In: Accounting
In the last few decades, we have seen the collapse of high-profile companies, partly owing to the weaker corporate governance mechanisms. This implies that corporate governance relates to only large public enterprises and is therefore irrelevant for small business. Discuss this assertion.
Corporate governance is the collection of mechanisms, processes and relations by which corporations are controlled and operated. Governance structures and principles identify the distribution of rights and responsibilities among different participants in the corporation (such as the board of directors, managers, shareholders, creditors, auditors, regulators, and other stakeholders) and include the rules and procedures for making decisions in corporate affairs. Corporate governance is necessary because of the possibility of conflicts of interests between stakeholders, primarily between shareholders and upper management or among shareholders.
Corporate governance includes the processes through which corporations' objectives are set and pursued in the context of the social, regulatory and market environment. These include monitoring the actions, policies, practices, and decisions of corporations, their agents, and affected stakeholders. Corporate governance practices can be seen as attempts to align the interests of stakeholders.
Interest in the corporate governance practices of modern corporations, particularly in relation to accountability, increased following the high-profile collapses of a number of large corporations in 2001–2002, many of which involved accounting fraud; and then again after the recent financial crisis in 2008.
Corporate scandals of various forms have maintained public and political interest in the regulation of corporate governance. In the U.S., these include scandals surrounding Enron and MCI Inc. (formerly WorldCom). Their demise led to the enactment of the Sarbanes–Oxley Act in 2002, a U.S. federal law intended to improve corporate governance in the United States. Comparable failures in Australia (HIH, One.Tel) are associated with the eventual passage of the CLERP 9 reforms there, that similarly aimed to improve corporate governance. Similar corporate failures in other countries stimulated increased regulatory interest.
The corporate governance characteristics of non-listed companies :-
Naturally, corporate governance issues vary not only from business to business, but also across countries. For example, in the field of enforcement, some identified that the level and quality of the judiciary is variable. While the view that privatization in itself is a good opportunity to improve corporate governance, this point will not be taken up in this synthesis note as it is one of the central issues of OECD’s programme on privatisation and corporate governance of state-owned enterprises. The debate on corporate governance has mostly focused on listed companies particularly in countries with developed capital markets and companies with dispersed shareholdings. A leading corporate governance issue concerns the appropriate design of a legal, institutional and regulatory framework that helps to align the interests of shareholders and managers. Policy makers worldwide have looked to devise an effective framework that supplies proper incentives for the board and management to act in the interest of the company and its shareholders; and furnish investors with sufficient monitoring information. For example, one of the primary risks that non-controlling shareholders face – in both private and publicly listed companies – is that they will end up in a situation where the controlling shareholder may use his or her position to deprive the non-controlling shareholder of influence over major decisions; and/or any significant distribution of the business earnings. Many jurisdictions have legislation that can prevent abuse of non-controlling shareholders in both circumstances, and typically these measures apply to both non-listed companies and public companies. It is observed that in most countries around the world, both listed and non-listed firms typically operate as a closely held company with concentrated ownership. While there are substantial similarities in the problems and solutions devised for both types of companies, the typical organisational structure of non-listed companies seems to demand, in some instances, an approach different from the one used for listed firms. Shareholders in publicly held companies – unlike those in non-listed firms – are protected mostly by mechanisms aiming to constrain large shareholders due to the presence of a market for transferable shares, and by reputational agents (e.g. accountants, rating agencies, and stock exchange watchdogs) who play an important role in both reducing information asymmetries and detecting fraud. In absence of these external mechanisms, an alternative framework is needed to improve the performance of non-listed companies, a framework with varying levels of control and commitment to help these firms tailor the company structure to their particular preferences. A corporate governance framework elaborated for non-listed companies could not only help to define the internal and external stakeholders’ expectations ex ante, but also, and more importantly, assist judiciaries, auditors, lawyers and other professionals in solving problems ex post.
