The Chinese succession model: A precarious event
Something new is happening in Chinese family firms.
As younger Chinese businessmen become increasingly exposed to Western values, the gap between them and the older generation widens and becomes a source of conflict in the succession planning of family businesses.
Family court business disputes are increasing at an alarming rate with poor succession planning seen as the root cause of the problem. The impact of poorly managed succession and family infighting can be significant, both for the family business and investors.
Some think the best path to future success is to ditch leadership by family members—and instead bring in the professionals.
But is this the right way forward—and what lessons can we learn from the family approach to business?
Declining value
Professor Joseph P.H. Fan, researcher and educator of family business governance at The Chinese University of Hong Kong wrote in his book “Critical Generations—Out of the Succession Dilemma of Chinese Family Businesses” that the market value of the 250 listed family firms in Hong Kong, Taiwan and Singapore declined by almost 60 percent on average, starting from five years before the year the family patriarch handed over the business to his successor.
In other words, if an investor bought shares valued at $100 five years before the succession, the value of his shares would be reduced to an average of $40 three years after the succession. Hong Kong companies dropped the most, losing some 80 percent on average with Taiwan and Singapore family owned companies falling about 40 percent and 20 percent, respectively. Hence, if greater China entrepreneurs take Professor Fan’s advice, there should be a lot more public companies. He wrote that a stock market listing is a good way to distribute ownership to family members.
According to Prof. Fan, the reason behind the shocking succession decline is twofold. First, intangible assets such as values, skills and networks, although commonly found among the first generation entrepreneurs, are difficult to be passed on to the next generation. Second, Chinese families also face various family, industrial, and institutional obstacles such as family brain drain, regulatory changes, and political uncertainty, which can destroy or ruin the families and their businesses.
To overcome these challenges, the book emphasizes three critical tasks including family governance, ownership design, and corporate governance. Chinese families need to install and enforce a system of governance which identifies shared values, consolidates family interests and resolves conflict. The system should also regulate family members’ involvement and exiting from the family business. Effective tools should be consistent with Chinese cultural values. Direct transplant of Western solutions are usually not applicable. In addition, Chinese business founders often prefer to “lock up” the wealth and ownership of the business in some way. Family members, however, expect to get a “fair” share of their inheritance and after the founding generation passes away, family fight and court action inevitably follow.
Another thing, successors of family business, even if they share values and passion of their parent founders, may not be seasoned business professionals. It is therefore important to build a strong management team and put into place an effective model of corporate governance which can effectively monitor leadership and results. They must also implement more transparent accounting practices and greater checks and balances.
Chinese family founders are using a range of different methods to solve their succession problems and often these are ad hoc resulting in varying degrees of success. Many Chinese business founders are now becoming more proactive on this matter and are joining classes and seeking knowledge to resolve the succession issue.
Fading traditional culture
Another culprit in internal family disputes is the fading of traditional Chinese culture and values within family businesses.
“The Chinese practice of bequeathing all the family wealth to the eldest son is diminishing,” says Prof. Fan. “This tradition, although perceived by some as ‘unfair,’” has helped preserve family wealth and preempt conflict. However, the new generation of Chinese family members who have been influenced by Western culture and education are adopting different family values such as equality and democracy. Succession planning is, therefore, less straightforward and more complex with greater potential for family disputes.”
Prof. Fan adds that the effects and extent of family disputes vary depending on how succession plans are structured within a business.
Legendary Taiwanese businessman Wang Yong-Ching transferred the controlling ownership of Formosa Plastic Group to Cheung Geng Memorial Hospital, a charitable foundation, before he passed away. A benefit of this structure would be the avoidance of the high government inheritance tax of 50 percent. Wang also knew that his big family would eventually start infighting for the family wealth after he had passed on.
Foundation ownership
The foundation ownership was established to protect his business from being affected by the anticipated family dispute. This was achieved through a charitable foundation upon which no family members could be a beneficiary of the assets. All of the income needs to be reinvested into the business and/or donated for charitable purposes and no family members could serve as manager unless he/she is elected by the 15-member board of the foundation. The 15 board members can only include five family members and the rest are non-family, professional managers and external directors. Wang Yong-Ching, by way of this charitable foundation, has achieved business continuity and has sheltered his family business from family infighting. However, it may be the exception rather than the norm that an owner is prepared to give the ownership of a successful business to a charitable foundation with the proceeds being given to charities.
(This article is written by Enrique Soriano, the resource speaker for the workshop on Families in Business Sustaining and Growing the Legacy on Nov. 9-11, 2015 at the Inquirer Academy Building, Chino Roces Avenue corner Ponte Street, Makati City.
Soriano is currently senior advisor of the Wong + Bernstein (W+B) Advisory Group, a strategic consulting group servicing Asean organizations on issues related to growth in Asian family businesses, organizational change and competitive strategies.
The workshop is brought to you by INQUIRER Academy and is designed for family members involved in the family business.
To know more about the workshop or the author, you may write to [email protected] or call 834-1557. Look for Astrud De Castro or Arvin Maghirang.)
