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How to Best Govern SMEs?
The role of SMEs as the backbone of the European economy and their contribution to growth and jobs remains crucial in 2012
According to a recent analysis by the European Commission, 85% of net new jobs in the EU between 2002 and 2010 were created by SMEs. As their performance is influenced by their governance, The Beginner asked its readers which governance model has been the most successful.
An overwhelming majority of respondents, however, didn’t believe there was a ‘one-size-fits-all’ solution - 67% said it depends on the specific company. Another twenty-two percent voted for a pyramid structure, with one director having all of the power. Only 11% thought that a board structure, where the power is shared among board members, was the best governance model for SMEs. None of the voters believed in a plane level structure, in which every employee has equal power.
Companies that are controlled by insiders (i.e company directors) and run in a pyramid structure enjoy certain advantages. Insiders have the power and the incentive to monitor management closely thereby minimising the potential for mismanagement and fraud. Moreover, because of their significant ownership and control rights, they tend to keep their investment in the firm for long periods of time. As a result, insiders tend to support decisions that will enhance a company’s long-term performance as opposed to decisions designed to maximise short-term gains.
Insider systems, however, predispose a company to certain corporate governance failures. One is that dominant owners and/or vote holders can bully or collude with management to expropriate firm assets at the expense of minority shareholders. This is a significant risk with pyramid ownership structures, for example, which enable insiders at the top to extend their control over corporations and vast corporate assets, leaving little direct equity ownership in corporations lower down the pyramid.
In contrast to insider systems, owners in outsider systems rely on independent board members to monitor managerial behaviour and keep it in check. Independent board members tend to disclose information openly and equitably, assess managerial performance objectively, and to protect shareholders’ rights vigorously. This creates the image that outsider systems are more accountable and less corrupt, contributing to the growth of liquid capital markets.
Despite these advantages, such dispersed structures have certain weaknesses. Dispersed owners tend to be interested in short-term profit maximisation. This can lead to the approval of policies and strategies that will yield short-term gains, but that may not necessarily promote long-term company performance.
At times, this can lead to conflicts between directors and owners, and to frequent ownership changes as shareholders may divest in the hopes of reaping higher profits elsewhere - both factors weaken company stability. Small-scale investors also have less financial incentive to vigilantly monitor boardroom decisions and to hold directors accountable. This can potentially encourage directors who support unsound decisions to remain on the board even when it is in the company’s interest that they be removed.
It is evident that both insider and outsider systems have inherent risks. Failure to institute the appropriate mechanisms to reduce these risks jeopardises the well-being of entire economies. Corporate governance systems are designed to minimise these risks and to promote political and economic development. An effective corporate governance system relies on a combination of internal and external controls. Finding the right balance, as the majority of our readers agreed, is thus dependent on the specific company.