- Introduction
- Definitions and Models of Corporate Governance
2.1 Corporate Governance in Developed and Emerging Markets
2.2 Corporate Governance in Developing Countries
- Corporate Governance Codes (CGCs)
3.1 Corporate Governance Codes in Developed Countries
3.2 Corporate Governance Codes in Developing Nations
3.3 Corporate Governance Codes in Saudi Arabia
- Corporate Governance Mechanism
4.1 The Board of Directors
4.2 The Board Structure
4.3 Non-Executive Independent Directors
4.4 The Board Committees
4.5 Audit Committees
4.6 CEO Duality
4.7 Nominations Committees
4.7.1 Nomination Committees in Developed Countries
4.7.2 Nomination Committees in Developing Countries
4.7.3 Nomination Committees in Saudi Arabia
- Successions
5.1 Succession in the Developed Countries
5.2 Succession Planning in Developing Countries
5.2.1 Succession Planning in Saudi Arabia
- Summary
- References
- Introduction:
Corporate governance is increasingly becoming a key area of focus in management research as corporations face more pressure to act responsibly in the business environment (Kolk and Pinkse, 2010). Following the 2007/2008 Global Financial Crisis, companies have faced more scrutiny concerning how their activities in the market impact on the well-being of stakeholders (Kirkpatrick, 2009). More specifically, organisations in Saudi Arabia are facing increasing pressure from customers, regulators, investors and the community to engage in socially responsible practices. In the Saudi Arabian context, an increase in regulatory focus on corporate governance practices (CGP) was driven by the 2006 collapse of the country’s stock exchange market. The exchange was mainly attributed to poor CGP enabled by the lack of key regulatory measures to guide the activities of corporations in the market. Reform in corporate governance was thus initiated by regulators to protect the interests of investors and ensure the improved performance of the stock exchange market. Furthermore, regulatory measures provided a means to prevent a future collapse of the stock market. By developing the Corporate Governance Code, the Saudi Capital Market Authority Board (SCMAB) sought to ensure the efficacy of corporate governance practices among listed companies in the country.
Corporate governance is seen as a means through which the activities of organisations in the market can be modelled to ensure that the firm attains a sustainable competitive advantage through socially responsible practices (Mishra and Suar, 2010). At the same time, intense rivalry in the business environment driven by changing consumer preferences has made it necessary for many business enterprises to ensure that their corporate governance enhances competitive advantage in the market (Sapra, Subramanian and Subramanian, 2014). The selection of the members of the board of directors thus contributes towards effective corporate governance. Due to the increasing importance of board constitution, the nominations committee has become a crucial element in corporate governance.
The literature review, therefore, examines the state of research on corporate governance and particularly on how the nominations committee has influenced corporate governance over the years.
- Definitions and Models of Corporate Governance:
To understand corporate governance, it is critical to first reach consensus on what the concept means. Corporate governance has continued to become a key area of focus in management literature and has thus been examined in several studies. One of the earliest forms of the definition of corporate governance was presented by the Chief of Financial Aspects of Corporate Governance Committee in the United Kingdom, Sir Adrian Cadbury. Cadbury posited that corporate governance is a system of practices, rules and processes that are used to direct and control the activities of a corporation (Cadbury, 1992). Cadbury further stated that corporate governance enables shareholders to have a say in how the firm is managed, through the appointment of auditors and directors. Cadbury’s definition has been refined with time; Iskander and Chamlou (2000) improved on this definition by arguing that corporate governance should be defined as a practice that is focused on ensuring a balance between the pursuit of profits and social concerns within an organisation. Instead of focusing entirely on management and the interest of shareholders, the definition expands to highlight the importance of conducting business responsibly in the market. The definition by Iskander and Chamlou (Ibid) reflects a shift in the market, as corporations found it increasingly unsustainable to focus only on profit generation without considering the impacts of their activities on other stakeholders, such as customers and the community.
