Introduction
MSMEs, an acronym for Micro, small and medium enterprises, play a major role in the growth of the economy. They are the backbone of developing countries. As growth engines, MSMEs contribute significantly to employment generation (particularly for the poor and marginalized groups), poverty alleviation, and rural development. The role of MSMEs in developing and emerging economies is well recognized. The United Nations General Assembly designated 27 June as “Micro, Small, and Medium-sized Enterprises Day” to recognize the contributions of micro, small, and medium-sized enterprises (MSMEs) in the achievement of the United Nations Sustainable Development Goals (SDGs). The rapid pace of globalization and liberalization has created numerous opportunities for MSMEs, both in the home market and in foreign markets.
Definition of MSME
There is no universal definition of MSMEs. Countries do not use the same definition for classifying their MSME sectors. The definition depends upon the purpose it is meant to serve.
The major parameters generally applied to define MSME include:
- Capital investment in plant and machinery.
- Volume of production or turnover of the business
- Number of workers employed.
The Government of India enacted the Micro, Small, and Medium Enterprises Development (MSMED) Act, 2006 on June 16, 2006. The Micro, Small and Medium Enterprises Development Act, 2006 defines the Micro, Small, and Medium Enterprises based on:
- Investment in plant and machinery for those engaged in fields of manufacturing or production, the processing/preservation of goods, and
- Investment in equipment for enterprises engaged in the provision or rendering of services.
However, under the Atma Nirbhar Bharat package on 13th May 2020, the government announced the revised classification of MSME. The new classification came into effect on 1st July 2020. It removed the distinction between manufacturing and service industries and inserted composite criteria for both investment and annual turnover. This was done to provide ease of doing business and to be realistic with time. The Central Government notified the following criteria for the classification of micro, small, and medium enterprises, namely:
- A micro enterprise, where the investment in Plant and Machinery or Equipment does not exceed one crore rupees and turnover does not exceed five crore rupees.
- A small enterprise, where the investment in Plant and Machinery or Equipment does not exceed ten crore rupees and turnover does not exceed fifty crore rupees.
- A medium enterprise, where the investment in Plant and Machinery or Equipment does not exceed fifty crore rupees and turnover does not exceed two hundred and fifty crore rupees.
The MSME registration in India is done through the government portal udyamregistration.gov.in. MSME registration process is fully online, paperless, and based on self-declaration.
Role of MSMEs
Indian Economy
In India, the MSME sector has gained significant importance due to its contribution to the Gross Domestic Product (GDP) of the country. MSMEs are playing a crucial role in providing employment opportunities and in the industrialization of rural and backward areas.
With over 63 million units throughout the geographical expanse of the country, MSMEs contribute around 6.11% of the manufacturing GDP and 24.63% of the GDP from service activities, and 33.4% of India’s manufacturing output.
According to the 2021 -22 Annual report – The micro sector with 630.52 lakh estimated enterprises accounts for more than 99% of the total estimated numbers of MSMEs. The small sector with 3.31 lakhs and the medium sector with 0.05 lakh estimated MSMEs accounted for 0.52% and 0.01% of the total estimated MSMEs, respectively. Out of the 633.88 estimated number of MSMEs, 324.88 lakhs MSMEs (51.25%) are in the rural area and 309 lakh MSMEs (48.75%) are in Urban areas.
The micro sector with 630.52 lakh estimated enterprises employs 1076.19 lakh persons. The small sector with 3.31 lakhs and the medium sector with 0.05 lakh estimated MSMEs employ 31.95 lakh and 1.75 lakh persons.
The below table shows the distribution of employment by type of Enterprises in Rural and Urban Areas
(Numbers in Lakhs)
| Sector | Micro | Small | Medium | Total | Share (%) |
| Rural | 489.30 | 7.88 | 0.60 | 497.78 | 45 |
| Urban | 586.88 | 24.06 | 1.16 | 612.10 | 55 |
| ALL | 1076.19 | 31.95 | 1.75 | 1109.89 | 100 |
World Economy
MSMEs represent about 90% of businesses and more than 50% of employment worldwide. Formal MSMEs contribute up to 40% of emerging economies’ national income (GDP). These numbers are significantly higher when informal SMEs are included. There are about 365-445 million MSMEs in emerging markets: 25-30 million are formal SMEs, 55-70 million are formal micro, and 285-345 million are informal enterprises.
Corporate Governance:
“If management is about running a business, governance is about seeing that it is run properly. All companies need governing as well as managing.”
Tricker 1984
The Organisation for Economic Co-operation and Development (OECD) describes Corporate Governance as follows: “Corporate governance involves a set of relationships between a company’s management, its board, its shareholders, and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.
The primary incentive for MSMEs to improve their governance practices is easy and increased access to cheaper financing options, as investors are more inclined to invest in companies/ businesses that follow good governance practices. The challenges that MSMEs face stem from the very nature of MSMEs. The most common challenges of MSMEs are decision making, strategic oversight, recruitment and retention of qualified management, and establishment of standardized internal control mechanisms and policies. A corporate Governance structure can provide a framework that can help MSMEs to address several challenges and to achieve long-term success for their stakeholders. Though corporate governance is not a panacea for all MSMEs’ problems, it is a necessary ingredient for their success.
