Pros and Cons of Corporate Governance
There are many pros and cons of corporate governance that you should consider if you're thinking about incorporating your business.3 min read
There are many pros and cons of corporate governance that you should consider if you're thinking about incorporating your business. The main benefit of corporate governance is that following these rules can protect the owners of your company from personal liability. On the other hand, complying with corporate governance regulations can be difficult, particularly for smaller companies.
What is Corporate Governance?
Corporate governance is a set of regulations and practices that control a company. The reason that so many companies find corporate governance difficult is that it requires carefully managing the interests of multiple parties:
Most proponents of corporate governance take a broad view of these rules, while detractors often view corporate governance very narrowly. Companies governed in a transparent manner can receive a variety of benefits:
- Improving investor confidence.
- Better access to capital.
- Increased profits.
Drawbacks of Corporate Governance
One of the most important things to understand about corporations is that they are distinct legal entities, meaning that the owners of the company and the company itself are legally separated. Shareholders of a corporation will appoint a board of directors, and the board will be responsible for managing the company.
With small corporations, it's common for shareholders to also serve as officers, managers, and directors. Corporate governance requirements have several disadvantages to take into account when forming a corporation.
First and foremost, corporations are beholden to both state and federal laws. The primary motivation for forming a corporation is shielding shareholders from the liabilities of the company. A corporation restricts a shareholder's liability to the amount of money or other assets they have invested in the company.
In addition to limited liability protections, corporations are typically formed so that the company can sell stocks in order to raise capital. The problem, however, if a corporation wants to sell stock and protect its owners from liability, is that it must follow a wide range of requirements. For instance, the board of directors and officers of a corporation must act in the best financial interest of the company.
If the directors and officers are not fulfilling this fiduciary duty, they may face personal liability. This is why most large corporations provide insurance to their officers and directors. While this insurance usually doesn't cover instances of fraud, it can defend the company from the consequences of poor financial decisions.
Another drawback of corporate governance is that complying with these regulations can be very expensive. Because of the need to comply with corporate governance rules, the administrative costs of corporations are typically much larger than those of other entities. For instance, limited liability companies (LLC) do not have to follow these requirements, meaning they spend much less on administration.
Administrative costs of a corporation can cover several different areas, including maintaining a variety of documents:
- Stock sales and purchases.
- Legal compliance records.
- Annual registration.
Perhaps the biggest disadvantage of corporate governance is that corporations must abide by a variety of formalities. This can include holding and documenting annual shareholders meetings and recording big decisions approved by the board of directors. Even if your corporation has a single shareholder, you still need to follow these formalities. If you do not follow corporate formalities, the court can pierce the corporate veil and shareholders can be held personally liable for company debts.
Corporate Governance Advantages
Corporate governance is also very beneficial in many regards. For instance, when running a company, it can be easy to violate rules and regulations if you don't have legal experience. Putting corporate governance procedures in place can help you comply with these laws so that you spend your time focusing on your company's success. Corporate governance provides a set of rules you can follow to better manage your company, while steering clear of ethical violations.
If you're diligent about following corporate governance regulations, you can also boost your company's reputation. A company with a strong reputation will have an easier time attracting investors and developing strong relationships with customers. Corporate governance, because it helps your company abide by the law, can also reduce the likelihood of expensive fines or lawsuits.
If you need help understanding the pros and cons of corporate governance, you can post your legal needs on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twilio.