Corporate Governance

Corporate governance is often in the news.  Among other scandals or corporate mid-deeds, we hear about eyebrow-raising CEO compensation packages, Board oversight (or lack thereof) over a company's financial statements, the questionable rise of meme stocks, and the Boards' role in shareholder activism.    We read about wild gender pay inequality and devastating environmental contamination by companies.  These splashy news stories are fascinating reads – but is any of this pertinent to the operation of smaller businesses and privately owned companies?

The answer to this question is Yes.   While the focus of governance may vary, the topic of corporate governance (or “LLC governance”) is highly pertinent to small businesses and privately owned companies.

Overall, good governance is essential for businesses to operate efficiently, ethically, and sustainably. Good governance can help establish a strong foundation for growth and success, and helps in building favorable long-term relationships with stakeholders.

In this blog post, we discuss 5 reasons why good governance is important, and 5 tips for how to implement solid corporate governance practices.  The Law Office of Jennifer M. Settles is available to advise companies on implementation of best practices in entity governance.  Contact us through our Contact Form, or by calling our office at (602) 617-3938.  The initial consultation is FREE.  

First, What Is Corporate Governance?

The term corporate governance refers to the system of rules, practices, and processes by which a company is controlled, directed and managed. It also involves the balance of power among a company's stakeholders, including its equity owners, Board of Directors and management team.   Although broadly referred to as “corporate governance”, the topic of governance can apply equally to other forms of business entities such as partnerships and limited liability companies.

One of the primary goals of corporate governance is to ensure that a company operates in an ethical and responsible manner, and that its operations are transparent, accountable and aligned with the interests of its stakeholders. Effective governance helps to enhance the reputation of a company, reduce risk, and create long-term value for the equity owners and other constituents of the company.

Why Is Corporate Governance Important for Small Business?

Good corporate governance is important for small business for many reasons.   Governance helps to establish a framework for decision-making and accountability. Good corporate governance can help small businesses to build trust and credibility with their customers, communities in which they do business, employees and investors. It can also help to minimize risk and ensure compliance with legal and regulatory requirements.

Some benefits of good corporate governance for small business include:

1.  Improved Access To Capital

Investors are more likely to invest in companies with strong corporate governance practices because such businesses are seen as less risky and more likely to succeed.   Investors generally appreciate transparency, clear and accurate disclosure and ethical company behavior.  A company's governance practices are often evaluated and scrutinized by third parties performing due diligence on the company.  

2.  Increased Employee Satisfaction And Retention

When employees feel that the company is being run ethically and transparently, they are more likely to be satisfied with their jobs and stay with the company.

3.  Enhanced Reputation

Good corporate governance practices can help small businesses build a strong reputation for integrity and responsibility, which can be a competitive advantage in attracting customers and partners, and in attracting prospective purchasers when it comes time to exit the business.

4.  Better Decision-Making

By establishing clear roles and responsibilities and implementing effective processes for decision-making and governance, small businesses can make more informed and effective decisions.

5.  Reduced Risk Of Legal Exposure

By implementing good corporate governance practices, the risk of rogue poor behavior by a corporate officer or director is reduced, and the risk of legal exposure for breach of fiduciary duty is similarly reduced.

How is Good Corporate Governance Implemented?

5 Tips to Implement Solid Corporate Governance 

Good corporate governance can be implemented in a number of ways, depending on the specific needs and goals of the organization.  Some common practices include:

1.  Establishing A Clear And Transparent Organizational Structure

This involves defining the roles, responsibilities and authority levels of the different members of the organization, including the Board of Directors, senior management, and other employees. Having a clear organizational structure helps to ensure that everyone on the team understands their role within the organization and is held accountable for their actions.  In many companies, its helpful to have a written document which describes the authority-level of different individuals or positions within the organization, and the types of approvals needed for different transactions or business decisions. 

2.  Developing A Code Of Ethics

A Code of Ethics (sometimes called a Code of Conduct) outlines the expected behavior of employees, officers and directors, and provides guidelines for ethical decision-making. Operating under a clearly written Code of Ethics helps to promote a culture of integrity and accountability within the organization.   A Code of Ethics may include the company's expectations or requirements regarding such topics as conflicts of interest, anti-bribery, confidentiality, anti-competitive behavior, health and safety, fiscal integrity, anti-harassment and discrimination, and more.