The general definition of “non-listed companies” is: closely held companies whose shares, unlike those of publicly held companies, do not trade freely in impersonal markets, either because the shares are held by a small number of persons or because they are subject to restrictions that limit their transferability. The profile of the target universe of companies is generally large companies (relative to the economy of countries where they are incorporated) that are by choice unlisted but that have financial stakeholders (equity and/or creditors) besides their controllers. This includes companies, partially or completely, under founder/family control, with professional management although the founder/family may continue to play an important governance/shareholder role. Also included are companies with experience in, or which seek to tap, private capital markets (including private equity), and understand what the corporate governance requirements are. In the challenges and opportunities for corporate governance of non-listed companies, there are a variety of non-listed companies, such as family-owned companies, state-owned companies, group-owned companies, private investor-owned companies, joint ventures, and mass-privatized companies. As the preponderance of non-listed companies is family-owned, these businesses attracted the most attention in the discussions. These firms are characterised by a smaller number of shareholders, no free market for the companies’ shares, and substantial majority shareholder participation in the management, direction and operation of the company. Nevertheless, they do not fit into a single mould. It is clear from the discussions that non-listed companies avail themselves of different internal and external corporate governance mechanisms. Non-listed firms employ, for example, different legal business forms to structure their organisation, varying from partnership forms to limited liability companies and joint stock companies. As noted, the choice of organisation defines and determines to a large extent the internal corporate governance mechanisms. In some instances, the chosen legal business form allows for a governance structure in which the owners have joint management and control rights without a board. Other business forms require companies of a certain size to have a two-tiered system, consisting of a management board and a supervisory board. Again, this varies from country to country, as does the relationship between the two boards. It is noted that the effect of internal mechanisms, such as ownership and compensation regimes, also depend on how the business is financed. Most non-listed companies rely on family and bank financing for expansion and growth. However, companies that are unable to obtain bank finance because of the high risk they present, must usually attract private equity to develop their plans. Venture capital funds are a very important source of private equity capital.
Professional management
The need for strong board oversight is very important. The role of independent non-executive directors, in particular, is a key issue. Independent directors were claimed to be an indispensable part of any good corporate governance framework. It is tobe noted that the creation of independent boards is problematic. In most non-listed companies, controlling shareholders retain the power to appoint and dismiss both the board and management of the company. Since independence is a matter of subjective judgement rather than definition, it became clear that there are no simple solutions with respect to criteria for defining independence. It is suggested that corporate governance problems could be minimised by the appointment of competent – rather than independent – professional outside directors. Another way is to foster professionalism and competency by providing training, education and support to incumbent directors. The latter approach also has the effect of strengthening self-discipline.
Imperfections in the financing of non-listed firms often arise because of information asymmetries between controlling and non-controlling shareholders: the controlling shareholder generally has much better information than the non-controlling investors. Giving non-controlling shareholders full and timely access to information enhances the governance of both listed and non-listed companies. In some European countries, companies are obliged to prepare and disclose to the register their annual reports and accounts but these obligations are much less demanding and informative than what is required for listed companies. The usefulness of the disclosed information often depends on the experience and quality of the auditors. Venture capitalists, for instance, have developed contractual mechanisms that not only give them immediate access to the company’s financial accounts, but also force the company to reveal performance problems and other essential information to the equity investors. To be sure, shareholders may have other direct techniques for acquiring information about the performance and financial situation of the company. But corporate governance goes beyond the protection of shareholders. Companies should also aim at protecting the interests of other stakeholders, such as employees, suppliers, and creditors. The purpose of mandatory disclosure is twofold. First, stakeholders other than shareholders and managers will have access to information. Second, and perhaps more importantly, it encourages business participants, in particular managers, to analyse and understand the business. When they are used to communicating openly and clearly, the costs of mandatory disclosure will diminish significantly. It was also mentioned that the requirement for transparency could serve as a risk management tool. The distinction between internal and external transparency was further discussed. Further discussion is required, however, to clarify what exactly should be disclosed and to whom.
