Report: Corporate Governance Challenges Faced by SMEs

This report delves into the critical challenges of corporate governance faced by small and medium-sized enterprises (SMEs). It highlights key issues such as the lack of independent directors, which can impact decision-making objectivity, and the lack of transparency, which can lead to poor stakeholder relationships and incorrect decisions. The report also explores the difficulties SMEs encounter in interpreting the need for governance improvements and the absence of standardized practices. It suggests strategies to address these challenges, including establishing well-functioning boards, board evolution, and adopting practices from the Malaysian Code on Corporate Governance (MCCG). The report emphasizes the importance of incorporating experts and external advisors to enhance corporate governance and ensure long-term success. Finally, the report references relevant literature to support its findings.

Business Environment 1
Business environment

Business Environment 2
Introduction
Corporate governance (CG) is deemed as the necessary building block in terms of stable
economies, as it helps the organization in protecting the rights and interest of the shareholders
and other stakeholders of the organization. Corporate Governance mainly gives the framework
for the effective monitoring of management actions and performance, and it also encourages
better business results.
This framework reflects the rules and policies through which board of directors of the
organization ensures the accountability, fairness, and transparency in the relationship occurred
between the organization and its stakeholders such as financiers, customers, management,
employees, government, and the community. Following things are reflected by the corporate
governance framework-
 Contracts which are explicit and implicit in nature signed between the organization and
stakeholders in terms of distributing the responsibilities, rights, and rewards.
 Procedures which deals with the conflict of interests of stakeholders in terms of their
duties and roles (Corporate Governance, 2018).
The main challenge for small and medium size firms (SMEs) is to establish the framework
related to the corporate governance which is mainly developed for the large and listed
organizations. These frameworks of the corporate governance fail to reflect the elements and
characteristics of the SMEs, as in these organizations owners are the managers of the
organization as well. In this ownership of the company is also shared across the family members.
This report mainly aims to encourage the understanding of the challenges faced by the small and
medium firms in terms of the corporate governance. In other words, this paper reflects all the
major challenges faced by the organizations in context of the corporate governance, and further
states the strategies which are used by the organization for dealing with these challenges (World
Bank Group, 2017).
Corporate governance structures can be used by the small and medium sized firms in terms of
ensuring the long term success for their stakeholders and for organization itself. As stated by the
Organisation for Economic Cooperation and Development (OECD), CG mainly involves the set
of connection between the management and board, its shareholders, and other stakeholders of the
organization. In terms of the SMEs, CG ensures the proper incentives for the board and
management of the organization in terms of achieving those objectives that are in the interest of
the organization and its shareholders, and also facilitates the effective monitoring of the
organization (ACCA, 2014).
Corporate governance guide prepared by the MCCG mainly targets the large and listed company,
and those organizations which are not listed are also encouraged in terms of including this code
in their day to day activities. These organizations must ensure the implementation of the

Business Environment 3
practices defined by MCCG in context of enhancing their accountability, transparency, and
sustainability (SC, 2017).
Major Corporate Governance Issues
The biggest issue in context of the Corporate Governance faced by SME is the lack of
independent directors. Structure of the Corporate Governance mainly based on the independent
directors of the company, as these directors are responsible to bring the objectivity I each and
every function of the board of directors and also ensure effectiveness (KPMG, no date).
As lack of independent directors on the board is considered as big issue for the SMEs, because it
ultimately cause influential effects on decisions taken by members of the organization. This can
be understood with the help of example, as IJ pharmacy is the organization which falls in the top
15 SMEs of Malaysia. This organization also face the issue related to the lack of IDs for ensuring
best CG practices in their business (Rachagan & Satkunasingam, 2009). It is necessary to
understand that, at the time when changes in the corporate governance law occurs, number of
challenges will resulted in terms of the corporate governance measures which affect the
efficiency of the organization. Some of these challenges are lack of understanding in terms of the
working of the board of the organization and the independent NEDs. It is difficult to find the
NEDs of high quality. However, there is expectation of the guarantee that SMEs get the benefit
related to the cost savings because of the enhancing corporate governance standards in the
business organization. There is no urgency on the part of the SMEs to improper the governance
in comparison of the other pressing issues related to the business such as there is issue in
managing the cash flow of the organization. Those advisers which are working with the SMEs
are under obligation to challenge these perceptions, which are generally the reason of the
inaction.
SMEs further face the issue of lack of transparency in terms of the corporate governance, as
there is risk of hidden transaction in the SMEs. Lack of transparency is deemed as big issue for
the organizations, because it enhance the risk of wrong decisions and also affect the interest of
stakeholders in negative manner.
There are some general challenges also which are faced by the SMEs for ensuring the effective
corporate governance in their business, such as difficulty in the interpretation of the expression
of need, there is lack of awareness of need, there is lack of standardization, issue related to the
understanding of the required changes, and there are concerns related to the cost (ACCA, 2017).
Another difficulty emerge in the interpretation of the expression of need, which means, family-
owned SMEs must identify some issues in the business which required to be addressed in context
of improving the performance and perspective of business. This can be understood through
example, following is the period of business growth, internal decision-making structures which
need to be strengthened or formalized. Solution of this issue actually lies in the improvement of