The evolution of the definition of corporate governance shows that ensuring business ethics is part of the practices that are considered essential for protecting shareholder interest. According to Habib and Jiang (2015), the pursuit of profits alone does not enhance investor interest if such pursuits are grounded in unethical business practices. Corporate governance, therefore, involves practices that seek to ensure that management decisions are ethical and designed to advance the long-term interests of the corporation. The definition further implies that a return on investment can be realised by ensuring that the activities of an organisation in the market advance the interests of the firm’s stakeholders, and not just the shareholders and management. Waemustafa and Abdullah (2015) also make similar claims, suggesting that corporate governance is a set of activities and practices aimed at advancing the interests of the stakeholders of an organisation. The definition implies that the Corporate Governance practices of a firm should be designed to protect the interests of the organisation’s stakeholders, such as customers, regulators, suppliers and shareholders. The definition of corporate governance provided by OECD also links corporate governance to the stakeholder theory. The organisation defines corporate governance as a practice concerned with the rights and responsibilities of the management of a firm, its board of directors, stakeholders and shareholders (OECD, 2019). This definition shows that corporate governance centres on how effectively firms are managed to advance the interests of stakeholders.
While the definitions contained in existing literature have some variation, they all point towards the effective management of firms. Over time, corporate governance has evolved from a concept mainly developed to maximise profitability, to practices aimed at ensuring the long-term success of an organisation through socially responsible business activities. Ahmad and Omar (2016) claim that the multi-stakeholder model of corporate governance has become the preferred shareholder model, because it enhances business success in the contemporary market environment. The relationship between corporate governance and business success has significantly influenced the newfound interest in board composition.
2.2 Corporate Governance in Developing Countries:
Businesses operating in today’s society are primarily interconnected with the community within which they set up their activities and the people that reside within (Claessens and Yurtoglu, 2013). Shareholders expect the different organisations to uphold high operational standards and develop a policy framework that will guide the conduct of the different stakeholders, ensuring that they champion the interests of the investors. In contrast to developed states, in developing countries legal systems are not well established, an attribute which might create leeway through which organisations could manipulate the powerless stakeholders within their franchise, such as the community, by taking advantage of the weak institutions and their unchecked powers and privileges (Khan, Muttakin and Siddiqui, 2013).
Corporate governance models were initially developed in the Western countries as a means of holding accountable the administrators tasked with the oversight and running of operations within corporations, to those shareholders who did not play an active role in the routine management (Khan et al., 2013).
In spite of the lack of relationship between board diversity and firm performance in Saudi Arabia, Ferreira (2015) argues that there has been an increasing general push around the globe from various stakeholders to ensure gender diversity in boards. Some studies show that the participation of women in corporate governance, especially in a complex business environment, results in improved business performance. According to Francoeur, Labelle and Sinclair-Desgagné (2008), there is a correlation between a high number of women in the board of directors of a firm and financial performance. The study employs the ratio of return on equity (ROE) to show that the financial performance of firms is likely to improve with more women on the board. Such firms will achieve a 6% higher return over a period of 3 years. Bear, Rahman and Post (2010) also determine that there is a relationship between board diversity and business performance. However, their study mainly attributes the improved business performance to an improvement in the reputation of the organisation. Bear, Rahman and Post (2010) posit that corporate boards with a higher number of women directors are likely to influence management decisions in favor of corporate social responsibility (CSR), which has a positive correlation with corporate reputation. However, technical strength and institutional strength mediate the impact of female directors on the board on overall firm reputation.
In summary, current studies fail to conclusively show whether there is a relationship between board composition and firm performance. The impact of board composition on the performance of a firm is contingent upon many factors, such as business ownership and national culture. However, many findings indicate that when selecting outside directors, candidates must have competencies and skills that will have a positive impact on the performance of the firm (Peng, 2004; Klein, 1998; and Ameer, Ramli and Zakaria, 2010). The findings imply that outside directors should be nominated based on merit because, in many cases, inside directors already bring key advantages to the organisation. Due to the relationship between the competencies of outside directors and their ability to contribute to the performance of the firm, the nominations committee has become a crucial element in corporate governance. This is especially the case when the inclusion of outside directors is seen by regulatory authorities and shareholders as a means through which effective corporate governance can be guaranteed. According to Abdullah (2004), the Saudi Arabia capital markets authority has itself often encouraged the appointment of independent boards, as a best practice in corporate governance. The move shows that even in conservative cultures, board independence, particularly in regard to business ethics, is a major concern, rather than simply financial performance.
