August 1, 2022

SME corporate governance

Compliance with codes of corporate governance has become the norm for listed companies all over the world (Joshua Abor and Charles Adjasi “Corporate Governance and the Small and Medium Enterprises Sector: Theory and Implications”) April 2007 (, accessed 01 – 08 – 2022)). Such codes should also apply to the Small Medium Enterprise (SME) sector. SMEs are privately held firms, small independent firms managed by owners or part-owners having a small market share.

Corporate governance forms the environment for the internal activities of a company (Joshua Abor and Charles Adjasi (op cit)). Appropriate environmental conditions are crucial for corporate entrepreneurship to flourish in a company. Corporate governance mechanisms may result in greater performance for SMEs as well if appropriate measures are mandated by the regulators. Corporate governance is concerned with ways of aligning the interests of investors and managers and ensuring that firms are run for the benefit of investors. ‘It is concerned with the relationship between the internal governance mechanisms of corporations and society’s conception of the scope of corporate accountability’ (Deakin, S. and Slinger, G. (1997), ‘‘Hostile takeovers, corporate law and the theory of the firm’’, Journal of Law and Society, Vol. 24 No. 1, pp. 124-51).

‘Corporate governance represents structures, processes, cultures and systems that engender the successful operation of the organisations’ (Keasey, K., Thompson, S. and Wright, M. (1997), ‘‘Introduction: the corporate governance problem: competing diagnoses and solutions’’, in Keasey, K., Thompson, S. and Wright, M. (Eds), Corporate Governance: Economic and Financial Issues, Oxford University Press, Oxford, p. 15). It is the systems by which companies are directed and controlled (Cadbury, A. (1992), Report of the Committee on the Financial Aspects of Corporate Governance, Gee Publishing, London). Different systems of corporate governance embody legitimate lines of accountability that define the nature of the relationship between the company and key corporate constituencies. Corporate governance is the mechanism for establishing the nature of ownership and control of organisations within an economy. Corporate governance mechanisms are economic and legal institutions (Shleifer, A. and Vishny, R. (1997), ‘‘A survey of corporate governance’’, Journal of Finance, Vol. 52 No. 2, pp. 737-83).

‘Company law along with other forms of legislation, both shape and is shaped by prevailing systems of corporate governance’ (Joshua Abor and Charles Adjasi (op cit)). The impact of regulation on corporate governance occurs through its effect on the way in which companies are owned, the form in which they are controlled and the process by which changes in ownership and control take place (Jenkinson, T. and Mayer, C. (1992), ‘‘The assessment: corporate governance and corporate control’’, Oxford Review of Economic Policy, Vol. 8 No. 3, pp. 1-10). Ownership is established by company law and defines property rights and income streams of those in or against the business enterprise (Deakin, S. and Slinger, G. (1997), ‘‘Hostile takeovers, corporate law and the theory of the firm’’, Journal of Law and Society, Vol. 24 No. 1, pp. 124-51). In designing a corporate governance system, it is important to include all the stakeholders, the company and all interested parties and resort to control mechanisms that align the interest of managers and all stakeholders.

‘The application of corporate governance should not be limited to the boardroom but should take into account issues that encourage corporate entrepreneurship’ (Joshua Abor and Charles Adjasi (op cit)). Fostering corporate governance mechanisms impacts innovative ideas in corporate business. Enforcing corporate governance practices results in strict stringent mechanisms which could dampen corporate entrepreneurship. Corporate entrepreneurship comprises of creativity and innovation in corporate values that must be taken into consideration whilst pursuing corporate governance mechanisms. Creativity and innovation are the value creation efforts of corporate governance in entrepreneurial firms and take the form of corporate entrepreneurship. Corporate entrepreneurship refers to efforts on the part of the firms to foster entrepreneurs, innovation and new ventures in the corporate setting.

‘Corporate governance is important as a growth strategy and competitive advantage’ (Merrifield, D.B. (1993), ‘‘Intrapreneurial corporate renewal’’, Journal of Business Venturing, Vol. 8, pp. 383-9) and contributes to the organisation’s renewal (Zahra, S. (1991), ‘‘Predictors and financial outcomes of corporate entrepreneurship: an explorative study’’, Journal of Business Venturing, Vol. 6 No. 4, pp. 259-85). Value creation is possible by harnessing the innovation and effort of the members of the corporation through corporate entrepreneurship (Joshua Abor and Charles Adjasi (op cit)). Innovation and creativity add value to firms when implementing corporate governance mechanisms. SMEs tend to have a less pronounced separation of ownership and management than larger firms. Because there is no agency problem, profit maximisation, increasing net market value and minimising cost are common aims of the members. Members are rewarded directly and, as such, there is no need for incentives to motivate them.

