familyownedbusinessblog

Using Game Theory to solve Business and Political Disputes

Bruce Bueno de Mesquita was the opening keynote speaker at the Family Firm Institute's 2010 annual conference in Chicago.  He is the Julius Silver Professor of Politics and Director of the Alexander Hamilton Center for Political Economy at NYU, a Senior Fellow at the Hoover Institution, Stanford University.  He is the author of The Predictioneer's Game.

Mr. Mesquita uses mathematical game theory as a way of "evaluating how people interact when they are trying to advance their own interests".  During his presentation he indicated that for the most part, he believes all people are rationally self-interested (however, he excluded two year olds and those that are mentally ill).  In his method he analyzes who has a stake in the outcome, what do they say they want, how focused are they on the particular issue vs. another issue, how persuasive can an influencer be, and how resolved are the parties to coming to an agreement. 

When working with a family business, we must also analyze these issues.  It is important to know who has a stake in the outcome of any decisions that must be made.  This often includes family members who may not be present for any discussions or may not be the ultimate decision-maker.  One member of the family may indicate that they want a certain outcome, however that family member may not understand all the ramifications of that outcome or considered other options.  The adviser must determine how important is the present issue - can the family be persuaded to resolve other issues that will assist with resolution of this particular issue?  It is critical when working with family businesses that the non-bloodline family members who are influencers be included or have a place in the process. With regard to the level of resolution, family businesses will often wait until the pain of doing nothing far exceeds the pain of resolving issues. 

Whether or not you are a fan of game theory, the factors used by Mr. Mesquita can be used to assist anyone who is working with family businesses. 

Understanding Corporate Roles and the Family Business

The governance of family businesses begins with understanding the role of shareholder, board of directors and the officers.  In those family businesses where a few family members serve in all three roles, the boundaries between the roles is blurred. That blurring leads to problems which could be avoided with an understanding of the roles and attention to the role being played at any given time. Following is a summary of those roles.

1. Shareholders.  The shareholders own the corporation but do not own the business. The corporation owns the business including all of the assets of that business.  The role of shareholders is to elect and remove directors, adopt certain amendments to the articles of the corporation, approve major actions such as selling substantially all of the corporate assets, merger and liquidation.

2.  Directors.  Directors sit as a board and it is this board that directs the management of the corporation. The board sets policy, elects and removes officers, establishes compensation of employees, issues stock, pays dividends, approves contracts, approves loans, initiates new ventures, purchases equipment and recommends actions to be taken by the shareholders.

3.  Officers. The offices conduct the day to day affairs of the corporation at the direction and guidance of the board of directors.

With this summary description of the roles to be played within a corporation it is easy to see how the lines between the roles get very fuzzy when a few people serve in all three roles. One of the most significant issues is the liability that can attach to a person who is not mindful of keeping the roles straight. If the line between shareholder and officer is so blurred, creditors are able to pierce the protective veil of the corporation and reach the shareholder's personal assets.

In family owned businesses it is also important to keep the role of business distinct from the role as family. When that role is blurred, the whole fabric of the business is weakened. Good governance structures will strengthen the fabric of these businesses. Those structures will include objective criteria for family members entering the family business and merit promotions. Other issues to be addressed in family business is compensation, mentoring and succession.

Governance of any business requires attention and intention. It is critical to the success of a family business.

How to get a younger generation family member to do their estate planning

Recently, the executive director of a local family office was talking to me about a 3rd generation family member who has not completed her estate planning documents, much to the chagrin of the director and the family.  He asked me for any suggestions that I had.  He explained that the family member is a woman in her mid to late twenties who has a professional degree and is working in the family business.  We discussed that the attorney who has been representing the family is of her grandparents' generation.

My first suggestion was to have the woman's parents or grandparents apply pressure to complete a simple plan.  He indicated that approach had been tried but as yet had not been successful.  I asked if there were any restrictions on distributions from existing trusts or gifts if she did not have an estate plan in place.  He indicated "no", that would have been a good idea, but it had not been included in the estate planning documents.

I suggested that he contact the attorney who has been working with the family and find out if they have a younger attorney in the office who could work with this family member.  I proffered that she may be more willing to work on an estate plan if she is working with someone who she sees as her contemporary, rather than her grandparents' or parents' attorney.  We discussed whether or not the professional should be the same sex as the family member.  My thoughts were that it really depended on the individual and to ask if she would be more comfortable with a female attorney to assist her.

One of the challenges that we as advisors face is the "transition" from one generation to the next.  We are seen as the "grandparent's" or parents' advisors.  It is important for us to take the advice that we give our clients - what is our succession plan?  Who will be assisting our clients once we retire.

