The winning paper in the Institute’s latest Corporate Governance Paper Competition suggests ways for both companies and government policy makers to improve the governance and sustainability of Chinese family-controlled firms.

Although the concepts of corporate governance and business sustainability are understood to be crucially important, the correlation and relationship between them still needs to be defined and be better accounted for. Companies increasingly recognise their critical part in the transition to a more sustainable society and economic environment, and corporate governance monitoring is increasingly applied to broader elements of corporate activities, including the organisation’s impact on the natural environment and society. The additional responsibilities that corporations are taking on mainly result from stakeholders’ requirements and demands. This suggests a general picture of how important corporate governance is to organisations and how it can affect their sustainability, but most of the studies and research in relation to these issues are global and mainly concentrate on public corporations that are not owned by one family. With an Asian perspective in mind, this paper pulls the issue back to East Asian countries, especially China, which is undergoing huge development and transformation, to generate some suggestions on ways to improve the governance practices of Chinese family-controlled companies thereby increasing their sustainability. In the late 1970s, China began its opening up and economic restructuring process and these reforms continue today. China has moved towards a free-enterprise system via the privatisation of state-owned enterprises and the development of modern stock markets. Subsequently, private enterprises have provided the strongest driver of the nation’s economic growth. According to a report released at the 12th International Forum on Entrepreneurship and Family Business, held in Zhejiang University, more than 90% of private enterprises in China have been established by one family. Despite the prominent position of these Chinese family companies, poor governance was found to constrain their performance and sustained development. By comparing China to countries which are pioneers and leaders in promoting better governance among family businesses, this paper sets out the problems and constraints of Chinese family-controlled firms and seeks solutions to these challenges.

Theoretical background

China’s ownership and governance structure

It is generally acknowledged that the legal environment of a country influences the corporate governance standards and performance of its companies. To analyse Chinese firms, we should therefore first place ourselves in the centre of the Chinese legal and economic environment. China has its unique ownership characteristics and governance structures. The mixed-ownership structure in China is dominated by three major groups of shareholders: the state (central government), legal entities (institutions) and individuals. A paper published in the Journal of Corporate Finance (‘Ownership structure, corporate governance, and fraud: Evidence from China’, Chen, Firth, Gao & Rui, 2006) estimated that on average about 40% of shares are held by private individuals and private institutions. The inference can be drawn that the ownership structure in China is highly concentrated. China adopted its reform strategy to restructure the economy in 1978. A series of policies were carried out to help the country transition from a centrally planned economy to a mixed economy. The reform process was designed to assign higher autonomy to board directors and managers so they could run firms with less intervention from the state. At the start of the reform process, there were few commercial laws and almost no laws in relation to property rights, which led to inconsistent decisions made by the regulators and put the reform progress in peril. To remedy this situation, the China Securities and Regulatory Commission (CSRC) was established as the main regulator of China’s securities market. The CSRC is responsible for several key areas – such as formulating regulations and supervising companies, investment institutions, stock exchanges and other professional entities. It is also responsible for reviewing the supervisory board report in listed companies’ annual reports.

Chinese family-controlled businesses

In Taiwan, Hong Kong and some Southeast Asian countries, family-controlled businesses are generally considered to be the engine that drives societies ahead. Although state ownership or public ownership is still the mainstream in China, the role of private businesses, especially small and medium-sized family-owned businesses, should not be neglected. Nowadays in China, owing to the strong emphasis on entrepreneurship, more and more people prefer to start their own business and become their own boss, and this has led to a proliferation of family-controlled businesses in many Chinese cities. Family business has served as one of the key factors fueling the economic takeoff in East and Southeast Asia since the 1960s. PricewaterhouseCooper’s Global Family-Controlled Businesses Report 2016 interviewed 100 senior corporate executives of family-controlled enterprises (48 from Mainland China and 52 from Hong Kong) and revealed that family business is contributing to much of the increase in the employment rate, as well as to Gross Domestic Product (GDP) growth. Furthermore, according to Tharawat magazine, an Indian publication aiming at inspiring entrepreneurs and family enterprises, 84.5% of privately owned businesses in China are family businesses. These family-controlled businesses help to employ 65% of all the working population and contribute more than 65% of China’s GDP. Nevertheless, Chinese family-controlled businesses still face severe problems that constrain their sustainability and further expansion. Traditionally, family-controlled enterprises are less aware of the principles of corporate governance and more governance problems are reported in these companies. Hence it has been found that family businesses are less efficient at generating profits. Moreover, the average lifespan of Chinese private firms is 2.9 years; only 3% of all firms are able to last for more than eight years. A lack of awareness of corporate governance principles and an inability to engage in sustained development are the main constraints on the prosperity of Chinese family-controlled businesses.

