CORPORATE GOVERNANCE

FINAL PROJECT

Banco Espirito Santo: The Fall Of

A Family Empire

Louis F. Badawy
 Introduction
• The collapse of the second largest bank in Portugal in 2014 was the biggest shock in the history of the Portuguese economy.
• In fact, after it survived the two financial crisis , one in 2005 and the second in 2008 , the both privatizations which plunged
the country in the difficult situation during the 20th century; the succession conflict was maybe the most or as some people
says the stone that made the castle collapse in the ES family.
• President of the Espirito Santo Group and Chief Executive of the Espirito Santo Bank Ricardo Salgado was the subject of
several charges among which money laundering, transfers of doubtful money, creation of new businesses for the purpose of
hiding funds and laundering money, most of them located in Tax haven financed with doubtful investment money and forgery
of accounts to mention only that.
• rescue the bank and also the group, the Bank of Portugal Bank suggested to the board of the Espirito Santo Group to change
its chairman of its executive board and also not to interfere anymore with the administration of the BES
• The family started a long succession conflict. Meanwhile, as the rumours became known by the Luxembourg’s government
which asked for an audit and the European Central Bank obliged the BES to refund the €10.000 million BES was ruined,
bankrupt. Salgado knowing that, transfer his goods to his wife and sons account (Amaral, 2015).
• As a result, the Governor and the BDP decide to split the BES in two parts, the good part became a new bank Novo Banco
and the bad stay BES.
• This move which was seen by many people in Portugal as using the taxpayers’ money to clean-up the messes caused by one
of the richest families in the country enabled the government and the bank of Portugal to avoid the collapse of the country’s
financial system, but on the other hand raised a controversy on the basis on which they decided to divide the debts between
Novo Banco (“Good bank”) and Banco Espirito Santo (“Bad Bank”).
 Pros of the Family Business
• Evidence about clan culture in family businesses in the literature shows that family business culture tend to be stronger,
sustainable over a longer period of time. I think that this clan culture was one of BES’s strengths and especially after its
nationalization in 1975 when the family fled the country and decided after meeting of the family’s high council to create a
holding company in Luxembourg to manage their family’s wealth.
• This is generally not a problem as the shareholders’ theory “principal-agent” relationship problem is far less critical in a
family business due to the high proportion of family owned share capital, the concentration of the family’s fortune in their
businesses, the heavy reliance on own funds to finance the business and the higher purpose of protecting the family’s name
and transferring the ownership from one generation to another.
• Understanding family businesses success factors is very important as by their number, assets, turnover and the number of
people they employ, they form the backbone of the economy of almost every country.
• Culture and ethical climate in the context of family versus non-family businesses and concluded that family as well as non-
family enterprises maintain positive attitudes towards the core values with ethical content. However, with respect to the type
of enterprise culture, the results of this study demonstrated a stronger presence of clan culture characteristics in family than in
non-family enterprises.
• Unlike typical workers, family members working at family firms are willing to contribute their own finances to ensure the
long‐term success of the organization. This could mean contributing capital, or taking a pay cut. This advantage comes in
particularly handy during challenging times, such as during economic downturns, where it’s necessary to tighten the belt or
personally suffer in order for the business to survive.
• The case of BES gives the opportunity to understand that corporate governance rules and recommendations are just as
relevant in family businesses as they are in other businesses. In family business groups, the concern is that managers may act
for the controlling family members rather than for all shareholders, or that some family members may take advantage of other
family members
 Cons of the Family Business
• Governance issues such as internal hierarchies and rules, as well as the ability to follow and adhere to external corporate laws,
tend to be taken less seriously at family businesses, because of the level of trust inherent at family firms. Unfortunately, this
can be gravely detrimental. Take the example of Samsung Group, whose chairman, Lee Kun-Hee, was forced to resign in
2008 after being indicted for tax evasion and criminal breach of trust charges. While his three- year sentence was suspended, a
fine of $109 million was still imposed. In this situation, a little governance would have gone a long way.
• Family business can be a breeding ground for family problems: jealousy, anger, resentment, and long-lasting bitter fights,
which can affect every person within the firm. When one unwillingly becomes part of a family business, conflicts are bound
to happen, in most cases. Nevertheless, conflict might happen in any firm, but because family members are involved, it may
result in a difficult ending.
• Some family businesses are reluctant to let outsiders into the top tier, and the result is that people are given jobs for which
they lack the skills, education, or experience. This, obviously, has a far-reaching effect on the success of the company. In
particular, it’s very difficult to retain good talent at lower levels if their performance, and their ability to succeed in the long
run, is consistently being affected by incompetence at higher levels. More family firms are recognizing this issue and are
taking care to strategically place outsiders in certain positions when necessary.
• Many family firms lack succession plans, either because the leader doesn’t have the desire to admit that he or she will, one
day, need to step down, or because there is too much trust in the family to work this out when it becomes necessary. In fact,
because of close relationships and long histories, it is of utmost importance in family firms that a strong succession plan is in
place.
• The origins of the idiosyncratic BES affair also offer a more fundamental lesson: family-controlled banks can be problematic;
but large, systemically important bank that are managed by family owners can be very problematic. Having family members
as controlling shareholders and significant players in both the supervisory and management boards thus obfuscated the
ownership structure and governance of Espirito Santo.
 Family Business in the banking sector

• The odds are stacked against family business succession: Only a third of family companies survive their founders and, of
these, only 10 percent make it to the third generation. As every major private bank is aware, much wealth can be
squandered when business families fail not as leaders of significant enterprises, but as families.
• While banks may understand the specialized nature of family enterprises—in which business, wealth, ownership and
family are interdependent—their track record for delivering services that provide comprehensive solutions is mixed.

