Cheques and balances

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Can too much corporate governance stifle SMEs’ freedom – or can it actually be a boon for businesses? Financial downturns often lead to an increased focus on corporate governance. So, given the scale of the recent recession, it’s hardly surprising the past six years have seen a succession of regulatory and compliance changes. Yet, just as Britain is getting back on track, questions are being asked about how to balance compliance with corporate governance strictures while remaining free from costly and stifling bureaucracy.

“The last five years have focused attention on the importance of governance and I don’t think it’s confined to large companies,” says Close Brothers chief executive Preben Prebensen, whose merchant bank has doubled its lending to SMEs to £5bn over the last half-decade.

“There’s a recognition about the importance of governance but I do think it needs to be proportionate to the risk to the system those companies represent. It also needs to be proportionate to the resources companies have. You have to strike a balance.”

Proportionality, he adds, “is important within the context of a clear recognition that governance and treating customers well is good business – and makes good sense. There’s a difference between the risks that small and large operations represent to a country’s financial system.”

Fortunately, for businesses concerned about being caught up in a mire of regulations intended for larger companies – for instance, those with more diverse ownership – that was never the intention of the disclosure and transparency structure now known as the UK Corporate Governance Code. The Code, which dates back to the Cadbury report on corporate governance, lays down guidance on a “comply or explain” basis, whereby publicly quoted companies differing from the guidelines are expected to outline the reasons why.

The contents include a principle that the chairman and chief executive of a listed company should not normally be the same person, plus advice on how to form and staff remuneration, audit and other committees.

However, many of its strictures may not be relevant to privately owned companies, which aren’t obliged to follow them. “Corporate governance can be defined as the problem of how to govern a company which is operating essentially with other people’s money,” says Dr Roger Barker, director of corporate governance and professional standards at the IoD. “It’s about how you make sure that a professional management team operates the company in a way that’s in the interest of the key shareholders and other stakeholders.

“It has therefore become thought of as something very relevant to larger listed companies and whether they have the right incentives to manage the company in the interest of all the stakeholders. Also, whether they have people on the board with the right levels of diversity and knowledge to properly oversee the business.

“For privately owned companies, there’s much more of a blue sky in terms of the governance,” he says. “It tends to be more about your own capital – and the issue of whether management operates in line with the wishes of the owners may seem less relevant, since the owners are usually much more involved with the business and may be heavily involved with managing it.”

The advantages of governance
However, as SMEs develop, corporate governance issues tend to emerge, often because their growth and size involves the money of other parties. Banks, private equity groups and other financiers will need to be reassured a company is being managed in an appropriate way.

As companies develop in complexity, they also become more complicated to manage, making it more difficult for the owner-manager to be everywhere at once. In this case, corporate governance becomes a way by which SMEs can ensure everyone in the company is making decisions that are in line with the companies’ shareholders as well as these other stakeholders.

Some companies with ambitions of floating on public markets may choose to shadow many of the Code’s requirements in readiness for an eventual listing.

However, having a robust set of corporate governance arrangements is increasingly being seen as something that not only prepares small firms for public ownership, and can safeguard them against developing potential problems, but can even increase a company’s value and improve its reputation.

Steps that can be taken in this regard include seeking external input into management decision-making, perhaps beginning with an advisory board, and progressing to non-executive directors from outside the company who have business, markets and governance knowledge that will be valuable as a firm matures and develops.

This can be tough for many founders, but it does reassure external stakeholders there’s a person involved at senior level who can be an independent voice. As a company develops, further non-executives or a non-executive chairman may be introduced.

Family businesses may also want to create a family council that is separate from the board – and contains only family members – to look after the interests of a family with a significant share in a business and resolve conflicts between those family members seeking growth and those more focused on drawing dividend income.

Oliver Parry, a former head of communications at the Financial Reporting Council, and who now works for the IoD as corporate governance adviser, says: “Broadly speaking, it’s generally acknowledged that improved corporate governance among this sector has the potential to significantly boost productivity growth and job creation.

“When we’re talking about governance in this sector, what we’re really talking about is establishing a framework of company processes and attitudes that add value to the business, help build its reputation and ensure its long-term continuity and success.”

He cautions, however, that merely appointing an external director is nowhere near enough. “Although its effect on boardroom behaviour and culture shouldn’t be underestimated, companies sometimes stop here and don’t go any further,” he says.

“A lot more should be done if a company is seeking to establish a strong framework of company process and attitudes that add value to the business, ensuring its long-term continuity and success. An effective governance framework defines roles, responsibilities and an agreed distribution of power among shareholders, the board, management and other stakeholders.”

Striking a balance
A key challenge for SMEs, however, is getting the balance right. Says Barker: “If you act too soon and put in too many components of big company corporate governance, such as having lots of independent directors, and an independent chairman too soon, it’s going to potentially create a very bureaucratic and costly structure which may not be acceptable to the owner-manager or entrepreneur.

“Firms need to take care to put in governance structures proportionate to the kind of company they are. Smaller companies don’t have in-house governance officers and don’t typically have a company secretary. You have to tailor your governance to your own structure and enterprise – that’s the challenge. There isn’t a blueprint. It would be a mistake to simply implement what’s in the UK Corporate Governance Code.”

The IoD’s Principles for Unlisted Companies in the UK?is one source of guidance, emphasising a phased approach that might mean establishing an advisory board before appointing a non-executive director and appointing external auditors before reaching the size at which it becomes compulsory. Finding a mentor to coach directors through such moves as their business develops can be another useful step. The IoD also recommends director training programmes that keep executives well-informed about corporate governance. The IoD’s Chartered Director programme is a good example. There are other sources of help too. One is a series of 12 corporate governance principles drawn up by the Quoted Companies Alliance. Although the alliance represents publicly listed companies as well as fund managers and business and legal advisers, chief executive Tim Ward says two-thirds of its corporate members are listed on AIM (the Alternative Investment Market) or ISDX (ICAP Securities and Derivatives Exchange), also aimed at small firms.

“There isn’t a particular SME corporate governance code,” says Ward, “but we have created a code that meets the needs of smaller quoted companies. It’s to do with an attitude of mind rather than a tick-box culture. It’s about being adaptable and acting in the best long-term interests of a company. No two companies are the same.”

Richard Sheath, senior partner at Independent Audit, a corporate governance specialist advisory firm, says there needs to be a clear focus on how adopting corporate governance processes will lead to better companies. “It’s about governance and the effective operation of company management and boards,” he says. “Some small companies are worried that corporate governance procedures will swamp them with red tape and tie them down in processes. But this is all about making better decisions that lead to better companies and it doesn’t have to be expensive. Although there are costs associated with non-executive directors and external advice, there are also self-assessment tools available and online resources that can help companies do some of this themselves.”

Barker agrees that corporate governance needs to provide clear measurable benefits for SMEs to consider it worth their while. However, he believes this is very much possible. “Corporate governance is about accountability,” he says, “but in SMEs it’s also very much about enhancing performance. The fundamental question about a corporate governance measure for an SME is whether it will enhance performance.

“If the answer is ‘no’ and it’s just a cost and a bureaucracy, is it really the right thing to be doing? Adding a non-executive to the board could cost £10,000 to £20,000 for a small company. If a benefit isn’t there, one should not go ahead with it.”

About author

Andrew Cave

Andrew Cave

Andrew Cave is head of corporate sustainability for the RBS Group

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