Corporate Governance for Non-Listed Firms
One of the legacies of the era of corporate scandals earlier in this decade is a heightened awareness of corporate governance issues. This development is most obvious for publicly traded companies in the United States, with the governance requirements embodied in the form of the Sarbanes-Oxley Act. The heightened governance awareness has also had spill-over effects for private companies (refer here) and even non-profit entities (refer here).
But there are many other types of non-listed firms, beyond just private companies and non-profit enterprises – including joint ventures and family-owned firms, as well as venture funds, private equity firms and hedge funds. The heightened governance awareness has also affected these other kinds of non-listed firms. But many of the principles and practices developed for publicly traded companies may be ill-suited to these other kinds of non-listed firms.
In a comprehensive book entitled “Corporate Governance of Non-Listed Companies” (here), Professors Joseph McCahery of the University of Amsterdam and Erik P.M. Vermuelen of Tilberg University take a look at corporate governance principles and practices for these other kinds of non-listed firms.
The professors begin with observations about current attitudes toward governance, particularly those evolved from the context of publicly traded companies. They note that “it could very well be argued that non-listed companies do not always benefit from the spill-over effect of the application of disproportionate governance rules” and that a “corporate governance framework that is not consistent with the social and economic requirement of non-listed companies will yield imperfections over time.”
In their book, the authors propose a corporate governance framework for non-listed firms that will “foster strong decision-making, accountability, transparency and ultimately firm performance.”
The authors organize their corporate governance analysis around “three pillars.” The “core pillar” represents “company law, which provides rules and standards for registration and formation, organization and operation.” The second pillar consists of “contractual mechanisms, such as joint venture agreements and shareholder limitations.” The third pillar consists of the non-listed firms “embrace of the corporate governance rules and principles that are tailored to the organization of their publicly held counterparts.”
The authors’ exhaustive overview of the transjurisdictional development of “company law” demonstrates how various legal norms have evolved in many jurisdictions to address concerns arising from the need to protect investors and creditors from “managerial opportunism.” But these paramount principles of governance for publicly traded firms, whose ownership is widely dispersed and at an informational disadvantage to management, may not be as relevant within the ownership structures of non-listed firms.
Because of the differing needs and structures of non-listed firms, many of their governance requirements and expectations are highly contractual in nature, and tend to be more focused on protecting one set of owners and shareholders from another set of owners or shareholders. These contractual arrangements tend to address “four fundamental elements – risk of losses, return, control and duration.”
From the authors’ perspective, the value and importance of these contractual arrangements underscores the limitations of a “one-size-fits-all” approach to corporate governance and also militates against the regulatory imposition of rigid governance mandates on non-listed companies. The authors particularly address these concerns in depth in the context of private equity firms and hedge funds.
The third pillar of the authors’ governance framework pertains to non-listed firms’ voluntary adoption of governance measures to improve transparency and accountability. The authors suggest that companies have “strong incentives to adopt or disregard governance recommendations based on a cost-benefit assessment.” Non-listed firms have a “high-powered incentive to comply with corporate governance provisions.” The implementation of appropriate internal control measures, for example can “(1) reduce financial/reporting errors; (2) help firms follow their business practices and performance; (3) assist in tracking inventory; and (4) signal potential weaknesses within the firm.”
The authors argue for the adoption of an “optimal set of recommendations” that not only would “create a dynamic and sustainable network of business practices and advice tailored to the needs of non-listed companies” but would also “head off legislative pressures.” The “steady and healthy growth” of these kinds of firms, which are so critical to overall economic growth and development, would be advanced by their implementation of mechanisms ensuring that
(a) financial statements fairly present the performance of the business; (b) independent and knowledgeable directors and/or supervisors are appointed; (c) audit committees are established; and (d) strong internal control systems and processes reduce business risks and lower costs.
The authors’ ultimate point is that “the ‘one-size-fits-all’ and regulatory mentality arguably led to some undesirable spill-over effects to non-listed companies.” They advocate “the introduction of a separate approach” based on the development of guidelines for non-listed firms that are “sufficiently attractive and coherent from a cost-benefit perspective to persuade non-listed companies to opt into a well-tailored framework of legal mechanisms and norms.” The authors conclude that non-listed companies that operate under “well-designed and effective governance structures are likely to perform better and consequently will be more attractive to external investors.”
