Largely, splits ensure better compliance with corporate governance standards

Updated: Nov 29 2004, 05:30am hrs
Indian business firms, by and large, continue to be family-run ever since the pre-independence era. Countries like Germany, Japan and the US were quick to adopt the corporate form of organisation that were listed on stock exchanges and today their economies are host to giant, professionally managed corporations like Microsoft, Toyota, Siemens, IBM and Motorola. Successful family businesses eventually grow beyond the ability of the family to manage it by employing professionals.

The recent speculation about the rift between the Ambani brothers and the split of Reliance Industries provokes a thought as to whether splits in family-run businesses are better or worse for the group.

Family businesses in India are dominated largely by trading houses that demonstrate great financial acumen, simple lifestyles and propensity to take calculated risks. As family business firms expand and diversify, such firms have the advantage of hedging their losses within the business units run by them. Some such business concerns have successfully stood the test of time by employing better business techniques. For instance, Ratan Tata has initiated measures since 1998 to restructure the Tata empire by utilising the services of McKinsey & Co. In private family concerns, high trust and security aids in lowering transaction costs, corruption and bureaucracy. Family-owned businesses, though good in various aspects, usually experience conflicts and hostility among family members, which results in influencing decision-making in strategic areas.

Most family businesses have similar weaknesses, like the inability to separate the familys interest from the business interest and a lack of focus which hampers the overall growth of the group. The major problem with family businesses is coping with incompetent and self-centred family members.

Due to these reasons, the fortunes of once-renowned family business houses in India have witnessed an unprecedented decline. With much erosion of the wealth of family businesses, they lie scattered because of infighting and mismanagement.

Thus, the cure for paralysed family businesses is that the individual families separate from the family business and grow, eventually saving the declining business group. According to the Nobel Prize-winning German writer Thomas Mann, splits in family-run businesses are inherent. In his novel Buddenbrooks, he described the saga of three generations: In the first generation, the scruffy and astute patriarch works hard and makes money. Born into money, the second generation wants power; it goes after it with a single-mindedness. Born into money and power, the third generation dedicates itself to art, showing the signs of decline.

Business splits, whether hostile or amicable, do have positive fallouts in making the business smaller and more manageable. Continuity of separate business units is ensured once a split occurs. Family business, if not split, may lead to nepotism and stagnation. Business splits also increase the possibility of the firms complying with corporate governance standards. Business splits ensure that interlocking directorships, a major stumbling block in effective independence of outside directors, are reduced to a substantial extent. Splits also improve recruitment policies, as there is less pressure from the family to recruit family members.

Splits, however, may not always be a boon, as in the case of many leading family business groups in Delhi, which left them in a financial mess. Family splits reduce the advantage of the combined group to borrow money or to negotiate common purchases. Business splits, if arising out of hostility among the family members, have to be resolved through the courts, which takes a long time.

The management of business by family is not necessarily a disadvantage as long as the family firms are able to overcome historic weaknesses. Even if the family business opts to split, it should do so logically along industry lines, keeping business interests foremost.

The writer is a managing partner, Fox Mandal