The Impact of Corporate Governance on the Performance of U.S. Small-Cap Firms

Abstract

Small-cap firms provide a significant nexus for entrepreneurship and innovation in the U.S., and hence might be viewed as less prone to governance problems than large firms. This paper tests this assertion, allowing for interactions between internal and external governance mechanisms and performance. Significant interactions between board independence, firm leverage, CEO ownership, and pay-performance sensitivity are observed. The results support the paradigm of entrepreneurial CEO’s whose ownership in such firms is optimally aligned with performance. Some suboptimal deployment of governance mechanisms is observed for the sample as a whole. In particular, excess leverage which significantly reduces firm value is observed. This is consistent with the view that debt reduces the entrepreneurial capacity of firms, by hindering the firm’s ability or willingness to compete aggressively, particularly against well-financed competitors. Larger board sizes are detrimental to performance. Pay-for performance compensation for CEOs, on the other hand is beneficial for small-cap firm performance. While Sarbanes-Oxley Act compliance may be difficult for many of these firms, its passage does not adversely affect their performance.

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