Microcap Board Governance

Annalisa Barrett is a clinical professor of finance in the University of San Diego School of Business and the founder and CEO of Board Governance Research LLC; and Jon Lukomnik is Executive Director of the Investor Responsibility Center Institute (IRRCi). This post is based on an IRRCi publication authored by Professor Barrett.

As investors seek returns in non-traditional asset classes, some have turned to microcap public equity (defined here as companies with less than $300 million in market capitalization). Most of these companies are not included in major indices and many do not have analysts following them. Therefore, their governance practices have not received the same level of scrutiny as larger capitalization companies.

Despite microcap public companies’ importance in our capital markets, there is a paucity of studies examining their board composition and governance practices. This post provides insights into the current governance landscape in this asset class. Where available, comparisons are made to the boards of the companies included in the Russell 3000 Index.

Additionally, as calls increase for companies to have more diverse boards, a broader pool of director candidates must be considered. Larger capitalization companies’ boards often desire director candidates to have prior public company board experience in order to be considered for an open board seat. Directors serving on microcap company boards have boardroom experience, but may not have previously come to the attention of larger companies’ nominations and governance committees via traditional board searches. The complete publication provides an examination of the pool of these experienced directors from which larger company boards can draw.

Key Findings

Microcap Companies

The 160 microcap companies in the study were randomly selected to represent approximately 10% of all companies with less than $300 million in market capitalization which are traded on a major US stock exchange.

  • The length of time that a company has been in business provides context for understanding a company’s stage in its corporate life cycle. Less than one-quarter (22%) of the microcap companies studied have been public for less than five years, and only 6% were founded within the last five years. These findings contradict the common wisdom that many microcap companies are early stage growth companies that have only recently accessed public capital.
  • In contrast to the notion that many small companies are founder led start-ups, only one in seven (14%) of the microcap CEOs studied are the founders of the companies they lead.
  • Although the microcap companies studied are likely to have at least 10% of their stock owned by insiders, very few (4%) have a majority shareholder (who owns 50% or more). In addition, a multiple-class stock structure is not common among the microcap companies studied, with 93% having a one-share, one-vote structure.

Microcap Board Composition

  • Microcap company boards tend to be smaller than boards of companies in the broader Russell 3000 Index. Most Russell 3000 boards have at least nine members, while fewer than one in five (18%) of the microcap boards are that large. Very small boards, with four or fewer directors, are much more likely to be found at microcap companies. One in ten (10%) of the microcap boards studied have such small boards.
  • Men dominate the boardrooms of microcap companies even more so than those of the Russell 3000 companies. The majority (61%) of the microcap companies studied have no female directors serving on their boards, compared to less than one- quarter (21%) of the Russell 3000 boards. Furthermore, only 12% of the microcap companies have more than one female director, while nearly half (45%) of the Russell 3000 companies have more than one female director.
  • Microcap directors may have less boardroom experience than their counterparts at larger companies. Only 17% of the microcap directors currently serve on the boards of other publicly-traded companies, compared to 35% of the Russell 3000 directors.

Microcap Board Practices

  • Microcap companies tend to have less independent board leadership structures. Although microcap companies are just as likely to have separated the roles of CEO and Board Chair as companies in the Russell 3000 Index, many microcap boards do not have an independent chair or lead director serving as the leader of the board. Among those microcap companies which have combined the roles of CEO and Board Chair, most (70%) have not named a lead director. In fact, many of the microcap companies studied state explicitly that they do not have a lead director and have chosen to not do so intentionally.
  • Microcap boards tend to have more variability in the number of board meetings held than do larger companies. More microcap boards (24%) held 12 or more meetings in 2016 compared to Russell 3000 companies (17%). The microcaps were also more likely (5%) than Russell 3000 boards 2%) to have held fewer than four meetings that year.
  • The committee structures in place at microcap boards tend to be less complex than those of larger company boards. While the microcap boards studied are just as likely to have the three key committees (Audit, Compensation, and Nominating/ Governance) as the Russell 3000 boards, they are less likely to have additional committees. Furthermore, many microcap board committees meet only once a year, and some reported holding no meetings during 2016.
  • Director elections at microcap companies happen about as frequently as those at larger companies, but their election standards differ. The prevalence of classified boards is similar among microcap and Russell 3000 companies. While the majority (54%) of Russell 3000 companies have adopted a majority standard for director elections, only 11% of microcap companies have done so. However, microcap companies do not escape negative shareholders votes: three of the microcap companies studied had directors who failed to receive support from a majority of the votes cast at their 2017 annual meetings.

Microcap CEOs

  • Despite less scrutiny from the investment community, microcap CEO tenure does not differ significantly from the tenure of CEOs of Russell 3000 companies. The average tenure of a Russell 3000 CEO is 10.3 years and the median tenure of these CEOs is 7.3 years, compared to 10.7 years and 7.0 years for the microcap CEOs.
  • However, CEO compensation is still under scrutiny at microcap companies. Three microcap companies failed to receive support from a majority of the votes cast at their 2017 annual meetings.

Microcap Director Compensation

  • Microcap companies pay their directors much less than Russell 3000 companies. At the median, the total amount spent on board compensation by Russell 3000 companies in 2016 was nearly $1.4 million, compared to about $425,000 spent by the microcap companies. Likewise, the average microcap director receives significantly less in director compensation than a Russell 3000 company director. At the median, the average individual director serving on a Russell 3000 company board received nearly $180,000 in 2016, while the average microcap director received just under $75,000.
  • The nature of equity awards granted to directors vary based on company size. While nearly half (46%) of the microcap companies which grant equity-based awards to their directors awarded stock options in 2016, only 13% of the Russell 3000 companies did so. On the other hand, Russell 3000 companies are much more likely to award restricted stock or RSUs to their directors.
  • While stock ownership guidelines for directors are a common practice among larger companies, fewer than one in five (16%) of the microcap companies studied reported having stock ownership guidelines in their proxy statements.

The complete publication is available here.

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