The authors’ analysis of the limitations of a one-size-fits-all approach to corporate governance is well-founded, and indeed these concerns may be valid even among listed companies as well as between listed companies and their non-listed counterparts. The authors’ analysis of the possibilities for and limitations of contractual mechanisms for non-listed companies is perceptive, particularly with regard to private equity firms and hedge funds.
In the end, the implementation of effective governance mechanisms and controls is critical for all firms, regardless of the particular form within which any specific firm operates. The most critical point is that mechanisms adopted must be suited to the form in which any particular firm does business. Mandatory regulatory requirements may not be sufficiently sensitive to the differing needs of different kinds of firms.
Very special thanks to Professor McCahery for providing me with a copy of this excellent book.
Olympic Questions:
1. Am I the only one that found the opening ceremonies scary?
2. Who decided beach volleyball is such a big deal?
3. Why does Bob Costas think Cris Collinsworth is so damned funny?
4. How did Mark Spitz win seven gold medals without a swim cap or goggles?
5. Bela Karolyi. Discuss.
6. Why do so many commercials (including political ads for both Presidential candidates) have images of wind turbines?
7. With a 32-year old winning two swimming relay gold medals, a 38-year old winning the women’s marathon, a 33-year old female gymnast winning silver in the vault competition, and a 41-year old winning two swimming silver medals, is it possible the Chinese are on the wrong track with their prepubescent “women’s” gymnastics team?
Re Olympic question 6 this article appeared in the UK's Sunday Telegraph:
US gets ready to blow its economy away
By Christopher Booker
17/08/2008
"Visiting America last week to talk to audiences across the country about "global warming", I was struck by television commercials for the two presidential candidates.
Senators McCain and Obama were each shown in front of film of the same giant wind farm, to lay claim to virtually identical "green" credentials. Since America has already built five times as many wind turbines as Britain, covering thousands of square miles, I checked out how much electricity all those 10,000 turbines actually produce. The answer is around 4.5 gigawatts - not much more than a single large coal-fired power station.
After years when America was vilified for not taking "global warming' seriously, it was a shock to find how "environmentalism" is now threatening to transform what is still the largest and richest economy in the world.
advertisementBoth candidates favour a version of the proposed "cap and trade" scheme to slash US greenhouse gas emissions to 63 per cent below 2005 levels, at an estimated cost by 2030 of more than $600 billion a year - representing a cumulative loss to the US economy, within 22 years, of $4.8 trillion.
Although America is still dependent on coal for around half its electricity, with reserves estimated as likely to last 200 years, state after state is proposing to ban new coal-fired power stations.
Environmental groups, with powerful political support, are now lobbying equally fiercely against natural gas or any new nuclear power plants.
Most dramatic of all are the implications of a Supreme Court judgment in the case of Massachussets v the US Environmental Protection Agency (EPA) which ruled by a single vote that the EPA must treat any greenhouse gases as "pollution", to be regulated under America's Clean Air Act.
The EPA is thus mandated to impose drastic new limits on emissions of carbon dioxide and other gases from pretty well any source, not just industry and transport but schools, hospitals, even lawn mowers.
Read more by Christopher Booker
The implications are so immense for almost every sector of the US economy that government departments -commerce, agriculture, energy and others - have been queuing up to protest, arguing that the effects of such regulation would be so damaging that it should be regarded as unthinkable.
But politicians of both parties, led by the two men vying for the presidency, are so carried away in the rush to appear "green" that it seems there is no longer any national voice powerful enough to question the sanity of such measures.
All the fashionable talk is of how fossil-fuels must be replaced by massively subsidised sources of "renewable" energy, such as vast arrays of solar panels, even though a recent study showed that a kilowatt hour of solar-generated electricity costs between 25 and 30 cents, compared with 6 cents for power generated from coal and 9 cents for that produced by natural gas.
What is terrifying is the extent to which America's leading politicians seem oblivious to the economic realities of what they are proposing. The readiness of Messrs McCain and Obama to posture in front of pictures of virtually useless wind turbines symbolises that attitude perfectly.
Here, in the EU we are only too sadly familiar with politicians floating off into cloudcuckooland over our future energy policy, with the virtual certainty that before many years this may leave us with a colossal shortfall in our electricity supplies.
But "the lights going out all over Europe" is one thing: if they go out in the richest economy in the world - while China cheerfully continues to build one new coal-fired power station a week - we may look back on the US presidential election of 2008 as a time when history really did reach a watershed; the moment when the nations of the West finally signed up to the most bizarre suicide note the world has ever seen."
I'm much more interested in whether Costas is wearing a hairpiece these days. Looks like it to me.