Development impulses for family businesses and publicly traded mid-sized companies.
Ensuring functioning supply chains has become a major challenge for companies, especially since the global Covid-19 pandemic. Currently, geopolitical tensions and regional conflicts pose the greatest threat to supply chains (BDO, 2022). In addition to these ongoing macroeconomic risks, the ongoing global climate change demands greater attention from corporate management. The ongoing droughts have a negative impact not only on agriculture but also on inland shipping and, thus, the transport of goods and raw materials. In addition, extreme weather events such as heavy rain, floods, or hail damage are becoming more frequent and seriously affecting operations. In addition to these so-called physical risks associated with climate change, companies are indirectly subject to further transition risks due to increasing regulation by the European Union or the legislator.1 Depending on the business model, the consumer also plays a significant role. So, what can be done? In disruptive times, where sometimes the only constant is uncertainty, suitable management systems are needed to ensure navigation in rough waters. An enterprise-wide risk management system plays a significant role in this context. While the formal requirements for establishing risk management have a long history in German legislation in the listed environment, the practical implementation of many systems often shows only a low level of maturity. Against the backdrop of the current disruptive market environment and the emergence of new risks (so-called emerging risks), this represents lost potential. The establishment of an appropriate risk governance structure and the associated holistic integration of risk management into the strategic process of corporate management provide the necessary basis for agile response to current challenges.
Current Challenges of Family Businesses in a VUCA Environment
Family businesses have the particularity that their governance is primarily shaped by the influence, experiences, and lived culture of the (owner) family (Astrachan et al., 2002; Klein et al., 2005). The lived risk governance in many family businesses and SMEs is less formalised and institutionalised than in the listed company environment (Gao et al., 2012; Hiebl et al., 2018) due to their history. Despite this often-missing procedural anchoring of risk governance entities, many family businesses have been operating successfully in the market for generations and navigate the company resiliently through various corporate crises with a compass and course.
In addition to the ongoing Covid-19 pandemic and its widely felt effects, family businesses are also affected to a greater or lesser extent by the VUCA environment. In addition to high volatility in commodity markets, they are often subject to increasing uncertainty in the global sales market. In addition, there are other factors, such as increasing complexity due to a variety of compliance risks associated with the globalisation of business activities. Finally, the business development of family businesses is subject to a high level of ambiguity regarding emerging future trends, with sometimes significant impacts on existing, traditional business models (Bennett and Lemoine, 2014). Emerging risk types, such as cyber risks or extreme risks arising from ESG risks, also require increased attention (ECIIA, 2021).
To navigate safely in the permanently stormy sea that is expected for the future, targeted further development of existing risk governance processes is essential, particularly considering the increasing complexity. In the past, it was sufficient for the family patriarch alone to make all risk-relevant decisions based on experience. However, today's decentralised, often multi-level corporate and investment structures require continuous further development of holistic risk management and continuous adaptation of risk governance to current requirements. (Lundqvist, 2015; Stein and Wiedemann, 2016).
Development impulses for the risk governance of family businesses
Current experiences from governance consulting practice with leading family businesses in the DACH region show that many families — consciously or unconsciously — are already reacting to the changing VUCA environment and adjusting their risk governance. The role of the actors involved and their executed role is particularly important in this regard (Hiebl et al., 2018). The following trends can be identified in the market as development impulses for the holistic further development of risk governance:
Changes in risk governance through an early corporate succession
As a significant driver for a change in Risk Governance, the early success of family businesses can be identified. The new generation of entrepreneurs is characterised by a high level of education and internationality. In addition to the high quality of academic training, practical training is often shaped by secondments in the international listed environment. Especially through the transition to management, young family entrepreneurs bring learned best practices into the family business. Along with changed control mechanisms, further development of Corporate Governance and Risk Governance processes is often intended.
A stronger professionalisation of Risk Governance through experienced advisory boards
New Risk Governance impulses are often made through changes in the advisory board structure. In addition to fulfilling their primary oversight function, experienced advisory board members enable the ongoing benchmarking of best practices. Family businesses with a low maturity level in their risk management systems benefit from the expertise and often respond with a desire to further develop existing management systems.
Enhanced professionalisation of Risk Governance through experienced external managers
In addition to the influence of the supervisory board and advisors, the appointment of external managers into the management team often marks a significant turning point. External managers with broad corporate governance experience appreciate the benefits of lean and transparency-enhancing management systems. Starting with the establishment of internal control systems and internal audit functions, there is often a continuous development of existing system landscapes. The manager acting as a change agent often acts as an evangelist of Risk Governance in the company. Particularly through lived communication ‘tone from the top’, this development has a positive impact on the Risk Governance framework in the family environment.
International regulatory efforts and global megatrends
In addition to changes in the internal circle of leadership and oversight structures, current national and supranational regulatory efforts are presenting new challenges to governance practices. Particularly, the frequency of legislative amendments and the depth of the impact of current compliance efforts on the value chain of family businesses are increasing. Examples of current regulations include the heightened requirements of CSRD2, supply chain regulations (Dutzi et al., 2022), and the EU Taxonomy. The transition to a sustainable economy, which is the intended outcome of these regulations, requires family businesses to undergo a sustainable transformation of their business model and to adapt to climate risks not previously considered in their risk universe. However, solely considering these risks within internal risk models is insufficient. To pursue a holistic management philosophy, it is recommended to perceive the impending regulatory challenges as an opportunity and to calibrate the risk governance framework agilely to the new circumstances early on.
Integrated risk management as a driver of value to increase resilience?
The establishment of a functioning risk governance structure, consisting of an organisational structure with relevant reporting channels, serves as a necessary condition for an appropriate risk management system.
The high market dynamics and often high complexity due to a multitude of new and simultaneous risks also require a holistic adaptation of corporate governance to the new circumstances. To provide decision-relevant information to management in times of crisis, risk management requires a suitable database, which requires a sufficient quantification of all risks in the company and a holistic aggregation of risk data. Modern simulation methods and the use of scenario analyses also provide another significant contribution to value: security over uncertainty. While stochastic models are inherently subject to model risk, they can be minimised through suitable assumptions.
The increase in geopolitical and macroeconomic risks and the growing importance of environmental, social, and governance determinants require an evaluation of risk management methodology. Many governance systems currently operate in isolation from each other. However, the consideration of many new types of risks requires an interdisciplinary approach. To generate efficiencies and reduce redundancies, it is advisable to establish a unified methodology for capturing risks. In addition, the use of suitable software solutions can help reduce potential problems in the interfaces of the system landscape.
In addition to moving away from a purely ex-post evaluation of the risk situation, current circumstances require ex-ante planning of risk management. To achieve this, it is advisable to break down the silos that often exist between controlling and risk management and integrate risk management with business forecasting. The resulting risk-adjusted performance measurement system — ideally integrated into a decision-relevant reporting system — enables agile responses to uncertainties through value-added transparency.
Summary and Outlook
The current business environment is characterised by high uncertainty caused by macroeconomic, geopolitical, and a variety of emerging risks. Many family businesses are already implicitly adapting their risk governance to this current situation. However, the high speed of risk occurrence and changing market conditions require an agile response to new circumstances. An integrated risk management system with established risk governance provides a valuable contribution to increase the validity of business decisions and support management in the context of holistic performance measurement. Companies should take advantage of the current turbulent times to adapt their systems to the current conditions.
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