Growing entrepreneurial firms are firms that have the growth and orientation to expand beyond their state of survival (Joshua Abor and Charles Adjasi (op cit)). The benefits of corporate governance practices assist SMEs to grow rapidly. Entrepreneurial firms need access to resources and growth. They need inputs on business operations, good strategy and best practices in the sector. These resources can be provided for through the presence of non-executive or external directors. Strategy influences corporate performance (McGahan, A.M. and Porter, M.E. (1997), ‘‘How much does industry matter really?’’, Strategic Management Journal, Vol. 18, Summer, pp. 15-30) and external board members challenge strategies by management (Pettigrew, A. and McNulty, T. (1995), ‘‘Power and influence in and around the boardroom’’, Human Relations, Vol. 48 No. 8, pp. 845-73). External board members could lead to better management decisions and help SMEs to attract better resources.

Access to finance is one of the challenges to the growth and performance of the SME sector (Joshua Abor and Charles Adjasi (op cit)). Incorporation of corporate governance into the sector could reduce constraints. The infusion of external board membership is crucial since there is a high incentive for the board members to introduce ways of attracting finance. Non-executives could also introduce creativity and innovations in decision-making. As entrepreneurial firms grow, the need to introduce professional governmental practices and managers arises. This begins the process of separation between management and owners. The non-family professionals would have to be motivated with incentives to gain from their expertise.

Corporate governance makes room for the composition of a board which will include external directors not linked to the owner to induce more independent best practices methods of running the business. Particular attention must be paid to the possible tensions that will exist between owners and the board in the case of sole proprietors. Corporate governance bothers around the role the board plays in directing the agent (manager) of a firm to attain the prime objective of its principal (shareholder) to fulfil a contractual obligation (Joshua Abor and Charles Adjasi (op cit)). Corporate governance mechanisms must incorporate other stakeholders on the board of the firm. They help promote corporate governance by promoting the interests of the previously excluded groups. Stakeholders can help augment corporate governance mechanisms. ‘Shareholders have a prime role in corporate governance issues due to the fact that they are a source of prime input for the firm capital and finance’ (Heath, J. and Norman, W. (2004), ‘‘Stakeholder theory, corporate governance and public management. What can history of state-run enterprises teach us in the post-Enron era?’’, Journal of Business Ethics, Vol. 53, pp. 247-65).

An SME with a corporate governance structure will assist in overcoming the agency problems through the expertise and more stringent internal control measures introduced by the board members. The separation of management from the control of the board mimics the division of the manager from the owner (Joshua Abor and Charles Adjasi (op cit)). In closely-held companies, fallouts amongst the people involved revolve around a failure to separate the two functions. If SMEs infuse corporate governance structures at an early stage, they will gain experience and instil discipline in the management of the firm. Good corporate governance practices assist SMEs in improving their prospects of obtaining funding from investors and financial institutions. Applying good governance practices reduces the problem associated with information asymmetry and makes the SME less risky to invest in. The SME will have healthier growth and be committed to business efficiency due to the presence of external supervisory parties.

Joshua Abor and Charles Adjasi argue that corporate governance constitutes the organisational climate for the internal activities of a company that can assist in the SME sector by infusing better management practices, stronger internal auditing and greater opportunities for growth, and bringing a new strategic look through external independent directors. It enhances the firms’ corporate entrepreneurship and competitiveness. It is not a threat to value creation if the guidelines on corporate governance are properly applied. Firms can and do adapt to weaker environments by adopting voluntary corporate governance measures. A firm may adjust its ownership structure by having more shareholders who can serve as effective monitors of the primary control shareholders. This may convince shareholders of their firm’s willingness to respect their rights.

‘Voluntary mechanisms result in a higher level of corporate governance disclosure’ (Stijn Claessens and Burcin Yurtoglu “Corporate Governance and Development— An Update (, accessed 01 – 08 – 2022)). Voluntary adoption of corporate governance practices lowers the cost of capital. The more firms adopt voluntary corporate governance mechanisms, the higher the valuation and the lower their cost of capital (Bauer, Rob, Nadja Guenter, and Roger Otten. 2004. Empirical evidence on corporate governance in Europe: The effect on stock returns, firm value and performance. Journal of Asset Management Science 5: 91–104). Operational performance is higher in a better corporate governance environment. Voluntary corporate governance adopted by firms only partially compensates for weak corporate governance environments.

The adoption of International Accounting Standards (IAS) enables firms to provide financial information in a form that is more reliable and more familiar to investors (Stijn Claessens and Burcin Yurtoglu (op cit)). It reduces information asymmetries and helps with signaling to shareholders the firm’s willingness to adhere to sound corporate governance practices, thus making the firm more attractive to investors. Firms that adopt IAS achieve a lower cost of capital (Chan, Kalok, Vicentiu Covrig, and Lilian K. Ng. 2009. Does home bias affect firm value? Evidence from holdings of mutual funds worldwide. Journal of International Economics 78: 230–241). ‘Increasing financial transparency is a way to encourage better corporate governance’ (Bryane Michael “The Role of Hong Kong Financial Regulations in Improving corporate Governance Standards in China: Lessons from the Panama Papers for Hong Kong (, accessed 01 – 08 – 2022)). Highly leveraged firms do not embrace disclosure which draws attention to their heightened financial risks. The lack of disclosure culture in corporate governance underpins the reasons for bad financial reporting.