- Corporate Governance Codes (CGCs):
According to Tricker (2015), companies operating in today’s hypercompetitive and dynamic operational environment are expected to report to the regulatory authorities on how they have applied the CGCs in the country in which they operate. Additionally, the CGCs are a set of standards that guide the practices and activities of the organisation, such as board formation, accountability, remuneration and shareholder management, with the intention of ensuring that their conduct is beyond reproach (Tricker, 2015).
According to Brennan and Solomon (2008), the codes of corporate governance are vital to an efficient and effective financial market. Organisations provide governance codes via various mediums, such as annual reports, which consist of the firm’s financial statements, management discussions, analysis, footnotes and other regulatory findings and requirements. Additionally, the adequacy, timeliness and availability of appropriate information concerning market and financial securities are crucial for both pricing efficiency and market confidence.
- Corporate Governance Mechanisms:
According to Lozano, Martínez and Pindado (2016), corporate governance of various institutions is based on both internal and external mechanisms. Internal corporate governance mechanisms are categorised into three segments; Executive Management, Board of Directors and Independent Control roles. Every segment has its specific set of unique and crucial responsibilities. However, in some corporations, the activities and actions of these segments are reinforced by conduct codes aimed at promoting and instigating proper corporate behaviour. The internal mechanism is solely aimed at achieving corporate accountability.
Additionally, Hassouna, Ouda and Hussainey (2017) state that external corporate governance mechanisms should be considered as forces of governance operating in the external environment of the corporation. The national government of each stock market is mandated for formulating, enforcing and enhancing corporate mechanism that supports external governance. From the perspective of financial markets, an effective system permits proper and effective capital mobilisation, risk management, investment opportunity identification and assets exchange. However, from the perspective of the structural market, an efficient system formulates authorities that enforce regulations and the rule of law, as well as the judicial processes mandated for handling bankruptcy and legal issues, along with proper supervisory institutions for overseeing the regional financial markets, agencies of credit rating and external auditors.
5. Corporate Governance Codes in Saudi Arabia:
According to Tricker (2015), intense competition in the business environment has placed considerable pressure on business organisations, as they seek to achieve profit objectives while meeting consumer needs and preferences. Driven by the necessity to deliver positive financial results to shareholders, CEOs can make decisions that are unethical and which pose adverse impacts to various stakeholders. Tricker (Ibid) further argues that to ensure that corporations operate within the desired legal and ethical framework, regulators have developed CGCs to guide management practices and board operations. Tricker defines CGCs as a set of standards established to guide organisational activities and practices, such as the formation of the board of directors, directors’ remuneration, accountability and shareholder management. The primary objective of corporate governance codes is to ensure that business ethics are adhered to, especially in a market environment defined by intense rivalry. Additionally, these codes contribute to market efficiency (Brennan and Solomon, 2008). Business organisations are expected to become more transparent with their CGC policies, as the information they contain is important to stakeholders, such as investors, customers and regulatory authorities. Firms publish corporate governance reports in their annual reports for ease of access. The timely provision of such information plays a vital role in share pricing, because the constitution of the board of directors influences investor confidence in the future of an organisation. For instance, Shivdasani and Yermack (1999) suggest that the share prices of an organisation are likely to drop when the CEO takes an active role in the board constitution process by being a key member of the nomination committee and the board.