3.  Ensuring Effective Communication And Transparency

Effective and regular communication with stakeholders is generally highly appreciated by the stakeholders and is an important element of good governance.  This can include providing timely and accurate information about the organization's financial performance, risks, and other important matters, in a manner consistent with applicable securities and other laws. Effective communication and transparency helps to build trust and credibility.

4.  Implementing Effective Risk Management Practices

Risk management relates to the identification and assessment of potential risks to the organization and developing strategies to mitigate those risks. Having such a structure in place helps to ensure that the organization is able to identify and manage its risks effectively and minimize the impact of any negative events. Risk identification and assessment should be reviewed on a periodic basis and updated as needed to reflect pertinent changes to the company's operating environment. 

5.  Ensuring Compliance With Relevant Laws And Regulations

It's always important to stay up to date with relevant laws and regulations and implementing policies and procedures to ensure compliance. This helps to avoid legal and reputational risks and promote a culture of compliance within the organization.

ESG, DEI.    What Do These Acronyms Mean?

Environmental, Social and Governance

ESG is an acronym for Environmental, Social, and Governance. ESG refers to a set of factors that are used to evaluate a company's performance and sustainability in these three areas. Environmental factors may include a company's impact on climate change, resource usage, and pollution. Social factors may include a company's treatment of employees, customers, and communities, as well as its involvement in social issues. Governance factors may include the company's leadership, executive compensation, and shareholder rights. ESG is often used as a framework for evaluating the sustainability and social responsibility of companies and investment opportunities.

Diversity, Equity and Inclusion

DEI is an acronym for Diversity, Equity, and Inclusion. DEI refers to a set of practices and initiatives aimed at promoting diversity, equity, and inclusion in the workplace. Diversity refers to the variety of backgrounds, perspectives, and experiences that individuals bring to the company. Equity refers to fair treatment, access, and opportunity for all individuals, regardless of their background or identity. Inclusion refers to creating a sense of belonging and valuing the contributions of all individuals, regardless of their differences. DEI is often used as a framework for promoting social justice, reducing inequality, and creating more inclusive and welcoming environments for all people.   

In recent years, investors, customers, employees and, in some cases, legislatures, have increasingly demanded or required that companies prioritize ESG and DEI, and many companies have responded by incorporating these concepts into their corporate governance structures. By prioritizing ESG and DEI in their governance practices, companies can help ensure that they are meeting the needs and expectations of their stakeholders and contributing to a more equitable and just society.   ESG and DEI are integral components of good corporate governance as they promote sustainable, responsible, and inclusive business practices, which are essential for long-term success and positive societal impact.

In some cases, on the other hand, there has been backlash against ESG and DEI corporate and regulatory initiatives, on the premise that their "woke" nature is unnecessarily costly from a compliance perspective and too heavy-handed from a regulatory perspective.  The topic has become highly politicized in recent years, which has unfortunately distracted from the potential value that such initiatives can bring.  

Data In Support of Good Corporate Governance 

There is evidence to suggest that good corporate governance can lead to a more profitable business. Studies have shown that companies with strong governance practices tend to outperform those with weak governance practices in several areas, including financial performance, risk management, and long-term sustainability.

For example, a 2016 study of over 2000 public companies by the Investor Responsibility Research Center Institute (IRRCI) found that companies with strong governance practices had higher return on assets, higher return on equity, and higher profit margins than companies with weaker governance practices. In another study in 2016, MSCI ESG Research found that companies with strong governance practices tended to have lower volatility and higher valuation multiples than companies with weaker governance practices.

Conclusion

Good corporate governance is about creating a culture of transparency, accountability and integrity within the organization, and ensuring that the organization is able to effectively manage its risks and deliver value to its stakeholders over the long-term.  Although careful planning and support are required, implementation of solid corporate governance practices can be a win-win strategy for small businesses and their stakeholders alike.  

Good Governance  . . . It Makes Good Sense!

Jennifer M. Settles, Esq. a corporate lawyer at the Law Office of Jennifer M. Settles.   She advises clients on corporate governance matters, M&A transactions, commercial contracts, real estate matters, financing transactions and more.  To schedule a free consultation with Jennifer, please call 602-617-3938, or email us through the  Contact Form on our website, www.jsettleslaw.com.

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