Corporate Governance and Business Ethics In SME Businesses.
Many business owners may think that Corporate Governance and Business Ethics only have relevance for larger businesses. However, in my view, small businesses should look to the same principles to regulate how they operate and follow proven processes and practices that demonstrate how they meet with the highest standards in social, regulatory and market environments. So what is Corporate Governance and where does it come from?
Corporate Governance can be defined as “a system of law and sound approaches by which corporations or companies are directed and controlled, focusing on the internal and external corporate structures, with the intention of monitoring the actions of management and directors and thereby, mitigating risks which may stem from the misdeeds of corporate officers.”
Origins of Corporate Governance
Corporate Governance standards have evolved over the past 25 years in the light of abuse and fraud within corporate businesses across the world. Key principles of effective Corporate Governance have become defined following the publication of The Cadbury Report in the United Kingdom in 1992, The Principles of Corporate Governance from the OECD in 1999, 2004 and 2015, and the Sarbanes-Oxley Act of 2002 in the United States.
Key Principles of Corporate Governance
The OECD Principles of Corporate Governance prescribes the responsibilities of the board in any business. They include:
- Board members should be informed and act ethically and in good faith, with due diligence and care, in the best interest of the company and the shareholders.
- Review and guide corporate strategy, objective setting, major plans of action, risk policy, capital plans, and annual budgets.
- Oversee major acquisitions and divestitures.
- Select, compensate, monitor and replace key executives and oversee succession planning.
- Align key executive and board remuneration with the longer-term interests of the company and its shareholders.
- Ensure a formal and transparent board member nomination and election process.
- Ensure the integrity of the corporations accounting and financial reporting systems, including their independent audit.
- Ensure appropriate systems of internal control are established.
- Oversee the process of disclosure and communications.
- Where committees of the board are established, their mandate, composition and working procedures should be well defined and disclosed.
Sarbanes-Oxley has a strong focus on financial management and financial record keeping. It demands that annual financial reports must include an Internal Control Report stating that management is responsible for an adequate internal control structure. It also requires an assessment by management as to the effectiveness of the control structure within the business. Any shortcomings in these controls must also be reported. Furthermore, it requires registered external auditors to certify the accuracy of the company management’s claims that internal accounting controls are in place, operational and effective. Sarbanes-Oxley also addresses the following 5 areas:
- Rights and equitable treatment of shareholders
- Interests of other stakeholders
- Role and responsibilities of the board
- Integrity and ethical behavior
- Disclosure and transparency
There are experts in Sarbanes-Oxley that will carry out an audit of your business to determine if you comply with its provisions. You may also use online software tools to guide you through the process of becoming compliant.
How Corporate Governance Impacts Businesses
Corporate Governance may sound like a complex set of bureaucratic rules, but what does it really mean in practical terms for a small or medium business owner? It actually starts by looking at all of the stakeholders in a business and at how they should behave and execute their roles. So who are these stakeholders?
The internal stakeholders will usually be the shareholders, the Board of directors and the management team. The external stakeholders will include customers, suppliers, government agencies, auditors, creditors and even the community in which the business operates.
Internal Governance Controls – these controls monitor internal activities and take corrective action to accomplish organizational goals. They include:
- Monitoring By the Board of directors
- Internal Control procedures and internal auditors
- Balance of power
- Monitoring by banks, large creditors and large shareholders
In smaller businesses, many of the internal stakeholders will be in more than one of these internal groups. The challenge is to separate the powers exercised by each group to ensure that temptation is removed from those that might consider wrongdoing and to build in appropriate checks and balances to quickly allow transgressions to be discovered, should they exist. Inviting external directors to sit on the board can be one way of achieving this, particularly if non-executive board members outnumber executive directors.
External Governance Controls – these are controls that external shareholders exercise over a business. They include:
- Debt covenants
- Assessment of performance information including financial statements
- Government regulations
- Managerial labor market
- Media pressure
Some of these external controls may not be evident in smaller companies, particularly if there are few or no external shareholders.
Unfortunately, implementing proper Corporate Governance in your business adds a layer of complexity and cost to your business. It takes a lot of work to get it right and to keep it right. However, the benefits derived from it make it worth the effort.
Relevance of Corporate Governance for Small and Medium Businesses
Corporate Governance is particularly interested in financial matters within a business. We all have to do personal annual returns for our earnings and we are obliged to pay the required amount of taxes, based on current laws and tax codes. Businesses are no different. They must file financial statements that are prepared in accordance with accepted accounting standards, and they must declare their tax liabilities and discharge them in full. The financial records and reports of the business must also be truthful, accurate and verifiable. There are no shortcuts.
There is a right way and a wrong way to run a business. Some business owners or executives look for all the shortcuts and may accidently or deliberately break the established rules, particularly in relation to taxation or financial reporting. However, trying to find loopholes and shortcuts is not worth the effort, particularly when you need to remember all the twists and turns you might take on your ill-advised journey.
In my view, it is easier to do the right things from the outset rather than seeking shortcuts. The problem is that shortcuts will frequently only offer short-term benefits and most transgressors eventually get caught and suffer the full rigors of the law. Constantly looking over your shoulder and enduring sleepless nights will prove that these tactics are just not worth it.
Business ethics come from the internal moral compass of right-minded business people. They demand that honesty and integrity remain at the forefront of business decisions. They require that business people adopt a set of standards or values that govern their actions and behaviors within their businesses on a daily basis. In many ways, they are the personal equivalent of many of the provisions of corporate governance discussed in this blog post. In simple terms, it means embracing the lifetime beliefs and behaviors at the very core of individuals and using these moral lessons in right living to guide actions, interactions and decisions within the business environment, as well as with external stakeholders.