The corporate governance codes in Saudi Arabia are developed by the Capital Market Authority (CMA), which is governed by the Finance Ministry. The CMA allows companies and organisations to develop their corporate governance practices, as long as they do not break the laws and regulations. The CGP developed should also be geared toward ensuring effective corporate governance (Al-Bassam, Ntim, Opong, and Downs, 2018). The CMA in Saudi Arabia has regulatory provisions requiring firms operating within the country to develop measures to improve corporate governance. For instance, companies are expected to develop corporate governance codes that ensure the separation of responsibilities between the board and the CEO (Al-Bassam et al., 2018). Shehata (2015) states that the establishment of such provisions makes it easy for firms within Saudi Arabia to improve their organisational culture, while at the same time upholding the regulations set by the ministry and government.
Current studies showing whether or not there is a relationship between board composition and firm performance have not been forthcoming. The impact of board composition on the performance of a firm is contingent upon many factors, such as business ownership and national culture. However, as mentioned in section 2.2, many findings indicate that when selecting outside directors, candidates with competencies and skills that will positively impact the firm’s performance should be sought (Peng, 2004; Klein, 1998; and Ameer, Ramli and Zakaria, 2010). This implies that outside directors should be nominated based on merit, as inside directors often have key advantages that they bring to the organisation. Due to the relationship between the competencies of outside directors and their ability to contribute to the performance of the firm, nominations committees are now a vital element of corporate governance. This is especially true when the inclusion of outside directors is seen by regulatory authorities and shareholders as a means through which effective corporate governance can be guaranteed. According to Abdullah (2004), the Saudi Arabia capital markets authority itself has often encouraged the appointment of independent boards as a best practice in corporate governance. As stated in section 2.2, this indicates that, even in conservative cultures, it is board independence that is a major concern, particularly in regard to business ethics, and not necessarily financial performance.
4.1 The Board of Directors:
According to Bommaraju et al. (2019), the Regulations of Draft CG require the formation of committees, including Compensation, Nomination, Audit and Risk Management committees. However, the Board of Directors is mandated with the freedom to create any additional committees that it may see as necessary for the effective governance of a corporation, for example, a Corporate Governance Committee. These must comprise of independent directors, and in cases where there is a sufficient number of members, the committees can include non-executive directors as members, provided that they are directed and controlled by independent directors. A board of directors is mandated with the responsibility of establishing the policies of the internal framework for the operations of every committee, except the audit committee.
Additionally, over time, organisations have sought to recruit and leverage the expertise of skilled professionals to manage the operations of the business. This undertaking, while sound, brought with it incidences of company collapse and failure, after the senior executives of enterprises such as Enron, colluded to defraud the investors (Dibra, 2016).
4.2 The Board Structure:
Various nations across the globe have adopted diverse structures and compositions of the organisational boards that are mandated to control and direct operations within companies. The Unitary Board Structure (UBS) is centred on the perspective that, during planning and formulation of organisational policies, consensus must be achieved before finalising final policies. This approach is considered effective, since it eliminates cases of insubordination that can derail and hinder the development plans of a company (Jeffers, 2005). Additionally, according to Smith (2003), UBS consists of executives and non-executive members, an aspect that is crucial in fostering impartiality and eliminating incidences of collusion that can lead to corporate failure. The dual board model is based on a two-tier structure that has operating and corporate boards, each with distinct responsibilities (Smith, 2003). For example, an audit committee must be comprised of three members constituted by an accounting or financial specialist.
4.3 Non-Executive Independent Directors:
Non-executive directors are corporation board members not actively involved in a firm’s daily operations and management (Kumar and Singh, 2012). The development of the post is attributable to the need for organisations to enhance the administration process and eliminate incidences of collusion to defraud investors between the managers and board members (Tricker, 2015). The non-executive directors, therefore, act as an integral corporate governance mechanism, through which businesses can improve their legitimacy to stakeholders; their use guarantees that all operations carried out will be effectively scrutinised and beyond reproach (Garcia-Torea, Fernandez-Feijoo and de la Cuesta, 2016). In ensuring that effectiveness is actualised in board operations, the firms within KSA are expected to recruit their non-executives from different fields, so as to bring together individuals with diverse skills and expertise.
