Saudi Family Businesses May Look for ‘Keiretsu’

JEDDAH, 21 December 2005 — Corporate governance is the most important element in a restructuring formula for family businesses that intend to go public. Going public involves the separation of ownership and management, not only conforming to the Capital Market Authority (CMA) regulations. This separation is potentially a source of conflict, and for small and medium-size family businesses this is a great challenge. The conclusion that emerged from the first “Forum for Leading Family Businesses to an IPO” held this week in Riyadh was that many businesses are unable to separate ownership and management. The most pressing problem is how to transform unprepared small and medium-size Saudi family businesses into joint stock companies with floating shares. A possible solution would be for Saudi companies to follow what is known in Japan as the Keiretsu corporate governance system.

When Saudi family-owned companies consider going public, they usually follow the American model in which owners (shareholders) elect a board of directors which then appoints the company’s managers. This model is broadly applied in North America, Great Britain, Western Europe and most other English-speaking countries. The Japanese Keiretsu, however, offers a different model for corporate structure. It is a group of companies interconnected through business partnerships and shareholdings. The system emerged in Japan after the demise of the pre-WWII Zaibatsu system of large conglomerates. Keiretsu links financial and industrial companies into one group.

Richard Brealey of Bank of England and London Business School, Stewart Myers of Massachusetts Institute of Technology (MIT) and Alan Marcus of Boston College identified several ways in which Keiretsu member companies are interlocked in the business group. First, each company in the group holds shares in many of the other companies. Second, managers may sit on the boards of directors of other companies in the group, and a “president’s council” of chief executives meets regularly. Third, companies generally borrow from the Keiretsu’s bank or from elsewhere within the group.

Brealey, Myers and Marcus argue that Keiretsu links carry several advantages for the members. First, companies can obtain funds from other members of the group without the need to reveal confidential information to the public, and if a member of the group runs into financial difficulties, its problems can be worked out with other members of the group rather than in the courts. Second, the more stable and concentrated shareholder base of large Japanese corporations allows them to focus on securing long-term advantages and resist pressures for short-term performance. Third, banks and other companies often own or control large blocks of shares and can push hard for changes in the management or strategy of poorly performing firms. Thus supervision and control are entrusted largely to banks and other member corporations.

Keiretsu are found only in Japan. Among the major Keiretsu formations is the Mitsubishi Keiretsu which contains 29 core companies. The activities of the Keiretsu vary since it includes two banks, two insurance companies, a real estate company, a research institute, an oil company (Nippon Oil Corporation), a steel producer, a cement company, and the famous automobile manufacturer, Mitsubishi Motors Corporation.

There are large companies, however, in continental Europe whose links are similar to those of the Japanese Keiretsu. The Virgin Group is one good example with a large number of fully or quasi-independent companies under varying ownership. Among them are Virgin Mobile, Virgin Atlantic Airways, Virgin Trains, Virgin Money (providers of pensions, investments and insurance) and Virgin Drinks.

The various Saudi family companies could adopt the same structure as the Keiretsu. Small companies that cannot float in the market due to organizational constraints could now form better business alliances with other companies through cross-shareholding. This is similar to forming closed joint stock companies although it is different since other firms, rather than individuals, will sit on the board of the directors and own shares in the companies. With a financial firm included in the alliance, small Saudi family businesses could stand in front of the fierce competition of both large transnational companies entering the Saudi market and large local corporations. In most cases, businesses take an existing model and apply it to themselves. But such cloning could, in some cases, lead to unforeseen problems. That’s why, while adopting a model for their businesses, Saudi families should look at those that could be adapted and used in their business environment and their culture.