Despite the efforts of national governments and international organizations to improve corporate governance in emerging markets, the response of the companies themselves has been underwhelming.¹ Many companies ignore the initiatives—which primarily involve reform of boards of directors—or just pay lip service to them. Little attention is paid to the directors' qualifications, even when reforms are mandated, as they are in South Korea, where 25 to 50 percent of a company's directors (depending on its size and sector) must now come from the outside. Could the problem be that the would-be reformers are focusing on the wrong reforms?

The corporate-governance model usually prescribed is the one that prevails in the US and the UK

The corporate-governance model usually prescribed is the one that prevails in the United States and the United Kingdom. Its emphasis on shareholder value reflects the environment in those two countries, where a very large, dispersed class of investors, with no prior connection to the companies listed on the public exchanges, insists on boards that are similarly independent. These investors also demand a high level of financial and business disclosure.

Compare this with the situation in many emerging markets, where family-owned businesses predominate. Since the top managers of these companies are also owners, it is natural and consistent for them to expect to have a board presence. Besides, there is no anonymous investor class for them to worry about (Exhibit 1). In fact, the kinds of reforms that well-run public companies in developed markets have embraced would have the unhappy effect of reducing the family's control. "More transparency means more opportunities for government to favor my competitors," explains the chief executive officer of one family-owned business.

But the market model of corporate governance isn't the only possible model. In Continental Europe, for instance, companies have evolved an integrated model based on dominant shareholder blocs and a quite different institutional context. However, if an emerging economy wishes to attract more equity investment, the market model would be the one to choose. But first, the conditions in which this model is appropriate—that is, the institutional context—must be created.

Over half (55 percent) of the respondents in a recent McKinsey survey of private equity investors² said that reform of the institutional context—reform driven by governments, local stock exchanges, and regulatory watchdogs—was at least as important as reform of companies. Within the institutional context, the two main concerns were weak enforcement of legal rights and the management of the economy (Exhibit 2).

Investors want such reforms in order to protect their own investments, but changes of this sort could also have the effect of transforming the governance policies and practices of family-owned businesses. To gain access to cheaper equity, the managers of these companies—especially younger managers who need capital to purchase control from the generation getting ready to retire—might push for internal reforms that would make companies more appealing to investors.

But because institutional reforms will take time to implement, corporate reforms urged upon family-owned businesses should promise benefits regardless of the progress of economy-wide improvements. More detailed and individualized internal financial reporting (a prerequisite for more accurate external reporting) would strengthen personal accountability. A more rigorous evaluation of top management and a system of performance-based compensation would soon translate into improved performance for the company as a whole.

It is unrealistic to expect family-owned businesses to change everything at once. A staggered approach, enabling family leaders to retain control over the process, is more manageable. In our survey, we grouped under five main headings the reforms within a company's control and asked survey participants to list them in order of priority.

Most important, the participants said, was greater financial transparency. In second and third place, respectively, were the adoption of internationally recognized legal standards—perhaps by stipulating, in commercial contracts, that the laws of a trusted jurisdiction such as New York should govern and that disputes should be adjudicated there—and enhanced shareholder rights. Board reform, despite its popularity among advocates of more effective corporate governance, came in fourth, while a listing on a major stock exchange (rather than a small, regional one) when a company went public was deemed least important (Exhibit 3).

Only when each of these measures produces unmistakable benefits can family members be expected to become more enthusiastic proponents of subsequent rounds of reform.