Private companies turn to corporate governance to protect slim margins

Ten years ago, the business sector in the United States was buzzing over the high costs that the Sarbanes-Oxley Act would impose on public companies in the name of corporate governance.

But as Sarbanes-Oxley (SOX) requirements were implemented, it became clear that the new oversight provided benefits to go along with the costs.

Private company executives who saw the benefits of SOX voluntarily added corporate governance policies to their strategies, picking the tactics that made the most sense for their particular situation.

“From a private company perspective this is all voluntary, and they have jumped on board in a significant way,” said Ken Esch, a partner in PwC’s private company services practice. “They have tackled the areas where they feel like the effort will provide them enhanced profitability and maybe financial control over things.”

Four in five US companies participating in PwC US’s latest Private Company Trendsetter Barometer survey reported that they are adopting specific corporate governance practices. These companies are developing official policies promoting oversight and accountability in areas that include financial reporting, strategy and risk management.

Esch said the recent financial crisis prompted many private companies to incorporate governance practices to protect their businesses as margins narrowed. The area most frequently subject to oversight at these companies is financial reporting, which is monitored by corporate governance policies at 71% of the companies surveyed.

“They really needed to sharpen the pencil on the financial side of the business to make sure that they were getting the right information at the right time, so they could make informed business decisions,” Esch said. “And if they were relying on a faulty report of financial data in a decision-making process, it could be catastrophic for the company.”

Companies that experienced declining revenue began using corporate governance practices to focus on trimming expenses, Esch said. He said corporate governance target areas have included:

• Capital budgeting, where expenditures are receiving additional review to make sure investments will generate the needed returns.

• Operations, which have been examined to find cost reduction opportunities.

• Performance monitoring, where those charged with governance are making deeper and more frequent dives into companies’ financial data.

“Companies are becoming more sophisticated with respect to the data that they have about their companies and their customers,” Esch said. “And they’re learning how to use that more effectively than they did ten or 15 years ago.”

Fiscal planning (subject to corporate governance at 61% of private companies surveyed), regulatory compliance (61%), long-term corporate strategy (56%) and risk management (54%) also are areas of significant focus.

Esch believes a majority of private companies are missing an important opportunity, though, because just 43% reported a corporate governance focus on talent management and business succession. He said part of that is human nature because business owners do not like to contemplate their own mortality.

The financial crisis has entrenched some private company owners and managers who have recommitted to helping their businesses survive and thrive. Some of them are reluctant to consider what would happen if they cede responsibility or control, and others have not been able to find family members or others who are willing or able to take over the reins, Esch said.

Failure to develop a succession plan can have dire economic consequences for a business if a highly influential owner retires, dies or is unable to continue working, he said.

“A succession plan does send a message of confidence to outside people,” Esch said. “And that could be customers. It could be suppliers. It could be potential acquirers of the business should the owner decide they’re going to sell the company. Having that plan in place is important because it gives your partners and potential buyers the confidence in the company that things are under control.”

The next step for private companies, according to Esch, is developing boards that are more independent. Although 71% of companies surveyed have a board of directors, just 27% of those directors are independent outside directors. And 71% of those boards are chaired by the company’s chief executive.

These private companies are getting outside advice from consultants, but Esch said that cannot replace the contributions an independent board member could offer at a time when corporate governance is robust, even though its implementation is voluntary.

“As corporate governance continues to grow in the private company space, they’ll start to look more toward some independent directors to supplement the board,” Esch said.

—Ken Tysiac (ktysiac@aicpa.org) is a CGMA Magazine senior editor.