Start-up corporate governance

The excesses of the 1980s led most blue-chip companies to develop and implement good corporate governance policies and practices. Whether through board direction or on the initiative of management, or under pressure from organised shareholder activism, corporate governance became a catchcry.

While the detailed practices of good corporate governance differ from company to company, primarily it provides a corporate structure with checks and balances in the interests of all stakeholders. Sound governance embraces the notions of adequate and proper disclosure of company operations, company performance in the interests of all stakeholders, regulatory and statutory compliance, independent oversight of management, and integrity in decision-making processes. There is little argument that good corporate governance policies have led to better profits, better shareholder returns, better performance and, to some degree, better management practices. But as we have entered the new millennium there is growing debate throughout the world on the role of corporate governance in new start-ups, particularly in Internet companies.

In many ways, the structure of newer start-ups bears little resemblance to the traditional structures of the established companies that attributed much of their success in the 1990s to corporate governance. The first authoritative study on the role of corporate governance in new start-ups was by the non-profit Investor Responsibility Research Center (IRRC) in Washington DC. The findings were published at a forum in New York City early this year. Generally, start-up boards of directors are smaller than the boards of traditional companies. The study found that Internet companies had an average of seven directors while S&P 500 companies averaged 12 - almost twice as many. After surveying 39 Internet companies, the same study found that almost half (47 percent) of the directors at these companies were regarded as company insiders - that is, directors who would not by traditional standards be viewed as independent, owing to some managerial or financial input. Traditionally, independent directors at blue chip companies are chosen for a wealth of qualities, expertise and experience.

In rare circumstances, independent directors have had great personal financial incentive to join blue chip boards. Generally speaking, however, no real or perceived conflict has been possible. Without any potential financial conflict, independent directors have no reason to act other than in what they consider the best interests of the company and its stakeholders. For some reason, these independent directors, so crucial to effective governance in successful blue chip companies, seem to have been forgotten in structuring start-ups. In many cases, hands on, day-to-day senior managers are also directors of Internet companies. In some instances, actual board control of a company's decision-making processes is in the hands of these senior managers - a reality that blue-chip directors would find simply awesome.

Alarming apathy

Even more alarming than the lack of independent directors is another finding of the IRRC study: Many boards of Internet start-ups do not see the need for proper oversight of company operations and performance in the same way as traditional blue-chip companies. While half of the S&P 100 companies have board committees overseeing corporate governance issues, only 6 percent of the Internet companies surveyed had similar committees. The thrust of the argument in support of fewer directors at dot-coms is that it allows companies to do what most Internet stock prices have done: move quickly. As a result, corporate governance seems to have been pushed aside - or at least well in to the background - when establishing start-ups. Apart from a perceived need for speed, there is no sound economic explanation or management logic for this to have occurred. Perhaps good management practices have simply been put to one side in the frenzy of becoming a flavour-of-the-month listing. So while blue chip companies pour more and more resources into the issues of corporate governance, business ethics and transparent statements of company goals, expectations and philosophies, according to the IRRC survey the bulk of dot-coms are happy to meet statutory and regulatory rules and guidelines but baulk at initiating their own governance and monitoring practices for the long-term benefit of the company.

This lack of traditionally accepted oversight raises the issue of whether some boards of Internet companies are acting in the long-term interests of the company and all its stakeholders, or in the short-term interest of director-shareholders. Quite possibly the interests of minority or external shareholders are being ignored. Good corporate governance is also about getting capital on the best possible terms for the company. Corporate governance is seen and recognised by major institutions as creating greater trust and confidence in companies. In turn, this trust can provide significant benefits for shareholders, such as access to cheaper capital. It is worth recalling that many start-up companies rely heavily on capital provided by people who do not have a say in the running of the business. Good start-ups attract venture capital. In most cases, venture capitalists can bring to companies more experienced and skilful managers. But that does not necessarily deliver a seat at the board table. In some instances, by contrast, venture capital is invested for quick gain: in other words, there is a possibility of a "get-in and get-rich" strategy by a venture capitalist that may in itself be contrary to the welfare of other shareholders and the ongoing success of a company.

Windfall millionaires

Generally though, it is the start-up directors and day-to-day managers who stand to reap vast financial windfalls through soaring stock prices or option-based compensation packages. Already, we have seen a new society of instant millionaires. Put simply, options are a benefit or reward given away free that are in effect paid for by other shareholders. One important function of corporate governance is to ensure that option-based packages are subjected to the proper checks and balances so that the company and minority shareholders are not unduly penalised. Start-ups should ensure that the "real money" provided by investors is used carefully and appropriately invested. Decision-making should not just benefit a few but should be aimed at the benefit of all stakeholders, and act as a company on a long-term path to success. For all these reasons, today's lack of independent oversight at many dot-coms is simply unsustainable. It is too easy to argue, as many of their directors do, that dot-coms operate in a new and different dimension in which speed in decision-making - in itself a classic reason for independent oversight - replaces sound management practices. Dot-com boards would do well to see appropriate corporate governance as a challenge worthy of their attention, rather than dropping it in the too-hard basket.

Certainly, it is wrong for aggressive and upbeat marketing spiels and practices not to be subjected to proper checks and balances. At the end of the day, the very sight of a crippled dot-com will have shareholders demanding to know why supervisory controls and independent oversight were not in place. Blue chip companies find independent directors to act as watchdogs. Why can't start ups do the same? Independent oversight would help address such fundamental issues as board and management structures and ensure proper checks and balances were in place prior to listing, and well before shareholders were asked to invest. As the experience of the past decade has shown, shareholders take a favourable view of companies that adhere to good corporate governance, independent oversight, diversity, and due and proper process, and tend to err on the side of experience.

*Christopher Thomas and Neil Waters are with Egon Zehnder International, Melbourne

Disclaimer

The purpose of this database is to provide a full-text record of all articles that have appeared in the CDJ since February 1997. It is aimed to assist in the research and reference process. The database has a full-text index and will enable articles to be easily retrieved.It should be noted that information contained in this database is in pre-publication format only - IT IS NOT THE FINAL PRINTED VERSION OF THE CDJ - therefore there might be slight discrepancies between the contents of this database and the printed CDJ.