Keeping it in the Family

Many clients with family businesses or with assets that they want to remain within their family's bloodline are concerned about how to leave those assets to their family members upon their death.  These clients fear that the assets will be transferred to the child's or grandchild's spouse through gift or divorce. 

One solution is to retain these assets in trust for the lifetime of the child or grandchild and limit the distributions to income only.  This may not be an ideal option for some who want their family to have the economic benefit of those assets. 

Another solution is to include a requirement in the estate planning documents that the beneficiary must have a prenuptial agreement or other type of asset protection agreement as a condition to receiving a principal distribution.  The purpose of the prenuptial agreement is to restrict the ownership of the family assets to the bloodline.  The prenuptial agreement can be limited to the assets that the beneficiary is inheriting.  If the beneficiary does not have a prenuptial agreement or other asset protection agreement, then the beneficiary will not receive any principal distributions. 

The estate or trust should include discretion for the trustee to pay for the reasonable attorney fees for  both the beneficiary and the beneficiary's spouse that will be incurred to adopt a prenuptial agreement.  The trustee should also have discretion to purchase a life insurance policy on the life of the beneficiary that is payable to the beneficiary's spouse. 

The prenuptial agreement is not a perfect solution because once the beneficiary receives the principal distribution, the beneficiary can terminate the agreement or, subject to transfer restrictions on the assets, transfer the assets to the spouse.  It is equally as important that the children and grandchildren are raised with an understanding or expectation that this is how our family manages the family assets - everything remains in the bloodline.  Along with this,it is important that the family members and future spouses understand that this is expected of all family members and their spouses. 

The Psychology of Having Money

At the October meeting of the Oregon Family Firm Institute Study Group held in Eugene, Nancy Frisch facilitated a discussion of The Psychology of Having Money. Ms Frisch led us through exercises that gave us insight into own relationship to money then turned our attention to what she describes as the 8 characteristics of a “rich kid”.

1. Self-esteem of a rich kid is often inadequate;
2. Maturity of a rich kid is delayed;
3. A rich kid lacks motivation; and
4. Self-discipline;
5. A rich kid is bored;
6. A rich kid will use of power by either its misuse, denial, avoidance;
7. A rich kid will feel guilty for being rich; and
8. A rich kid will feel alienated.

It turns out that being rich can make a person unhappy and marginalized from the rest of society. Because we and our clients have seen these characteristics in other rich kids, wealthy parents want something else for their children. What can make the difference between the typical "rich kid" syndrome and a happy, motivated child of wealth who is a credit to his or her family and a productive member of society? Ms Frisch suggests that parenting has a lot to do with the difference. So what set of behaviors in parents will result in well adjusted rich kids?

In raising wealthy children: 

1. Understand what values you want your children to learn?
2. Understand what is important to you and your family?
3. What do you want your children to remember from your teachings and parenting?
4. What kind of relationship do you want with your children?
5. What is the mission (purpose) of the family's money?
6. What the family stands for; what are its values; how will it use wealth;
7. Develop board strategy for accomplishing these goals;
8. Create rules and procedures for interacting; and
9. Share hopes for the future and family legacy.  

Whether rich, poor or middle-class, raising children with the understanding and intention outlined in the 9 action items above would go far in creating happier, more motivated and productive adults.  It certainly will give those children who do not have to work a sense of purpose and mission so lacking when there is nothing required of them.

A Business Plan for Education

At a recent FFI Study Group meeting, we were discussing some of our challenging cases.  One of the family business consultants was asking my advice about one of her particular clients.  The grandparent wants the youngest grandchild to obtain a specific degree within a limited time frame.  However, the grandchild wants to obtain a different degree that she believes would be useful in the family business.  The grandparent is also refusing to provide financial assistance to the grandchild, so the grandchild is attending school part-time and working part-time.  If grandparent provided financial assistance to the grandchild, then the grandchild could attend school full time and complete the education within time frame that grandparent has set.

What to do?  I suggested that the grandchild develop an educational plan, similar to a business plan and present it to grandparent.  The plan would detail the proposed program of study and the educational institution where the study program is to be undertaken.  It should also include performance requirements for continued financial support.  In this case, the grandchild should make a case as to how the degree will be beneficial to the family business. 

This is a technique that can be used for any educational trust.  I have several clients who do not have children, but want to provide for the education of their family members.  They want to make sure that their funds are used to pay for education for those family members who are serious about getting an education.  In some cases, the amount of support has been limited to a certain percentage, in others only tuition and fees were covered and did not include living expenses.  In another case, the education trust was set up as a source for loans.  A family member was able to borrow from the education trust under very favorable terms, but the loan was required to be repaid so that there would be funds available for the next generation to attend college or university. 

The educational trust or plan can be tailored to fit the beneficiaries, rather than a one-size fits all plan which provides that a trustee can pay for educational expenses.