Business Environment 4
the corporate governance, but in actual SMEs fail to frame these needs in such terms. In this
context, they required the external advisers and institutions in terms of making the link with the
corporate governance structures and also give them advice on further solutions.
Strategies to deal with these challenges
There are number of strategies which can be used by the SMEs in Malaysia to deal with the
above stated challenges, and some of these challenges are defined below-
 A board with proper functioning can help the organization in ensuring that performance
and management of the organization both conducted in well manner, and also monitored
properly in the SMEs. There is also an enhanced risk that poor quality of the management
information makes it harder to analyse whether SMEs are going to be insolvent.
 Failure of the board of the organization and business is the result of the family-owned
board, because in this board members are not well-experienced. In other words, there is
lower failure rate in those SMEs in which board of the organization holds the experienced
members.
 Another strategy in this context is the board evolution, which means, there are number of
business organization in which business does not exist in the static state, but it is evolved
on continuous basis. This is the reason, because of which role of the board needs to be
evolved over the time.
There are number of practices which are stated by the MCCG in terms of resolving the issues
faced by the SMEs while emerging the corporate governance in their organizations. Following
are the practices which can be adopted by the SMEs in terms of meeting the strategic aims of the
corporate governance-
 Strategic aims of the organization must be set by the board of directors of the company in
terms of meeting the corporate governance standards, and also ensures that all the
necessary resources are available in terms of meeting these objectives, and also for
reviewing the performance.
 The Chairman of the board who is responsible for ensuring the good governance practice.
 The position of chairman and CEO in the board must be hold by the different individuals.
 The board of the SMEs must be supported by the qualified and suitable company
secretary in terms of giving the sound governance advice, and also ensure comply of the
rules and procedures related to the CG (SC, 2017).
Improvements in Corporate Governance
There are number of factors which need to be incorporated in the CG practices, as all these
practices also helps the organizations in resolving their issues-

Business Environment 5
 Board of directors of the organization must include the experts related to the corporate
governance, which means, those directors who hold the expertise in terms of the
corporate governance, so that they are able to give their expert advice on the issues
related to the corporate governance.
 SMEs can also take the advice from outside experts, which means, those consultancy
firms who help the SMEs in resolving these issues (Abor & Adjasi, 2007).

Business Environment 6
References
Abor, J. & Adjasi, C. (2007). "Corporate governance and the small and medium enterprises
sector: theory and implications", Corporate Governance: The international journal of business in
society, Vol. 7 Issue: 2, pp.111-122.
ACCA, (2014). Governance for all: the implementation challenge for SMEs. Available at
https://www.accaglobal.com/content/dam/acca/global/PDF-technical/small-business/ea-
governance-for-all.pdf. Accessed on 11th October 2018.
ACCA, (2017). What the new Malaysian corporate governance code will mean for companies.
Available at https://www.accaglobal.com/in/en/member/discover/cpd-articles/governance-risk-
control/mycorpgov-cpd.html. Accessed on 11th October 2018.
Corporate Governance, (2018. Corporate Governance. Available at
KPMG, (no date. Role of Independent directors. Available at
https://www.in.kpmg.com/SecureData/aci/Files/RoleofIndependentDirectorsIssuesandChallenge
s.pdf. Accessed on 11th October 2018.
Rachagan, S. & Satkunasingam, E. (2009). "Improving corporate governance of SMEs in
emerging economies: a Malaysian experience", Journal of Enterprise Information Management,
Vol. 22 Issue: 4, pp.468-484.
SC, (2017). Malaysian Coe on Corportae Governance. Available at https://www.sc.com.my/wp-
content/uploads/eng/html/cg/mccg2017.pdf. Accessed on 11th October 2018.
SC, (2017). SC Releases New Malaysian Code on Corporate Governance to Strengthen
Corporate Culture. Available at https://www.sc.com.my/post_archive/sc-releases-new-
malaysian-code-on-corporate-governance-to-strengthen-corporate-culture/. Accessed on 11th
October 2018.
World Bank Group, (2017). Corporate Governance and Small and Medium Enterprises.
Available at https://www.ifc.org/wps/wcm/connect/e4267212-baf6-401e-9c4e-165eb3e41908/
CG+SMEs+fact+sheet.pdf?MOD=AJPERES. Accessed on 11th October 2018.