CORPORATE GOVERNANCE MECHANISMS AND UNLISTED FAMILY BUSINESS PERFORMANCE WITH THE MODERATING ROLE OF INTERLOCKING DIRECTORATES
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Date
2024
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Universiti Teknologi Malaysia
Abstract
Despite the prominent role family businesses play in the Saudi Arabian economy, which is deeply embedded in the societal fabric, their economic contribution remains relatively modest compared to their significant presence in the society. This performance discrepancy is often attributed to the resource dependence challenges confronting the family business sector, particularly exacerbated by their deliberate choice to restrict ownership exclusively to family members and uphold familial control through family-dominated boards. However, there is a notable scarcity of empirical evidence on how family businesses in Saudi Arabia navigate these resource dependence challenges. Hence, this research examines how interlocking ties, moderate the relationship between family ownership and board composition, particularly, their impact on business performance within family businesses in Saudi Arabia. This study is rooted in the understanding that family business ownership is often underpinned by the emotional commitment owners invest in their enterprises. Furthermore, the effect of family connections on board composition and functioning, in fostering business networks, exerts a significant influence on the performance of family businesses. Consequently, this research explores the interplay between family ownership and board composition, with the moderating effects of sent interlocking directorates and received interlocking ties. The survey method was employed for data collection, involving a sample of 204 respondents. Data analysis was conducted using the statistical tools, SPSS and SmartPLS. Four out of the eight moderation propositions received empirical support, underscoring the significance of discerning between these moderating factors. Hence, this study makes noteworthy contributions to the family business research in Saudi Arabia. It has successfully constructed and validated a model that establishes a connection between the dimensions of family ownership and board composition as a precursor to family business performance in Saudi Arabia. This relationship is moderated by the sent and received dimensions of interlocking directorates. Furthermore, the findings from this study lend considerable support to the theoretical model which posits a direct linkage between family ownership, board composition, and family business performance.
Description
1.1 Background to the Study
Historically, the livelihood of the people of Saudi Arabia depended, and still does, now on commerce: the desert environment of Saudi Arabia is not hospitable for an agricultural economy. The people are therefore predisposed towards the mercantile occupation (Al-Dubai et al., 2012). There are several allusions to this fact in the Qur’an. Allah mentioned in Qur’an 106:1-4 the secure, bi-annual summer and winter trading missions of the Quraysh, a prominent Meccan tribe. Thus, wealth and livelihood in Saudi Arabia are made and earned through enterprise, which was and still is organised around family units (Palaiologos, 2017). The most recent available data from official sources show that as of 2018, there are 919,078 fully operating commercial establishments in Saudi Arabia, of which 74.83% are family businesses (GAStat, 2018). However, Asharq Al-Awsat (2021), a financial magazine, reported that 63% of all operating enterprises (registered and unregistered) in Saudi Arabia are family business contributing about USD216 billion to Saudi GDP. These statistics show that family businesses in Saudi Arabia play a focal and strategic role in the economic and social life of the Kingdom. Their governance is, therefore, of national interest.
Why do family businesses dominate the economic landscape across the globe? The first answer lies with the very nature of human beings and their social upbringing. The dominance of the family business is an extension of the importance and centrality of the family to the individual human being (Neubaum and Payne, 2021). Payne (2020), in an editorial of the journal Family Business Review, remarked that “the most important matters in our lives, both personal and professional, revolve around people and the relationships we have with each other” (p. 6). In addition to the filial rationale for the family business as the vehicle of choice for the running of commercial activities worldwide, scholars have adduced economic reasons. The 10th Global Family Business Survey (PwC, 2021) points out commitment to values (family businesses are the most trusted among business forms), long-term thinking (the future is paramount in family business strategy), and sensible leverage (most family businesses do not borrow to finance their activities but raise funds from retained earnings). All these facts buttress the central role played by the family in the economic lives of nations. It is in this regard that this study considers family ownership (consisting of socioemotional wealth and core business focus) as an important determinant of family firm performance.
The International Family Enterprise Research Academy headquartered in Springfield, Illinois, USA, reported that “family businesses dominate most economies around the world” (IFERA, 2003, p. 235). In the Gulf Cooperation Council (GCC) states (Saudi Arabia being the largest economy in the region), more than 75% of all businesses are family-owned and account for about 90% of all commercial activity in the GCC (Sahni et al., 2017). In Saudi Arabia, family businesses constitute 95% of all registered companies, employing 80% of the Kingdom's total private-sector employees and producing about half of its GDP (Alrubaishi et al., 2020; Alrubaishi, 2017). As the most locally embedded form of business (Amato et al., 2021), family businesses tend to contribute more to the local economy (Khan et al., 2015) or region (Ljungkvist and Boers, 2016) than their counterparts which are more likely to repatriate their earning to other economies.
