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Think Corporate Governance Is Only For The Big Guys? Think Again!
I am often asked what changes may lie ahead for privately held companies in the wake of the corporate scandals rocking Wall Street. My answer is straight-forward: when the dust finally settles, company owners, financial institutions, and boards of directors, are going to hold private companies to most of the same reporting requirements and behavior standards as that of public companies. There won't be much difference between public and private companies when it comes to the issue of corporate governance.
That is good news for those executives who have been managing their companies honestly and openly. Being ethical has always been, and will continue to be, an important requirement for the successful top executives of companies large and small.
But even ethical executives will find themselves facing greater scrutiny in their day-to-day business activities compared to the lax oversight of past years.
I see many changes ahead for the boards of closely held companies. In many cases, those changes will be quite dramatic. For instance, the Sarbanes-Oxley Act of 2002 requires public companies to have more outside, independent directors, including special standards for the chairman of the audit committee. It is highly likely that privately held companies will be required by lenders or shareholders to follow these same guidelines whenever possible. The new outside directors will exercise a great deal of independence in terms of the activities they oversee. Until recent events, we have rarely seen an emphasis on this from private companies.
With the anticipated reforms in place, professional investors, such as venture capital firms, will add directors who have well-defined backgrounds in finance, marketing, or technology, to represent them in the businesses in which they've invested. Obviously, this will have a big impact in this region where venture capitalists have interests in hundreds of companies. These new directors will set the tone for corporate accountability, especially in the financial realm. Like their counterparts in public companies, the audit committee members of private companies will find themselves in highly visible roles as trusted guardians. They understand the consequences should they become involved in corporate fraud.
I can see other changes ahead beyond the selection of board members. Many of these changes will involve the financial aspects of how a company is governed. Executives will face increased accountability for their decision-making. For example, such actions as loans to employees will be closely scrutinized, as will be the granting of employee stock options. And such windfall benefits as bonuses to exercise stock options in the event of a sudden executive departure will become a practice of the past.
Meanwhile, commercial banks may be called upon to assume the role of "watchdogs" of private companies. U.S. bank regulators have, in the past, used the banking system to influence compliance with select issues. One example was in 1999 when federal bank regulators used the banking system to create awareness of Y2K risks in mission critical computer systems of companies. The regulators identified Y2K as an additional risk factor that banks were required to consider when granting credit to a business.
Private companies seeking credit from a bank are going to find themselves under more scrutiny than in the past. Lending officers will be looking not only at the track record and repayment ability of the borrower, but they will also look closely at the character and decision making processes used by companies. They will become less forgiving of paperwork errors and will scrutinize all documents to ensure that all the "i"s are doted and "t"s are crossed.
The situation facing corporate America today is somewhat similar to the one that confronted the savings & loan industry during the scandal-plagued 1980s. Congress enacted a series of corporate governance regulations to correct the weaknesses of the financial services industry, as it then existed. Effective legislation was passed and regulators were given broad authority to deal with problem banks quickly. As a result of those actions, the financial services industry is much healthier today and will have fewer corporate governance issues to deal with than will the typical company. Even with a major downturn in the economy these past two years, banks have stood up well.
A more closely regulated corporate governance environment does not mean the end of the world for private (and public) companies, only the beginning of a new era.
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Richard M. Brenner is the founder, President, and Chief Executive Officer of the Brenner Group. Inc., an interim executive management and
financial advisory services consulting firm headquartered in Cupertino, California. Mr. Brenner is also a founding director and Chairman of the audit
committee of Bridge Bank, National Association.
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