4.4 The Board Committees:
The overall board effectiveness within a firm is dependent on its members’ ability to receive responsibilities and duties that require advancement and management, based on their respective personal skills and experiences (Tricker, 2015). Through its boards, an organisation is obligated to formulate various commissions, which are mandated in serving different roles. These include remuneration scales development, the appointment and vetting of applicants to senior vacant firm positions, as well as oversight of executive activity. (Adams, Hermalin and Weisbach, 2010). The different committees that are established within a business by the executive and non-executive members are intended to improve overall accountability and ensure that the oversight role is well executed. Furthermore, they help to establish the transparency of the different activities carried out by the company. According to Smith (2003), the board members tasked with responsibilities in the nominations, audit and remuneration committees. These are critical areas of interest within the organisation that can determine the commitment of its top administration and overall performance, so such committees need to be comprised of independent non-executive directors (Adams et al., 2010).
4.5Audit Committees:
According to Sultana, Singh and Van der Zahn (2015), during an Ordinary General Meeting (OGM), a resolution is derived and an audit committee is often formulated, with outlined quarterly committee meetings.
Executive directors, or individuals who have served as a firm’s auditor for the past two financial years, are prohibited from joining an audit committee. There are various duties mandated to an audit committee, although its main function is to verify the accuracy of the firm’s financial reports and statements, as well as review the compliance level of the corporation with its interior mechanism oversights.
However, the effectiveness of these committees is dependent on the financial understanding of the appointed representatives, and the continuous provision of training and development initiatives to enhance their skills and expertise on audits. Notwithstanding the above factors, according to Kulkani and Maniam (2014), the independence of these auditors is a crucial element in determining their ability to perform exceptionally.
4.7 Nominations Committees:
A nomination committee must comprise at least three members, with an independent director as a mandatory member. The establishment of these committees is based on the desire for governments and regulatory bodies to reign in the powers and influence of the chairman and the chief executive officers through a board representative’s appointment (Ntim, 2018). Additionally, its formation is initiated by the desire to ensure that the board of directors within a given enterprise is independent of the influence and control of the reigning CEO, an aspect which can help advance transparency and reduce incidences of mismanagement. Moreover, nominations committees ensure that only qualified individuals are considered during the selection and nomination of the board members. This helps eliminate cronyism and nepotism, which might impede meritocracy-based appointments (Eulaiwi et al., 2016). While the nomination committee is central to effective corporate governance, for many years, corporations have considered it their prerogative to define the terms of engaging their nomination committees and constituting the board of directors (Carson, 2002). Additionally, boards are free to determine their corporate governance structures from a range of possibilities. The possibility of corporations using their own guidelines to form nomination committees poses a major challenge to board independence and corporate governance efficacy. Cotter and Silvester (2003) establish that board independence enhances corporate governance monitoring and thus mitigates against the negative impacts of agency. CEOs are more likely to be prudent in their decision-making when they are subjected to effective monitoring. Therefore, both selection and nomination committees are ineffective if majority shareholders have direct control over the activities of the board, as in family enterprises and government-owned corporations, similar to those in KSA (Shehata, 2015).
4.7.1 Nomination committees in developed countries:
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4.7.2 Nomination committees in developing countries:
160 words
4.7.3 Nomination committees in Saudi Arabia:
While corporate governance codes exist in Saudi Arabia, there have been concerns about their ability to enhance corporate governance practices based on the evolving governance challenges within the business environment. According to Shehata (Ibid), the GCC region has been working toward improving CGP in the business environment to cope with international developments. Significant changes have been made with regard to improving CGP in the country since 2006, when SACMA developed and published CGCs. Amendments to the code were made in 2009 to reflect new challenges in relation to corporate governance. The 2008 global financial crisis was a particularly challenging incident, because it led to the poor performance of national economies. However, it also drew attention to the need to ensure that corporations are effectively governed. The code is applicable to all the listed firms in the country and is monitored on a comply/explain basis.