BUT WHAT’S WRONG?

• Private banks often are unrealistic about the organizational adjustments and recourses needed to succeed with these clients.
They haven’t figured out how to offer customized business continuity and wealth management solutions that truly fit the
complexities of multigenerational family enterprises.
• Too often, private bankers fall back on canned trust structures, investment products and advisory services that the bank is
familiar with, leaving clients with the impression that the bank’s goal is to sell them a pricey suite of services, regardless of
whether it fits their fundamental needs.
• While most successful private banks offer valuable services to their client families—wealth and investment advice,
customized family office services, trust administration, estate planning and educational programs— they’re often delivered
in a piecemeal manner that raises client expectations, but misses the mark. The family- oriented spin banks use to market
themselves to wealthy families conveys sensitivity to the issues, but offers little substantive engagement with the particular
complexities their clients face, something clients come to experience sooner or later as a disappointing misrepresentation.
• Recruiting independent advisors for investment committees, as well as independent directors for their operating company
boards, have become more common than ever before. Others chose to join multi-family offices that inherently understand
families better and are thus more receptive to truly customizing the products and services they render.
 Family Business in the banking sector

BARRIERS TO SUCCESS:
1- Cost: The initiatives required to help family business clients are often costly in terms of staff and financial
resources and frequently yield returns that, while real, are hard to quantify in the short term.For many banks, it
becomes too costly to have their professionals spend a disproportionate amount of time devoted to these
concerns at the expense of selling trusts, financial products or estate plans, particularly when the return these
services generate seems so much more tangible at the end of the budgetary cycle when bonuses are paid out.
2- Organizational constraints: Delivering integrative services effectively in a manner most useful to family
business clients requires banks to work across traditional commercial, investment, wealth advising and trust
departments that typically operate (or are required to operate, as in the case with trust departments with
fiduciary responsibilities) independently from each other. In addition, retrofitting client needs into an existing
line of proven products and services is never easy, further enhancing the organizational complications these
services pose.
3- Staff turnover: Turnover of wealth advisors and relationship managers often undermines the effective
rendering of continuity planning services. the constant rotation and the limited process of hand-off from one
relationship manager to another is so flawed that it’s the clients who become the institutional memory for the
bank, reminding the bankers about the particulars of their accounts and trusts, as well as the initiatives and
products that might have been unsuccessfully tried before.
 Ownership and corporate structure of the
Espírito Santo group.
• Salgado and the Espírito Santo family owned 88.4% of ESC, 57.2% of ESI (Based in Luxembourg), 100% of Rioforte, 49.4%
of Espirito Santo Financial Group and 20.1% of Banco Espirito Santo.

• The controlling stakes of the Espirato Santo Control are 57% in ESI, 100% in Rioforte, 100% in Espirito Santo Irmaos SGPS
and 49% in Espirito Santo Financial Group – BANKING.

• The controlling stakes of the Espirito Santo Financial Group are as follows:
1. 100% of controlling stakes in BSF Portugal (which has a controlling stakes of 73.6% in Bespar and Bespar has 35.3%
controlling stakes in BES Grouo).
2. 1.4% in BES Group
3. 100% of controlling stakes in ESFIL (Which has a controlling stakes of 100% in BPES and 44.8% in BESV)
4. 95% of controlling stakes in BSBD
5. 100% of controlling stakes in ESBP
6. 9% of controlling stakes in BEST

• The controlling stakes of the BES Group are:

1. 42.7% of controlling stakes in BESV
2. 66% of controlling stakes in BEST

It was announced that BES will be restructured by splitting into two entities – its debts and toxic assets will be put into a ‘bad
bank’ to be wound up, while a new bank created from its healthy assets, Novo Banco, will be managed by Bento and his team
 Portugal’s Code Of Governance
• As at 31 December 2013, the BES Board consisted of 25 members - 10 were executive and 15 were non-executive directors. Of
the 15 non-executive directors, seven were considered by the Board’s Corporate Governance Committee to be independent.
The day-to-day management of the company was delegated to an Executive Committee chaired by Salgado, comprising 10
members, three of whom were part of the Espírito Santo family
• The independent directors occupied positions in the Audit Committee, Corporate Governance Committee and Remuneration
Advisory Committee, as well as the Chairman of the Board of Directors. BES stated in its 2013 Annual Report that they had
complied with the Corporate Governance Code in that the company had an adequate number of independent directors on its
Board.
• In addition, disclosure for non-independence of family directors was made in the 2013 BES Annual Report. The main reasons for
non-independence were attributed to the following: (i) the director being a member of the Executive Committee (10 members),
(ii) the director also being in the Board of Directors of related companies, specifically, ESFG or ESI (two members), (iii) or the
director being a board member in, or being employed by one of the shareholders and related entities of BES (six members).
• Looking at the corporate governance in BES, it is difficult to see what was wrong. For example its board of directors had a good
balance of non-executive directors (66% in 2012), although I have not been able to know if they were independent from the
executive directors or not.
• I think that Ricardo Salgado’s status as the Patriarch of the family and a very influential and trusted person in the banking sector
internally and Portugal at the time gave him the ability to impose his views on the board without much resistance.
• In substance I can argue that despite the “façade” view that corporate governance arrangements in BES were good, BES was
managed as the property of the ES family and Salgado could do whatever he wanted.
• The nonexecutives directors seemed to be intimidated to ask the right question and demand for the right answers. When
during the last decade of its existence on many occasion, accusations of money laundering, fraud and other financial crimes
surfaced the audit committee and other non-independent directors did not put pressure on the executives to understand what
was going on.