Corporate governance, through the federal Sarbanes-Oxley Act, is now mandated for publicly traded companies. While privately-held companies are exempt from this legislation, the process of creating corporate governance procedures is a wise step for all companies private, public, or not-for-profit and regardless of size says Dr. Constantine Konstans, executive director of the Institute for Excellence in Corporate Governance at the University of Texas at Dallas School of Management.
“Weak corporate governance may result in financial reporting that is lacking transparency and clarity, and does not reflect economic reality of a company,” says Konstans. “Having a system of accountability is critically important to the health of a company, even if that company is private and does not have to answer to its shareholders or to the SEC.”
Smart Business spoke with Konstans about the importance of corporate governance to privately-held companies, and a strategy of putting a plan in place.
Could you describe corporate governance?
Corporate governance is the structured system of policies and processes established and maintained by a board of directors to oversee an organization’s strategic activities and resulting performance. The reason for corporate governance is to ensure proper accountability, clarity and openness in a company’s finances, and for the long-term benefit of shareholders.
While corporate governance is required in larger publicly traded companies, why should private companies be concerned about corporate governance?
Private companies are not required by Sarbanes-Oxley (SOX) legislation to have corporate governance in place. The risk of corporate scandals whether in a public or private company can be minimized if a good system of internal controls that corporate governance provides is in place.
Another reason that a private company will want corporate governance is that it may wish to go public at some point in the future. If there is even a chance that the company will go public, it is in the best interest of the business owner or owners to put these corporate governance systems in place now. A company needs to comply with SOX once it is publicly traded.
Does having a corporate governance plan help in other ways?
It is beneficial to companies seeking investors, who will also look for financial information that can be viewed as reliable, transparent and true. Without this high degree of confidence, investors both foreign and domestic will be reluctant to part with their money. Having a corporate governance plan in place certainly enhances the image and reputation of a company, and will make it more attractive to investors. Similarly, in nonprofit companies it is also extremely beneficial in establishing trust with potential donors.
What are some steps a private company should take to put a corporate governance plan in place?
Most private companies have some form of corporate governance already. But business owners should take the following steps to get the right elements in place.
- Create a board of directors. Many privately-held companies may already have a board, but make sure your board is composed primarily of independent outside directors. These directors should be like a portfolio of investments that are varied and balanced. Directors should be leaders from a variety of industries who provide value, contacts, opportunities and plenty of objective advice. A good board is worth its weight in gold.
- Develop policies and procedures. While this sounds like a lot of busy work, the beauty of creating this is that once it is done, everyone knows exactly what the rules are. The board of directors should approve this document and provide oversight in its application.
- Develop efficiencies. Make sure that the company’s physical processes and day-to-day operations are efficient. These processes include: purchasing, vendor receipts, how sales are generated, how the business gets customers, etc.
- Get a good financial accounting system. Get a good accountant that can pull all the financial data together with strong controls that will flag any inconsistencies. Without good accounting, a business owner will never be certain that what is recorded is reliable. Good accounting is an accurate financial expression of the physical process of the business; it should reflect reality. All too often there is a huge gap between what is actually going on in a business and its financial statements.
- Establish a culture of honesty and accountability. Management needs to set the tone of ‘doing the right thing.’ If you set the example of honesty and project an image of caring about your company, customers and employees, pretty soon you’ll have not only a company but a family that believes the same way.
CONSTANTINE KONSTANS is executive director of the Institute for Excellence in Corporate Governance at the University of Texas at Dallas School of Management. Reach him at (972) 883-6345 or [email protected].