The Saudi Arabian CGC was again reviewed in 2017, as new regulatory measures demanded more transparency, in terms of corporate governance practices among listed companies. Therefore, CGP has been improved to this end. The new regulations extend the rights of boards, shareholders and stakeholders in corporate governance (PwC, 2017). They differ from the 2006 regulations in that they are geared towards ensuring that stakeholders have more say in corporate governance than previously. They also demand that the selection of board members be based on competence, in order to improve the efficacy of boards in corporate governance. The code has changed the nomination process to an extent that it enhances the independence and effectiveness of the board. The nomination process should thus be guided by competency objectives, rather than culture or nepotism. Extending the regulations to private companies might significantly improve corporate governance in the private sector.Board composition is designed to ensure good business ethics, as opposed to driving firm performance (Ameer, Ramli and Zakaria, 2010). For instance, the appointment of more female directors does not necessarily improve the performance of a business organisation through increased innovation or production, but through an enhanced corporate reputation. In a real sense, corporations with more female board members are likely to be more socially responsible in the business environment; this would have a positive impact on the reputation of the firm. However, in markets where CSR does not influence consumer perception regarding corporate reputation, the pursuit of board gender diversity would not result in improved business success. Merely ensuring gender parity in the boardroom does not necessarily lead to better firm performance. Bear, Rahman and Post (2010) emphasise this when they argue that technical strength and institutional strength mediate the impact of female directors on the board on overall firm reputation. However, due to accountability concerns, board composition becomes a key factor in effective corporate governance.
A nominations committee plays a crucial role in determining board composition. According to Kaczmarek, Kimino and Pye (2012), board composition has become a key area of concern in corporate governance, especially after the 2008 financial crisis that was largely attributed to bad corporate governance practices. Due to the importance of board composition, much attention has been directed toward nominations committees that play a crucial role in determining board composition, and ultimately the CGP of a firm. Kaczmarek, Kimino and Pye (Ibid) determined that when nominations committees have more females or foreign nationals on them, board composition is likely to be characterised by diversity in terms of gender and nationality. Additionally, the study finds that the presence of the chief executive on the nominations committee is negatively correlated with the level of board faultlines. Kaczmarek, Kimino and Pye argue that even if CEOs form part of the nomination committee, they should have minimal influence in the selection of board members to ensure that the constituted board can provide corporate governance oversight.
In an earlier study, Shivdasani and Yermack (1999) argue that CEOs may want to get involved in the board constitution process to reduce active monitoring and ensure that they operate without much interference from the board. Moreover, having a friendly board reduces the performance pressures that most CEOs face. Shivdasani and Yermack (Ibid) suggest that the share prices of an organisation are likely to drop when the CEO takes an active role in the board constitution process. Most investors are likely to view CEO involvement as a sign of future challenges in the management and performance of the firm.
The relationship between nominations committee and board composition is also examined in an earlier study by Ruigrok et al., (2006), who find that nomination committee composition influences board composition. A nomination committee constituted of a mixture of foreign and independent members tends to put together a board that is diversified. Furthermore, gender diversity in the nomination committee results in gender diversity in the constituted board. Similar claims are made by Osma and Noguer (2007), who suggest that a nomination committee plays an integral role in determining the competence of the board of directors, and thus the management of a business entity. The findings of their study imply that large corporations should focus on having a nomination committee that can perform its duty independently and competently, in order to enhance the efficacy of corporate governance.
However, the activities and decisions of the executive can only be monitored by the board when there is a clear separation between the roles of the top management and the board. As argued by Kaczmarek, Kimino and Pye (2012), CEOs being part of the nomination committee compromises the independence of the board, and thus its ability to effectively monitor the decisions and practices of the top management. As stakeholders increase demand for more ethical management decisions, the constitution of the nomination committee becomes a key concern. That is because it directly influences board independence and, therefore, corporate governance efficacy. The existence of several family-owned business organisations in Saudi Arabia, however, makes it difficult to implement corporate governance codes and regulations.
