When Joe or Alice opened a corner shop in the neighborhood they never thought of governance frameworks and policies. They knew they had to sell stuff at a price exceeding cost and make a living out of what is called profit. They may have
not known standard costing or absorption of fixed overheads nor understood variable cost, etc. They could have continued this way without any borrowings from financial institutions and being below the tax bracket. They may not need more employees and didn’t have the need to segregate duties to safeguard assets, etc.
If Joe wants to scale up and become an SME or become even bigger he has to invest more, expand beyond a one man show and put processes to sustain long term success. Therefore, impact of other stakeholders like financiers, employees, society, government, etc will start to increase. If the corner shop becomes a medium sized company then, external directors and internal control processes and many other structures will be required. Good corporate governance will make it easy to bring in outside expertise, attract funding, and ensure long-term sustainability. There are many researches and organizations like the OECD and IFC supporting this view.
Joe’s corner shop nor any other business does not exist in a static state. All businesses are constantly evolving due to volatility and uncertainty in the business world. This requires the role of the owner or the board also to evolve over time. As the corner shop evolves into a SME and matures, there will be a greater need to bring in outside directors. Those external board members may initially be most valued for their complementary skills. Such external director’s role will be useful to improve governance practices and to manage future related party transactions and potential conflicts of interests.
However there are many obstacles to implementing good governance measures in SMEs. These may include:
- a lack of understanding of board room dynamics and roles
- a lack of understanding of how independent non executive directors (NEDs) are supposed to work
- difficulty in finding high-quality NEDs who are independent.
- a distrust about the positive results of raising corporate governance standards in the business
- failure to see the urgency of improving governance when compared with other pressing business issues, such as managing cash flow
- a concern about the additional costs.
There are many challenges to understanding the role that corporate governance can play in helping SMEs to grow. The biggest challenge is to make the owners of SMEs to take the time to understand what corporate governance means and how improving it could benefit the business. Another challenge is the belief that, in an economy characterised by widespread corruption or weak enforcement of laws and regulations, implementing corporate governance standards will lead to frustration and have limited impact.