs of the family and their enterprise.
The effect on governance
In Type X – trust people we know or who are like us – ownership will be tightly controlled. It would feel right to the family that ownership be restricted to bloodline family members because of their innate concern about trusting outsiders, like spouses or non-family, to understand the family’s values in relation to ownership. This might even extend to the feeling that ownership should be restricted to working owners, because of concerns that direct family who do not work in the enterprise might develop a different ownership agenda and are better not to be trusted with ownership.
Type Y ownership on the other hand – people are generally trustworthy – would be more open, with less concern about extending ownership to include the wider family, non-working owners and spouses or partners. In order to help mitigate any feelings of this being risky the family could arrange to educate owners about their rights, the expectation being that they can then be trusted to act responsibly.
The different attitudes to trust are likely to make it easier for Type Y to raise capital from outside equity investor. On the other hand, this is likely to be a step too far for Type X, who might view these as the worst type of outsiders who should never be trusted.
In Type X, board and management positions will be dominated by family members and trusted insiders. The logic of this approach might extend to the family seeking in each generation to invest in enterprises that exploit the talent in their lineage, because they will then feel they can innately trust the insider who is running this business. This will appeal as a better way of expanding the family’s wealth than taking the risk of recruiting outsiders to run any part of the family’s enterprise.
In contrast, Type Y will more readily engage talented outsiders to run their enterprise. While Type X will always feel more comfortable with an enterprise that is family owned and family run, Type Y will one day move with ease to become an enterprise that is family owned, but not family run.
It is important that the family’s attitude to trust is reflected in any policy they have on employing family members. Type X should devise a policy that encourages family members to join and gives them every opportunity and advantage to do so, because ultimately the family will only be content if family members hold senior positions in the enterprise. Type Y on the other hand will favour a policy that promotes competence and ability over family relationships, and the policy will challenge family members to prove themselves worthy of the position. In Type Y the policy may even state categorically that there will be no advantage in being a family member.
The different attitudes to trust will also affect family governance, such as the family assembly. Type X will instinctively see the assembly as an inner sanctum where the family can discuss issues that no-one else need know about. If they define insiders as bloodline family members, it would not feel right to invite outsiders like spouses, non-family directors or advisers to attend the Assembly. Type Y, in contrast, would be more likely to involve these other stakeholders in the family assembly and see their contribution as enriching the assembly’s role.
The different effects of Type X and Type Y on family enterprise governance are summarised below and here it is worth reiterating some essential points:
Type X and Type Y are different.
One is not better than the other, although supporters of each view are likely to feel this because they are prone to compare the advantages of their view with the disadvantages of the other view.
In family enterprise governance it is essential to go with the flow of a family’s innate values in relation to trust and families should resist any attempt to make them adopt practices that make them feel uncomfortable. There is no ‘ought to’ in family business governance. The task instead is to discover what each family wants and is capable of delivering.
Summary of Types X and Y in Governance
Type X
We trust people we know or who are like us
Share ownership restricted to family insiders. Spouses and non-working owners may be excluded.
Board and management dominated by family and insiders who can be trusted.
Employment policy promotes interests of family who can be trusted.
Family Assembly is inner sanctum restricted to bloodline.
Type Y
Treat others as you wish to be treated by them
Ownership more open; could include spouses, managers, employees and outsider.
Ability and competence matter as much as insider status.
Employment policy challenges family members. Outsiders treated equally.
Family Assembly open to outsiders participating.