- Successions:
According to Berns and Klarner (2017), the most significant duties of a board of directors is the CEO appointment, as well as formulation of effective contingency plans addressing succession frameworks; these are applicable in the event of incompetency or incapacitation of the incumbent CEO, thereby rendering them unable to execute their responsibilities. The incumbent CEO manages the succession plan in ideal circumstances, but in the event of a crisis where the board loses trust in the incumbent, then it is the responsibility of the nomination committee, with the advice of the entire board, to select a new executive to manage the business (Larcker and Tayan, 2016). According to Berns and Klarner (2017), the effective execution of the succession is crucial for the stability of the company, and the investors expect the process to be fast and effective, so that markets do not lose confidence in the corporation because of poor planning.
5.1 Succession in the Developed Countries:
180 words
5.2 Succession Planning in Developing Countries:
180 words
5.2.1 Succession Planning in Saudi Arabia:
The local business environment in Saudi Arabia is significantly influenced by Sharia laws that have been developed by the Kingdom’s government to guide the conduct and practices of business organisations (Shehata, 2015). In spite of the government making efforts to liberalise the economy and modernise specific sectors, such as banking and telecommunications, Islam and Sharia laws have an impact on the local firm’s operations (Al-Bassam et al., 2018). The existence of several family-owned businesses in Saudi Arabia means that succession is kept within the family in many firms. According to Chung and Luo (2013), inside succession in business organisations is only beneficial when firms focus on domestic investment. Saudi Arabian corporations perform better when they have a family succession plan and focus on investment within the country, because they have better access to resources.
However, these companies cannot perform well when they have to invest in foreign countries, due to the lack of investor confidence. Piesse, Strange and Toonsi (2012) also suggest that family-owned firms face management challenges due to lack of transparency and management efficacy. These findings support the claims made by Chung and Luo (2013), which show that family-owned business organisations would not attract outside investors due to a lack of management efficacy. In contrast, Glover (2014), finds that family-owned businesses face long-term performance challenges, due to conflicts between family members. The study determines that succession in family-owned businesses is not a guarantee for long-term success, especially when succession is not based on merit, but legitimacy issues Zamberi Ahmad, (2011).
Culture plays a central role in how succession is conducted in family businesses in Saudi Arabia, and most Arab countries. According to Ghee, Ibrahim and Abdul-Halim (2015), while succession planning in family-owned firms in Middle East culture can be centred on competence and capabilities, in some cases it is determined by cultural issues, such as age and gender. The study finds that more men than women are usually groomed to take over the family business in the Middle East. The study also establishes that in some cases, family business succession is determined by the closeness of a family member to the founder or owner of the company. A family member that is close to the business founder is thus likely to be given control of the firm, even if she or he is less deserving. Stewart and Hitt (2012) suggest that this is a major problem because, in many cases, family ties overrun competency needs. The selection of top managers is, therefore, likely to be based on issues such as age, gender and favouritism, instead of merit. When management is comprised of individuals without the ability to effectively manage business operations and implement strategies, the firm will perform poorly in the market. Chung and Luo (2013) support these findings by claiming that investors tend to avoid family-owned and managed businesses because they lack effective corporate governance mechanisms. Such companies may succeed in Saudi Arabia where the family-management business model is favoured, but cannot effectively grow and expand in foreign markets, especially when outside investors are required to raise funds. The lack of distinction between business ownership and management poses significant risks to the future growth and expansion of family-owned and managed business organisations. Nomination committees can play an important role in mitigating the challenges associated with corporate governance in such businesses.
The formulation of laws and regulations in the kingdom of Saudi Arabia is mainly influenced by Islam, both as a religion and by civil laws (Al-Bassam et al., 2018). The country is regarded as a religious state because religion plays a central role in governance. Reliance on the Sharia system to develop government policies implies that both culture and religion extensively determine business practices in Saudi Arabia. Family business and concentrated ownership are the most common forms of business in the country. The importance of family as seen in the Saudi culture means that company firms are mainly managed by family members. The existence of many family-owned enterprises in the country necessitates an examination of how succession planning impacts on corporate governance.
