When the head of a family firm ranks lower in the family hierarchy than another leader at that firm, the misalignment can help prevent fraud in the emerging market context
For hierarchical inconsistency to work its magic, the two leaders must both have influence and legitimacy
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Corporate governance is a challenge in emerging markets where the rule of law tend to be weak. The usual mechanisms for reducing corporate fraud aren’t as effective there as they are in developed economies. Take the real estate industry in China. Recent years have seen a crop of fraud cases – such as excessive leveraging followed by bankruptcy – that hurt many investors.
The problem isn’t just weak rule of law. It is not rare for independent directors to be personal friends of top executives. When everyone is cosy, it can open the door wider to potential wrongdoing. This prompted us to look at an informal corporate governance mechanism that could compensate for the ineffectiveness of the usual ways to monitor and reduce securities fraud.
The novel mechanism we propose is hierarchical inconsistency. Let’s use an example: In the context of a family business, if a son serves as CEO with his parent as a member of the top management team, the son occupies a higher rank in the formal business hierarchy, while the parent has a higher rank in the social (family) one. While the parent’s standing is bolstered by deep-rooted Confucianism, a patrilineal system emphasising younger members’ deference to their elders and women’s subservience to men, the child is the unequivocal head of the firm.
This hierarchical inconsistency can occur for various reasons. A common one is succession planning. For example, the second generation takes over, while the first generation (often the father) remains active in the firm, with or without a formal title. This can help ensure a smooth transition.
Another common reason is when the more junior family member has superior expertise, a better business background, or more extensive relationships in a specific industry. That person may be appointed as chair of the board (the highest position in the business pecking order) to meet specific expectations of important stakeholders, while the parent reports to him or her. Alternatively, it can mean the wife is head of the firm, with her husband reporting to her.
[This article is republished courtesy of INSEAD Knowledge, the portal to the latest business insights and views of The Business School of the World. Copyright INSEAD 2024]