Independent Directors and Family-Owned Companies

I came across an interesting article Guests at the Table?: Independent Directors in Family-Influenced Public Companies by Professor Deborah DeMott. Although the article focuses primarily on U.S. law (where family-owned companies are more the exception than the rule), it does have a significant bearing on the Indian situation as well. In India, a large number of publicly listed companies continue to be family-controlled, and hence several corporate governance mechanisms (such as the independent director) need to be attuned towards this reality. The abstract is as follows:

By some measures, family-controlled companies account for about a third of large public companies in the United States. Public companies that retain characteristics of family firms pose a series of intriguing questions about corporate governance, in particular the roles and duties of directors, that are surprisingly underexplored in legal scholarship. Although concentrated ownership is more significant in many capital markets outside the United States, recent examples of governance questions associated with publicly-held family companies are numerous. In such companies, shareholders who are members of the founding family often have perspectives and interests that diverge from those of non-family public shareholders.

The paper focuses on directors who are independent of both management and the controlling family and identifies a set of functions that they are uniquely situated to fulfill. Independent directors are the sole actors at the highest level of firm governance who have the capacity to bring detached judgment to bear in resolving difficult questions that implicate family ties as well as business necessity, including management succession and external threats to the firm’s position and separate existence. The paper relies on a series of recent empirical studies that quantify the incidence of family-controlled public companies, examine their performance relative to other public companies, and identify characteristics that are associated with better or worse performance. The paper also relies on reported cases to furnish concrete illustrations of variations in independent directors’ effectiveness.

The above article some important suggestions, primarily those relating to the special role of independent directors in such companies, including on dealing with the specific interests of the controlling shareholders as well as the minority investors. Here is an extract:

It is possible to identify several functions that independent directors are uniquely positioned to exercise that are useful counterweights to the presence and influence of controlling shareholders within family firms. These include: (1) vigilance on behalf of the interests of public shareholders; (2) furnishing a reality check that may helpfully complement or challenge the perceptions of management and the controlling family and that may protect the primacy of the firm’s business needs and interests, while assuring that high-level decision-making is not dominated by spillover from intra family dynamics; (3) serving an intermediary function between the controlling family and senior management, whether or not members of the family; and (4) reinforcing formal institutions and practices of governance. Independent directors’ positioning is unique because no other set of actors within the corporation is systematically unaffiliated with its senior management and controlling shareholders.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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