Study says company size can affect governance

A new survey shows investors are taking a closer look at the governance practices of small and mid-cap companies, especially when it comes to director election procedures

Pressure from greater shareholder scrutiny, Sarbanes-Oxley and Dodd-Frank legislation has certainly put large company boards on the hot seat, but now some investors are taking a closer look at the governance practices of small and mid-cap companies, especially when it comes to director election procedures.

Apparently, size does matter. A recent study published by the Society of Corporate Secretaries & Governance Professionals and the EY Corporate Governance Center, finds that small and mid-sized companies are following different corporate governance practices than larger companies. The study included the governance practices of Russell 3000 companies from information gathered from their proxy statements filed with the SEC.

‘Many of the differences reported are due to recent changes made by large-cap firms due to Sarbanes-Oxley and Dodd-Frank,’ points out Lori Verstegen Ryan, PhD., director of the Corporate Governance Institute at San Diego State University.

One interesting finding is that small and mid-cap companies are more likely to have independent board chairs than larger companies.  ‘Investors are increasingly asking for independent board leadership,’ says Allie Rutherford, leader of EY's Corporate Governance Center. So in this area, small and mid-size firms may be ahead of the big guys.

The study highlights a handful of key differences:

Elections.  Smaller companies, according to the report, have historically been much less committed to annual elections than larger companies. About 84 percent of large-cap companies have annual board elections, however, the percentage of small and mid-cap companies that hold annual elections is 51 percent and 62 percent respectively. Institutional investors favor annual elections because they believe it helps keep directors accountable. Companies who use staggered elections say they protect against unsolicited takeovers. 

‘Given that staggered boards appear not to harm firm performance, small and mid-cap companies should focus on maintaining the type of board that works best for them,’ says Verstegen Ryan.

Voting. Nearly 85 percent of big companies require directors to be elected by the support of at least 50 percent of the votes cast. But less than 20 percent of small-cap companies and just over half of mid-cap companies have majority voting procedures for board elections. Smaller companies, according to report may prefer this type of voting because of the disruption caused when a director is not re-elected. They also likely have smaller boards, which means it is no small matter to have to evaluate and recruit a new director.

But that's a price that may be worth paying, Verstegen Ryan, says. ‘Pluralist voting tends to support management positions and encourages board entrenchment, so it's clear that smaller firms should also shift to holding elected based on the majority of votes cast.’

Gender diversity. When it comes to recruiting women on boards, large companies aren't exactly setting a great example. Verstegen Ryan says female representation on large-cap boards was about 17 percent in 2012, compared to 8 percent a decade ago. However, according to the report, smaller companies appear to be doing an even poorer job—about a quarter of mid-cap and 45 percent of small-cap companies have no women directors, whereas 7 percent of large-cap companies had no women on their boards.

Verstegen Ryan explains the differences: ‘Small and mid-cap ownership structures are more likely to have founder and blockholder stakes in male hands, so it's not surprising that during these earlier stages they do not focus on adding women to their boards.’

Opposition. Support for directors remains high. However, when there is opposition to a director, small and mid-cap company directors tend to receive more votes against re-election. This disproportionate lack of support is likely a result of higher ownership levels by a larger number of significant shareholders, concludes the report. 

‘Investors in smaller firms are also more likely to be aware of the elections and nominees, and therefore are more likely to have an opinion and to vote their proxies accordingly,’ say Verstegen Ryan.

What to do about the differences?

Should small and mid-cap company boards mirror that of larger companies? ‘Instead of just succumbing to shareholder pressure and adopting a large-cap model, smaller firms should focus on maintaining ideal bundles of corporate governance structures and processes that work for them,’ says Verstegen Ryan. ‘Their job then becomes to educate shareholders and proxy advisors concerning why their governance mechanisms are an optimal fit, so that proxy voters do not vote against the board or demand additional governmental regulations of these smaller firms.’

The study is a tool for evaluating governance practices, says Rutherford. ‘It's important for small and mid-cap companies to understand the implications of governance practices. Investors are engaging companies on their governance practices. The study though, is not a call to action to make changes – each company has its own unique circumstances.’


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