Studies (e.g., Amin and Hamdan, 2018; Iwasaki and Mizobata, 2020; Reyna, 2018; Zandi et al., 2020) suggest that firm ownership type influences firm performance. Davis et al. (2000) have noted that maintenance of ownership control has remained an enduring challenge for family businesses in the Gulf-region, including Saudi Arabia. Unlisted (private) family businesses in Saudi Arabia are highly embedded in the local economy and function as the primary socio-economic units of organisation, and this explains the preference that ownership stays local and with the owning family (Alrubaishi, 2020; Ramady, 2010). These characteristics are most pronounced in the few unlisted businesses registered with the Tadawul (the Saudi Stock Exchange) as they deliberately opt not to have their shares traded publicly (OECD, 2006). This family-centred policy, while entrenching family hegemony, places constraints on the firm in its ability to raise outside resources, and may thus hinder its performance.
Also, studies (e.g., Bawaneh, 2020; Majeed et al., 2020; Okeyide, 2018) seems to suggest that board composition influences firm performance. Sengooba (2010) of PricewaterhouseCoopers (PwC) understood board composition in terms of the skills and attributes available in the board for effective oversight. Similarly, the Capital Market Authority (2017) of Saudi Arabia underscored the relevance of knowledge and skills in board composition by making professional competency, ability to lead and to guide, financial knowledge and physical fitness as conditions for board appointment. Article 18 of the Corporate Governance Regulations (2017) provides that board members possess the “professional capabilities required to perform their duties effectively pursuant to this Article”. In other words, the true referent of a board’s composition includes members’ knowledge and skills and the use of these knowledge and skills in doing the board’s work. Thus, a board is appropriately composed where members collectively possess the requisite knowledge and skills and also used the same knowledge and skills in performing the board’s functions. The challenge here is for Saudi family businesses “to move away from conservative, traditional, weak corporate governance mechanisms” (Sahni et al., 2017, p. 39) that tend to rely on shifting family alliances and politics (Bodolica and Spraggon, 2020) in making board appointments. However, Razzak et al. (2020) noted that the mediating role of professionalisation (or its near cousin, interlocking ties) is hardly considered in the family business literature.
Furthermore, studies (Tian et al., 2021a; Wu, 2008) suggest that both sent and received interlocking directorates may potentially moderate the relationship between several elements of the corporate governance domain. The researcher has earlier noted that in their bid to remain private (Tucker, 2011), unlisted family businesses on the Tadawul have by default effectively chosen to close financing windows from the Exchange which available to their listed counterparts. To overcome such limitations, family businesses resort to what they know best: networking and connections. Family businesses in Saudi Arabia thus overcome the consequent resource dependence challenges through reliance on inter-firm networks at local and global levels through which they could tap into the needed resources, suggesting a possible moderating role of both sent and received interlocking ties in the performance of unlisted family firms.
Using the concept of organisational embeddedness, Salvaj et al. (2008) explain that the web of filial and social relationships which underpins most family businesses has a moderating influence on the firm’s performance because such embeddedness affords it both access to resources and markets (positive perspective) (cf., Lee et al., 2016b) as well as places limitations on what it can and cannot do (negative perspective). Thus, this study sought to understand the moderating influence of both sent and received interlocking directorates (the formal term for networking and connections in corporate governance) in the family ownership–firm performance and board composition–firm performance relationship. The study sought to unravel the web of filial relations across different boards, the ownership explanations of such compositions and how these severally and collectively influence the performance of family businesses in Saudi Arabia.
However, despite the importance of family businesses to the socio-economic health of the Saudi economy and its citizenry, longstanding governance problems exist that pose existential threats to the sector. The authorities responsible for oversight of corporate governance practices in Saudi Arabia (especially the Capital Market Authority and the Ministry of Commerce and Investment) are aware of the governance challenges in the Kingdom. Indeed, they have instituted several reforms, both legal and institutional, to address them (Al Kahtani, 2013). One such measure is the issuance of a new Corporate Governance Regulation in 2017 (Capital Market Authority, 2017) which replaced the first issued in 2006 following the stock market crash in which the Kingdom’s “stock market index (the TASI) lost approximately 65% of its value” (Lerner et al., 2017, p. 1). The 2017 Corporate Governance Regulation seeks to address the lapses in Saudi corporate governance practices related to determinants of corporate governance (e.g., firm ownership) as well as mechanisms of corporate governance (e.g., the composition of the board of directors and interlocking directorates), and how these impact on the consequences of corporate governance (e.g., firm performance).
Keywords
CORPORATE GOVERNANCE