A must read study examining corporate governance issue in closely-held corporations was recently published by the Harvard Law School Forum on Corporate Governance and Financial Regulation.
Closely-held Corporations Integral part of Global Economy
The study is important to business owners and shareholders all over the world given the integral role closely-held corporations play in the global economy. Indeed, the vast majority of firms in the U.S. are closely-held corporations and are a significant part of the business landscape in other countries, e.g. private corporation in Britain, the close corporation in Japan, the GmbH firm in Germany, and the SARL firm in France
Study Examined Benefit of Having Multiple Large Shareholders
The study, Governance Problems in Closely-held Corporations, examined the benefits of shared corporate ownership by using a large cross-sectional dataset of operating and financing patterns of closely-held corporations.
The main problem in closely held corporations, according to the study, is the squeeze out of minority shareholders by the majority shareholders.
The study found that performance is higher for private firms with a diluted ownership structure resulting in substantially higher net income relative to firms with one controlling shareholder and other minority shareholders.
The findings validates and bolsters the prevailing view that multiple large shareholders play an important role in mitigating expropriation and governance problems.
Failure to Take Advantage of Other Protections is a Big Mistake
There was one part of the study that I found particularly interesting. Although legislatures in the U.S. (and other countries) provide basic protection for minority investors in the form of boilerplate shareholder agreements that firms can choose by electing close corporation status, only around five percent of corporations elect to be covered under close corporation statutes, even though around ninety percent of the corporations in the U.S. are eligible. While data for other countries is not available, it would be interesting to see if the pattern is similar.
I think it is a big mistake for shareholders in closely-held corporation to overlook the protections afforded by the laws of their state or province. One of the main advantages of electing close corporation status is that it provides minority shareholders with a comprehensive checklist of agreements, which they can subsequently adjust for their specific situations. This affords some semblance of control in deciding the scope of the relationship relative to the other shareholders.
The Take Away Lesson:
- Consider structuring your closely-held corporation with multiple large shareholders. This will not only minimize corporate governance issues but may play a significant role in increasing net income as a result of the focus placed on the monitoring of performance indicators.
- Take advantage of the laws and regulations afforded by the laws of your state or province to minimize corporate governance issues. These laws serve as important guideposts in determing the scope of your relationship relative to the other shareholders.
What do you think?