Corporate governance reforms involve changes in control and power structures – reforms depend on ownership structures (Joshua Abor and Charles Adjasi (op cit)). A high concentration of wealth could impede improvements in corporate governance (Bryane Michael (op cit)). Wealth structures need to change to bring about significant corporate governance reform (Stijn Claessens and Burcin Yurtoglu (op Cit)). More concentrated ownership can be beneficial unless there is a disparity of control and cash flow rights. Investors become more confident in a company because its operations, including financial statements, are more transparent and it respects minority shareholders’ rights. Performance is better for companies with high levels of accounting disclosures and high levels of outside ownership concentration.

Corporate governance is important for younger founder-managed firms, particularly for those reaching a point in their development when they begin to face constraints on their ability to realise growth opportunities (David Guest “Corporate Governance, Human Resources Management and Firm Performance” (, accessed 01 – 08 – 2022)). ‘When an entrepreneurial firm matures and its management becomes more professional, changes in the ownership structure and the growing importance of external stakeholders may shift the balance toward the monitoring and control functions’ (Zahra and Filatotchev, 2004“Governance of the Entrepreneurial Threshold Firm: A Knowledge-based Perspective” (, accessed 01 – 08 – 2022)).

‘Corporate governance is a dynamic system that may change as firms evolve over different stages of the firm life-cycle (David Guest (op cit)). The firm’s evolution is accompanied by changes in ownership structure, board composition, the degree of founder involvement, etcetera. The balance of accountability and enterprise roles of various governance elements may change over the life-cycle from establishment, growth, maturity and decline. The firm’s strategic dynamics and corporate governance changes are inter-linked, and the firm’s life cycle may go hand in hand with dramatic shifts in its governance system (Stijn Claessens and Burcin Yurtoglu (op Cit)). Changes in the organisational development stages are accompanied by different combinations of resource diversity and accountability, and these combinations define the strategic positioning of an individual firm with respect to its environment. In the early stages of the life-cycle, the entrepreneurial firm has a narrow resource base. It is owned and controlled by a tight-knit group of founder managers and/or family investors, and the level of management accountability to external shareholders is low.

The governance system begins to change and the balance between resources and accountability starts to shift towards greater transparency and increasing monitoring and control by the emerging external providers of resources as the firm grows (Stijn Claessens and Burcin Yurtoglu (op Cit)). The transition from “entrepreneurship” to “professional” requires an effort on the part of the firm’s top management team, existing investors and advisors to prepare the firm for the scrutiny of the regulator and investment community and to establish corporate governance systems that will comply with the regulator’s guidelines, e.g. codes of good practice (Catherine M. Daily, Dan R. Dalton “Board of Directors Leadership and Structure: Control and Performance Indications” (, accessed 01 – 08 – 2022)).

‘Corporate governance manifests itself in different roles, at different parts of the life-cycle of firms and organisations’ (Stijn Claessens and Burcin Yurtoglu (op Cit)). ‘Successful transition over the threshold is accompanied by a dramatic re-balancing in the structure and roles of corporate governance as compared to each previous stage in the cycle’ (David Guest (op cit)). For firms at different stages in their life cycle, the number of external directors may matter less than their expertise. Corporate governance parameters may be linked to strategic “thresholds” in the firm’s life cycle. The firm’s evolution along its life-cycle is associated with changes in the balance between the wealth-protection and wealth creation roles of corporate governance. The right mix of governance functions may help the firm to overcome its strategic thresholds.

‘Lawyers, accountants and other intermediaries should use the client handling procedures and risk management procedures as those used in banks and large corporate secretarial firms’ (Bryane Michael (op cit)). Legal, accounting and corporate services firms need to modernise their corporate governance practices by adopting the risk-based approach in managing their clients and their own corporate governance issues. ‘Good governance mechanisms among SMEs are likely to result in boards exerting much-needed pressure for improved performance by ensuring that the interests of the firms are served’ (Joshua Abor and Charles Adjasi. (op cit)). Good corporate governance does not guarantee business success; however, poor governance could be symptomatic of a business failure.


 Please note that our blog posts are informal commentaries on developments in the law at the time of publication and not legal advice.




About the author 

Sipho Nkosi

Sipho Nkosi is an experienced Legal Professional with a demonstrated history of working in the legal services industry. A strong legal professional with a B Proc degree focused in Law from the University of Natal (Howard College), with a keen interest in corporate governance and a profound insight into Compliance Risk Management. Skilled in litigation and procedural law, and an affiliate member of the Compliance Institute Southern Africa.

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