BoardMatters Quarterly, June 2013

Governance may depend on size

How small- and large-cap companies differ

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Public companies face an evolving corporate governance landscape shaped by a combination of factors: greater public attention to governance practices and board oversight; new regulations and proxy statement disclosure rules; and shareholder initiatives aimed at reforming certain practices.

While much of the focus of the governance community has been on larger companies, some investors, for example, are beginning to turn their attention to governance practices at small- and mid-cap companies, particularly as they relate to director election procedures.

While some emerging governance trends might be appropriate for larger organizations, smaller companies often face unique circumstances that call for a different approach. For example, some small- or mid-cap companies may have only recently gone public, or they may have investors with relatively large ownership stakes. And smaller companies typically face an array of business issues and challenges that differ from those of larger enterprises.

Key differences

A recent study published by the Society of Corporate Secretaries & Governance Professionals and the EY Corporate Governance Center1 reveals that small- and mid-cap companies are indeed following different corporate governance practices than those of larger organizations.

The report, which offers a data-focused review of the governance practices of Russell 3000 companies, is based on actual company practices disclosed in proxy statements filed with the US SEC.

Following is a summary of some notable governance trends seen in smaller companies and how and why they might differ from practices at larger organizations:

  • Evenly split on annual elections vs. staggered boards. The percentage of small- and mid-cap companies with annual elections stands at 51% and 62%, respectively, compared to about 84% for large-cap companies. Overall, the proportion of companies holding annual elections represents a significant shift from 2007, when staggered board elections were far more prominent across all companies. Still, smaller companies have historically been less committed to annual elections than larger companies. Most institutional investors believe that annual elections force directors to be more accountable. Companies, on the other hand, defend staggered elections as protection against unsolicited takeovers. This concern may explain why smaller company boards are more likely to have staggered boards.
  • Majority voting in director elections is not common practice. Less than 20% of small-cap companies and just over half of mid-cap companies have majority voting procedures for board elections. On the other hand, nearly 85% of large-cap companies require directors to be elected by the support of at least 50% of the votes cast. Smaller companies may favor plurality voting, in which a single vote “for” a director nominee would be enough for him or her to win a board seat. Smaller companies may prefer this voting method because of the disruption caused when a director is not re-elected. In addition, they often have smaller boards and may be more challenged to meet the resource and time requirements necessary to evaluate and recruit new director candidates.
  • Less likely to include a woman on the board. The survey found little change in gender diversity since 2007, with the overall level of women directors at all companies coming in at around 11%. About a quarter of mid-cap and 45% of small-cap companies have no women directors. This lack of women directors is in stark contrast to large-cap companies, where only 7% of large-cap companies had no women on their board of directors.
  • A greater percentage of director nominees receive opposition votes. Overall, support for directors remains high, but when there is opposition, 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 (those owning more than 5% of the stock).

Looking ahead

Shareholders will likely continue to encourage small- and mid-cap companies to embrace more large-cap company governance practices. While some investors may see this encouragement as a positive development, some small organizations may not be ready to adopt majority voting or annual elections.

So shareholders must be vigilant in making sure that both boards of directors and management are accountable to shareholder interests. They also need to consider the nuances between small-, mid- and large-cap companies when engaging companies on governance practices.

Shareholders will likely continue to encourage small-cap companies to embrace more large-cap company governance practices.

 Questions for small- and mid-cap company boards to consider

Questions for small- and mid-cap company boards to consider

  • Has the company received inquiries from investors about its governance practices? Is it prepared to answer questions or respond to requests related to annual elections, majority voting or other governance practices? Has the board discussed this possibility?
  • Has the board reviewed its governance practices with those of similar sized organizations to identify similarities or differences? If not, should it consider doing so?
  • Does your company’s process for evaluating director candidates consider diversity of race, ethnicity, gender, age, cultural background and professional experience to appropriately support the company’s strategic direction and competitive challenges?
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1 Governance trends and practices at US companies: a review of small- and mid-sized companies, EY and The Society of Corporate Secretaries & Governance Professionals, May 2013