TABLED : Governance in SMEs

Literature and research in the field of corporate governance is relatively new phenomenon. While various forms of governance of business entities have been used over many centuries, it is only in the past 20 or so years that governance has been the subject of serious academic study. In the New Zealand context, there are relatively few opportunities to engage in training and education in governance and the focus of both research and education has been on larger, corporate-type organisations.
Recently, Christine Grice, writing in the Institute of Director’s magazine Boardroom, provided an interesting article on whether or not the activities and structures of corporate governance are appropriate to small and medium enterprises (SMEs).
She concluded that for many SME owners, “governance has no relevance for the day-to-day job of keeping the business going”. She states that New Zealand’s corporate law framework is essentially “one size fits all” framework, irrespective of size, and that the time, energy and cost of setting up board outweighs any benefit the business owner can see.
In other words, formal governance, (ie, establishing board), is not seen to be of value to the average SME, although Grice does see value in informal “advisory boards”.
These views can be found throughout the somewhat limited academic literature on governance in SMEs, but are countered by an equally positive view that sees substantial benefits to SMEs which embrace governance function. To explore the dichotomy further, I will drop the word “corporate” and simply use the term “governance”.
In the case of SMEs, the major reasons for not pursuing governance function include the inappropriateness, (a corner dairy, for example, hardly needs board); that involving others in the running of the business means “letting go” of control, which is anathema to many SME owners; and the cost of establishing governance function is seen to be an unnecessary cost.
On the other hand, there are many commentators who claim that having governance function brings many benefits to an SME, such as access to external advice; access to wider networks, assistance from experienced business people; access to resources; better overall decision making; mitigation of risk; strategic thinking; and many others.
The quantity of literature supporting governance seems to outweigh the opposing viewpoint, however. The 2007 ANZ Business Barometer found that in sample of over 1000 significant privately held companies, with turnover between $10 million and $150 million, one of the six most important issues facing these businesses was to do with governance:
• One in three companies had no board.
• Only half of the companies with boards had regular meetings.
• Half those with boards had no independent directors.
In other words, many significant New Zealand-owned businesses appear to be devoid or deficient of effective governance.
The problem appears to be lack of understanding of the benefits to an organisation of having an effective governing body which oversees the activities of management; holds management to account; and sets the strategic direction of the business.
These fundamental activities, along with reporting to owners, ensuring compliance and managing risk, may be said to be the essence of governance. They are what boards do.
Besides the short list of activities above, the agreed most important output of boards or their equivalent is effective decisions.
For corporations, board of directors is “given”. When corporates are created, board is expected to be established.
In an SME however, it appears that the governance function evolves, either through an emerging realisation by the owners that external advice and access to networks, resources and professional assistance is good thing for the business; or, more likely, that critical event, such as an investor, partner, funder or adviser becoming involved, requires governance function to be established; or the act of incorporation which establishes legal reason for nascent governance to occur.
Research by the author is being undertaken to establish how the governance function emerges in an SME, for, with rare exceptions, it almost never occurs when an SME is set up. The research will also look at whether or not the existence of governance affects an SME’s performance.
It is contended that the development of governance parallels, or is related to, the various states of development of an SME, perhaps best illustrated by the business life cycle. Governance is believed to emerge during the growth and maturity phases of the life cycle. possible model could include the following:

State Governance activity
Start-upBusiness advisers, mentors, professionals giving advice.
GrowthAdvisory group or board with director skilled in high growth.
MaturityFull board with some independent directors.
DeclineGovernance changes due to selling, franchise or exit.

Supporting this process is research into family businesses, which gives other perspectives on governance in SMEs, by including family-oriented factors in the governance equation. Often, the board of family-owned business is paralleled by family governance structure such as family council, which provides advice and input into the board of directors.
Most of the research into governance in SMEs has focused on various aspects of boards of directors (size, skills, diversity etc), and company performance, (usually return on assets). Not surprisingly, the research is inconclusive or negative. That is, performance appears to be either neutral or negative when governance is present.
This could, of course, mean any number of things – performance using non-financial measures is enhanced by governance (and there is some evidence of this); factors other than the mere existence of governance structure are impacting on financial performance; or perhaps there is no causal relationship between the two.
There is however an interesting new approach to governance in SMEs which looks beyond the relationship between variables (eg, number of independent directors and financial results) to governance as process.
In this approach, governance and firm performance are affected by complexity of relationships between factors such as board effectiveness; the internal and external environments; and the commercial “players” involved. This approach looks to be very promising in understanding governance in general.
SMEs are vital part of the New Zealand economy. In spite of the current government’s apparent indifference towards business in general and SMEs in particular (which are being increasingly disadvantaged by politically motivated decisions to require of SMEs longer holidays, KiwiSaver, increased compliance costs, paid parental leave and so on), the health of the SME sector is critical economic determinant.
The improved performance and success of SMEs could well be enhanced by their developing an effective governance function, either structurally (by establishing advisory groups or boards of directors) or through developing their expertise in governance-related activities (such as strategic thinking, monitoring management, mitigating risk) or both of these.

Martin Devlin is professor at Massey University’s Department of Management and director of Valeo International, company providing governance services to SMEs. www.valeointernational.co.nz

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