Corporate governance

Corporate governance is typically applied as an essential way of balancing stakeholders’ interests, where stakeholders include shareholders, customers, suppliers, government and community. The main corporate governance issue has tended to be the need to balance the relationship between shareholders, especially big shareholders and management, but it is generally recognised that principles of corporate governance go beyond this. Aras and Crowther, in their 2008 paper Governance and sustainability: An investigation into the relationship between corporate governance and corporate sustainability, highlight four principles of good corporate governance:

1. fair treatment of all stakeholders
2. ethical behaviour and integrity
3. responsibility of the board of directors, and
4. transparency and accountability of information.

In conclusion, corporate governance is concerned with balancing the company’s economic goals and its corporate behaviour in the social environment. Implementing good corporate governance should help foster the sustainability of a company.

Business Sustainability

As discussed above, the principles of corporate governance are related to balancing economic goals with the sustainability of organisations. In other words, corporate governance is concerned with a firm’s corporate social responsibility, utilising resources, accountability of power usage and appropriate corporate behaviour in society. The World Commission on Environment and Development (2017) defines sustainability as ‘meeting the needs of the present without compromising the ability of future generations to meet their own needs’. Applying the same logic to business sustainability, shareholders and managers want their business to generate as much profit as it did in the past while building a solid foundation for future profit growth. Business sustainability could be defined as a firm’s ability to meet short-term needs without compromising its ability to meet future needs.

Recommendations

Rationalise ownership and management structures

In Chinese traditional culture the family head has absolute power over the whole family and it is very common for the founder (usually also the parent of a family) of a Chinese family-controlled enterprise to have the highest authority and the power to make the final decisions. However the drawbacks of this kind of ownership structure have increasingly been recognised. In particular, a lack of internal and external corporate governance brings a higher risk of uncertainty associated with decisions on strategic issues, for example, the company’s direction of development. A study published in the International Review of Finance (‘Family control and corporate governance: Evidence from Taiwan’, Yeh, Lee & Woidtke, 2001) investigated 208 Taiwanese family-controlled businesses and found that those with the highest relative performance usually had a high level of control over the company but relatively lower levels of board representation. The study concluded that high levels of ownership and low levels of family board representation help to mitigate the conflict between majority and minority shareholders and hence results in higher performance. Following the Taiwanese firms’ experience, Chinese family-controlled businesses should seek a balance between the family’s ownership over the company and managerial authority. In the US, where family businesses are well-developed, the owners of the company usually exercise real control but are not involved in daily operation and management. The stock price responds to the fair value of a company, which provides a reference for the family business owner to evaluate the performance of management. It is very common in the US for professional executives to be responsible for the company’s daily operations, and for ownership and management to remain relatively separate. Such a structure helps to enhance management efficiency and promote the long-term stable development of the company.

Establish a business sustainability framework and integrated management system

A company’s business sustainability framework must be supported by an integrated management system. It is very common nowadays for companies to apply an internal quality management system such as ISO 9001. Using an integrated management system could help the organisation increase efficiency and effectiveness and reduce costs, while at the same time minimising the disruption of an external audit. An integrated management system should focus on the processes of doing business instead of management procedures. This is especially important for Chinese family-controlled firms, where bureaucracy and formalism have been a custom since ancient times.

Improve the legal environment and economic regulations

The government should provide a strong and powerful guarantee for the development of family businesses. According to Japan’s Corporate Governance Code, the mission and vision of Japanese companies is to seek sustainable corporate growth and increase corporate value over the medium to long term. The Code clearly sets out the general principles of corporate governance; shareholders’ rights and equal treatment; cooperation with other stakeholders; transparency and disclosure of appropriate information; board responsibilities; and dialogue with shareholders. By releasing this Code, the government is playing an important role in effecting related policies and providing guidelines for companies. In a modern market economy, government control and management of economic affairs guards against systemic risks. It is necessary to gradually change from governing the country by policy to systemic governance. Systemic governance means ensuring the effectiveness of the infrastructure within which companies operate.

Conclusion

Family businesses play an important role in both developed and developing countries. It is suggested that family businesses are one of the most important ingredients in the economy and their key economic role should not be ignored. Family businesses are also the main driving force for promoting entrepreneurship and innovation. This paper aims to provide some guidance for Chinese family-controlled companies to help them survive in the current fiercely competitive environment. Business sustainability has become an emerging field in recent years, but it is still a relatively young topic. This paper discusses the relationship between business sustainability and corporate governance. By putting the issue in the context Chinese family-controlled business, the paper elaborates on the constraints and challenges that restrict further development and expansion of Chinese family enterprises. By comparing Chinese family-controlled enterprises with those in Japan and the US, where family business has a long history, the paper explores the differences and provides many suggestions for both Chinese government and Chinese firms to improve the current situation. Nancy Bao Shiyao BBA (Hons) in Management, The Hong Kong Polytechnic University