GOVERNANCE
Avoiding scandal:
Good intentions won’t do it

What’s ethical? In a family business, it isn’t always easy to tell

Most of us are aware of the well-reported scandals at Enron, WorldCom, Tyco International, Global Crossing and Adelphia. But what about all those daily unreported ethical or judgmental lapses that slip beneath the media’s radar? How about, say, the family business owner who misuses his power or position for personal benefit? Or the one who uses poor judgment as a fiduciary when acting for other stockholders?

ARTICLE REPRINT This article is adapted from one that appeared in the August 2002 issue of Family Business magazine.

How would you handle the following questionable situations?

Scenario #1: John runs a real estate land development and property management partnership in which he and his two sisters each own a one-third interest. John learns of an attractive strip shopping center that’s for sale at a great price with seller financing. He decides to buy it for his own account (instead of for the partnership) without mentioning the transaction to his sisters.

Scenario #2: When Bentley started working in the family business, he enjoyed attending auto shows with his dad, an amateur car collector. Bentley bought his first antique car ten years ago with a bonus from the company. Since his dad’s death, he has used company funds to buy five more. He keeps them in a temperature-controlled garage at the company. One of the company’s employees maintains the cars as part of his job. Bentley’s brother Royce (not active in the business) just found out that the cars were purchased with company funds and maintained as a corporate expense. Royce almost blew a gasket. Bentley wonders what the fuss is all about.

Scenario #3: Sharon runs the family’s retail clothing store chain, which she owns jointly with her five cousins. Several of the company’s stores need renovations. She awards the contract to her husband, James, a sometimes-employed carpenter, without requesting any outside or competitive bids. James sub-contracts the work to another construction company for 75% of the price, oversees their work and keeps the 25% as a management fee.

Some family business owners cross these ethical lines knowingly. But more often they’re just confused by the gray areas that inevitably develop when issues of money, family and business overlap.

In the start-up years, a single entrepreneur is preoccupied with survival—and may have no shareholder concerns. Her personal financial sacrifices are put on hold for some future date when the business is sound and her debts can be recouped.

Successful owners know intuitively that sound business ethics and stockholder relations are essential to keeping trust alive.

As the business prospers, cash flow begins to support expenses such as meetings, conventions and the corporate plane (or boat). “Charging” expenses to the company becomes easier as the company’s cash flow improves. But the next generation of owners (or the current generation’s siblings) may question some of the perks that senior management has come to expect.

Another problem: Different family members may operate under different sets of standards.

For example, elder siblings who have been in the business longer than younger siblings may believe they’re due more perks based on years of service. Next-generation owners entering the business may have been too young in the “sacrifice” years to remember their elders’ financial hardships. Instead, they may envision the family business as a piggy bank of perks for owners. A rational compensation policy for family members may be foreign to their experience, especially if they grew up with a liberal understanding of what a “business expense” is.

Active family members who become owners along with inactive siblings or cousins may see themselves held to a higher ethical standard than the previous generation. Is it a “higher” standard or simply a different measure of accountability, because the business is in a different place?

This issue isn’t always easy or pleasant to address, but it can fester if it’s not confronted head-on. Most of us want to do the right thing. The tough ethical decisions that perplex reasonable people usually occur when expectations are fuzzy, communication is poor, and accountability and oversight are unclear.

The good news for family business owners is that they’re generally close to their employees, their stockholders and their customers, so they answer for their personal actions one-on-one. Successful owners know intuitively that sound business ethics and stockholder relations are essential to keeping trust alive. But as a family business grows, how can you maintain an ethical climate within the family? Mission statements describing business practices may not go far enough. You may also need a written “family ethics policy“ that includes:

• Admonitions against self-dealing for corporate officers.
• Expectations that full-time family employees work full-time on business affairs.
• Full disclosure of business and financial information to all shareholders.
• Standards of fiduciary behavior for company officers.
• Guidelines regarding family access to corporate perks.
• A process for presenting and discussing questionable practices.

More important, family values and ethics need to be communicated, with someone in a leadership role committed to seeing that these values are understood and practiced—not by command, but by example. True ethical behavior can be encouraged and supported, but it can’t be imposed or dictated. A family ethics policy is only a piece of paper unless it’s an integral part of the culture.