The Corporate Governance Gap

Abstract

A reliable system of corporate governance is considered an important requirement for the long-term success of public companies and for the good of society at large. After decades of research and policy advocacy, there is a growing sense that corporations are finally nearing the promised land: boards of public corporations seem more diverse, large investors seem more engaged, and directors seem more accountable than ever. But is this perception accurate? While many large, high-profile companies tend to serve as role models of desirable governance practices, the picture of corporate governance—as this Article reveals—is considerably different in the far corners of corporate America, away from the limelight of the Fortune 500 and within the universe of small-cap corporations. In these smaller, less-scrutinized corporations, the adoption of governance arrangements is less systematic and often significantly departs from the norms set by larger companies. This results in what this Article calls the “Corporate Governance Gap.”

What prompts this governance gap? Corporate governance, we argue, is not self-driven. It requires engagement with agents and forces of change, which, as we detail theoretically and empirically, are less likely to be as prevalent or effective for smaller corporations. Corporate governance scholars have long debated the merits of contractual freedom in corporate law. This debate cannot be resolved without a fuller understanding of how governance terms are disseminated in the marketplace and without a recognition of the Corporate Governance Gap between large and small companies.

This Article, the first to address the sharp divide in the governance of American corporations, makes three key contributions. First, using a comprehensive, hand-collected dataset, it offers an empirical account of the differences in governance practices, shedding new light on the corporate governance of small-cap firms. Second, the Article develops a theoretical account of the forces that promote corporate governance changes, which help explain the stark governance gap. Finally, the Article proposes policy reforms aimed at overcoming the gap between large and small firms’ corporate governance norms, with the potential of prompting a new line of inquiry regarding the role of key governance agents in smaller public companies

Keywords: Corporate Governance, Corporate Law, Small-Cap Companies, Shareholder Voting, Shareholder Activism, Hedge Funds, Shareholder Proposals, Securities Regulation, Board Diversity, Directors, Governance Gap, Private Ordering

JEL Classification: K2, K22, G34, G38