David F. Larcker is James Irvin Miller Professor of Accounting at Stanford Graduate School of Business and Brian Tayan is a Researcher with the Corporate Governance Research Initiative at Stanford Graduate School of Business. This post is based on a recent paper by Professor Larcker and Mr. Tayan.
We recently published a paper on SSRN, Scaling Up: The Implementation of Corporate Governance in Pre-IPO Companies, that examines the process by which startup companies implement corporate governance systems.
An effective system of corporate governance is considered critical to the proper oversight of companies. While companies are required to have a reliable corporate governance system in place at the time of IPO, relatively little is known about the process by which they implement it.
At its founding, a typical private company lacks many, if not all, of the features that will later be required by regulatory authorities. The board of directors is composed primarily of insiders—founders, investors, managers—and usually has no directors who meet the independence standards of the New York Stock Exchange and NASDAQ. Financial statements may be subject to an external audit but are usually not prepared in accordance with generally accepted accounting principles (GAAP). Financial reporting systems lack many of the controls necessary to comply with the Sarbanes-Oxley Act of 2002. Compensation contracts are dominated by equity awards and milestone-based payouts whose amounts are not justified in an annual proxy or explained in light of the company’s compensation philosophy, pay objectives, or the peer-group analysis that public companies are required to disclose. And yet, by the time companies go public, they have in place fully established (if not fully matured) systems of corporate governance.
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