Family-owned business organisations do not face agency challenges, but rather face disclosure problems, due to the lack of an independent management team. According to Ali, Chen and Radhakrishnan (2007), family firms do not experience agency problems because ownership and management is fused in most cases. However, significant agency problems usually occur when there are controlling and non-controlling stockholders. Controlling shareholders tend to make fewer disclosures to non-controlling or non-family directors. Ali, Chen and Radhakrishnan (Ibid), state that these firms make fewer disclosures about their corporate governance practices, an issue that creates transparency challenges. In firms where the government or individual families hold the largest shares, there are bound to be transparency and accountability challenges, due to the lack of board monitoring mechanisms that influence CGP.
In the event that a board exists, it will be solely to promote the interests of the majority shareholders (Al-Bassam et al., 2018). Lam and Lee (2012) support these claims by arguing that family-owned and managed businesses make even fewer disclosures concerning remuneration, and are often characterised by CEO duality. The study further shows that, while such firms tend to have long-term success, the management structure makes it difficult to achieve expansion and growth objectives. These claims conform to the argument advanced by Chung and Luo (2013), who state that family-owned and managed business organisations usually find it challenging to attract outside investors when seeking capital for expansion.
Nomination committees can mitigate some of the governance challenges experienced by family businesses in Saudi Arabia. Lam and Lee (2012) suggest that having a nomination committee can enhance the corporate governance practices of family businesses, and improve their financial performance. The association between nomination committee and firm performance in family businesses is also supported by Chen and Nowland (2010), who claim that optimal monitoring of the board of directors through the nomination committee enhances the performance of family-owned businesses. They argue that board monitoring improves CGP, and thus business performance in Middle Eastern family businesses.
Having a nomination committee can, therefore, create a path to the inclusion of women in the succession plan of family companies.
While nomination committees can play an important role in ensuring effective corporate governance practices, establishing one for family businesses is difficult, due to the level of control exercised by family members. In spite of the correlation between nomination committee and firm performance, establishing such a committee can be challenging due to the perceived loss of autonomy and business control by family owners. Chen and Nowland (2010) argue that the use of these committees in board monitoring is only employed optimally. The findings imply that unless family owners decide to have a nomination committee to improve governance practices, its establishment would be difficult. The nomination committee is consequently ineffective, because only shareholders with large share percentages have power and influence with regard to corporate governance practices. They can thus influence management decisions, with minority shareholders powerless to effect alternative measures (Shehata, 2015). Families and the Government control a significant percentage of the organisations within Saudi Arabia, a factor that enhances the concentrated ownership structure and limits the impact of nomination committees on succession planning, since decisions are made by large shareholders (Al-Bassam et al., 2018). Although, limitations are imposed on firms in Saudi Arabia, such as the separation of the role of the CEO and chairperson, nomination committees rubber stamp appointments made by investors with large stakes in the corporation (Shehata, 2015). The key question, therefore, is how family-owned businesses in Saudi Arabia can be encouraged to form nomination committees to improve their governance practices. As argued by Ali, Chen and Radhakrishnan (2007), non-family shareholders are unlikely to have their interests advanced, unless a distinction between the management of the firm and its ownership exists. Having a nomination committee can reduce corporate governance challenges and ensure that the interests of stakeholders are considered when making business decisions.
CGCs can significantly impact on the corporate governance practices of family businesses, because they are designed to ensure the effective management of corporations. However, they do not apply to private entities not listed on the stock exchange, an issue that makes it difficult to implement them in family businesses. The development and review of the CGC in Saudi Arabia shows that adherence to the code enhances governance practices. The question, therefore, is whether private family businesses can apply these codes to ensure board independence and governance efficacy.
- Summary:
- References
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