The driving forces for improving corporate governance practices in non-listed companies
Access to capital and implications for corporate governance:-
The majority of non-listed companies are characterised by large or medium holdings of stock held by a family, industrial firm, or the state. Controlling shareholders in listed companies, in contrast, usually do not hold more than 50% of the total outstanding shares in a company. Empirical research indicates that the difference in ownership structure has a positive effect on company performance. Both listed and non-listed companies usually leave management in charge of the business plan and operations. But the controlling shareholder’s closer levels of monitoring and cheaper intervention in the event of management failure seem to entail superior performance in non-listed companies. Increased information symmetry between the controlling shareholder and management in these firms arguably helps to create a more secure and stable environment for long-term investment strategies. The financing structure of non-listed companies can also bring major benefits. Large controlling shareholders in non-listed companies typically prefer to finance business development with internal funds. In order to prevent dilution of the shareholder’s controlling stake, non-listed companies tend to use bank finance when additional funding for expansion and growth is required. The basic structure of the debt contract gives managers a strong incentive to ensure the company’s success and ability to meet the repayment requirements. As defaults on repayment would eventually deprive the managers from control, discussants argued that debt should be viewed as a disciplining device to align managers’ and shareholders’ interests. The policy implication is to guarantee strong creditor rights. The role of institutional investors, particularly pension funds, banks and bondholders, was discussed. It is to be noted that debt finance offers an additional advantage. Banks and credit rating agencies could help to implement good corporate governance by demanding that non-listed companies comply with best practice norms as part of the risk assessment process. The Basel II accord, with its overriding aim of improved risk assessment procedures by individual banks, could speed up this implementation strategy for some large non-listed companies. This does not mean that private equity investors could not produce the same effect. Venture capital associations, for instance, promulgate principles that help to increase respect, integrity, transparency and confidentiality within the company.
Succession planning and conflict resolution
Case studies have shown that it is imperative to take the interests of non-controlling shareholders into account in business decisions. This can be accomplished, for instance, by the formalisation of the board’s decision-making process and the establishment of a family council. In non-listed companies, especially when personal family relationships are involved, it is of utmost importance that the directors are aware of potential conflict of interest issues. Decision-making procedures that reveal information to shareholders and increase the involvement of non-controlling shareholders prevent internal disputes. A family council, which protects and combines family and business affairs, is another mechanism for anticipating internal strife and disruption of the company’s business operations before they occur. In family-owned businesses, non-controlling shareholders are often members of the second, third or later generation of the founding family. They do not participate actively in the business and leave the operations of the company to another controlling shareholder or manager. In these cases, dissatisfaction is usually associated with the reduction or expected reduction of dividends Different classes of shares may be an effective solution. Legal mechanisms that would help them to obstruct the operation of the business and make mischief for the other shareholders and family members may only exacerbate potential conflicts.
The role of a public policy framework in supporting good corporate governance in non-listed companies
It is evident that a primary source of corporate governance instruments is the company or corporation laws of individual countries. The need of offering clear and simple legal rules to a firm’s managers, shareholders, creditors and other stakeholders. For instance, company law plays an important role in protecting key shareholder rights. These rights enshrined in the company laws of most jurisdictions include:
(1) attendance at annual general meetings and possibility to ask questions;
(2) proposing shareholder resolutions;
(3) exercising voting and cash-flow rights;
(4) receiving information about company matters;
(5) preventing non-pro-rata distributions; and
(6) different classes of shares.
Company law also contains instruments that ensure that non-controlling shareholders share in the profit in proportion to their stake in the company and prevent the controlling shareholder from extracting profits. In this respect, discussants indicated the role that the duty of loyalty and care provisions play in curtailing the siphoning off of profits and other company assets. The primary source of information for investors is the periodic publication of the company’s annual accounts and reports, which is common in many jurisdictions, though different from requirements for listed companies. It is to be noted that individual information rights, such as the right of inspection of the company ledger, books and other records, should protect shareholders in cases where public information is inadequate and market controls and trust are weak.