Benefits of Corporate Governance
- Access to credit
One of the major obstacles to the growth of MSMEs is access to finance. The MSMEs borrowers, particularly the new generation entrepreneurs, do not have collaterals to offer to avail of bank finance. Entrepreneurs have to rely on internal/ personal funds to launch and initially run their businesses. An alternative source of finance is angel funds/risk capital. Good governance practices enable them to evaluate the risk exposure and to determine the proper value of shares. Investors aim to maximize returns and minimize risks, so investors understand the importance of corporate governance. Corporate Governance is a long-term process, so the sooner an MSME adopts good practices, the better it can reap the benefits of good governance.
- Internal control and Risk Governance
Corporate Governance describes how companies should be directed, controlled, and managed. It is about holding accountable those who are in direct control of management. Internal control is one of the important components of corporate governance. Internal control can be defined as policies or measures that allow MSME to detect errors or mistakes, prevent fraud and ensure reliable reporting of financial results. An internal control system consists of five elements: control environment, risk assessment, control activities, information and communication, and monitoring. The management sets standards, policies, processes, and structures that provide the basis for carrying internal control in an organization. An employee can understand management philosophy through understanding internal control. The role of internal control has expanded to managing key risks to company success.
Risk assessment involves an established formal process for identifying and evaluating risk in relation to the achievement of objectives. Successful entrepreneurs regularly perform risk analysis. The focus should be on both external and internal risks. For example, A small/ medium enterprise interested in becoming part of the supply chain of a large corporation must address the social and environmental sustainability risks.
MSME can establish control activities by defining line of responsibilities and respective authorities, implementing regular checks and reviews, making an accurate record of transactions, cross-checking and regular reconciliation of books and accounts, and limiting access to equipment and cash. Further, in MSMEs, related party transactions are not unusual. Under some circumstances, they can be useful to business, but unfortunately, they are also one of many ways to siphon money from a Company to enrich individual directors or managers at the expense of others. Therefore, the MSME should establish an explicit policy for dealing with related party transactions.
Communication is a continual process of providing, sharing, and obtaining information. Information and communication ensure that management obtains relevant, timely, and quality information for better decision-making and to support the other functions of internal control.
Monitoring activity is an ongoing evaluation to ascertain that each of the components of internal controls is adequate and functioning.
- Better management, transparency, and growth
Many MSME starts as sole proprietorship or partnership with or without family members. As the organization grows, other investors including professional investors join the organization. In the initial stage, the number of owners is small so managing a business is not a problem as they all run the business and have direct input in shaping the future of the business. The problem arises when the business becomes large and complex to the extent that those who are not initially involved in the business can lose the big picture of the business and strategic control of operations. Unlike founding members, the new owners do not have inside information about the company, and this lack of transparency can lead to trust issues. All these issues can be mitigated by establishing a proper governance code. A good governance practice helps in attracting and retaining external investors. These external investors are not only a source of capital but also a source of knowledge, connection, and expertise to enable companies to fully realize their growth potential.
- Attract and retain high-quality staff.
Good governance makes the organization more desirable for talented people. Eliminating the reason for job dissatisfaction is the first step in building a productive workforce. Corporate governance helps to establish practices that enable MSMEs to attract and retain high-quality staff. A few of such practices are listed below:
- Develop simple and effective means of communication with staff to communicate organization decisions, policies, and strategies.
- Document each position’s job description, including details of the qualities and qualifications required.
- Create a proper incentive system to attract and retain talented employees and motivate them to perform.
- Develop credible and transparent remuneration policies.
- Reputation enhancement
Compared to listed entities, unlisted entities are generally viewed with suspicion because of their low level of transparency. Good governance practices are important in gaining and boosting the confidence of stakeholders, such as creditors, suppliers, employees, and customers. Good governance practices give assurance to stakeholders, particularly external stakeholders, that the company is being run in a responsible manner.
Corporate Governance model for MSMEs
There is no universally approved standard model of corporate governance for MSMEs. However, there are sources of guidance that MSMEs can use to establish a good governance code for their organization. For example, corporate guidance and principles for unlisted companies in Europe (ecoDa 2010). Though the model was developed for European companies, its principles have relevance for businesses in other regions. EcoDa 2010 presents fourteen governance principles that are based on a dynamic stepwise process. This phased approach has been framed to fit the specific nature of a company in terms of size, complexity, and maturity. Two categories of corporate governance principles are proposed.
Phase 1 principles (principles 1-9) apply to all kinds of unlisted companies, regardless of size or level of complexity. Such principles are universal in their application and do not necessarily involve costly governance procedures.
Principle 1: Shareholders should establish an appropriate constitutional and governance framework for the company.
Principle 2: Every company should strive to establish an effective board, which is collectively responsible for the long-term success of the company, including the definition of the corporate strategy. However, an interim step on the road to an effective (and independent) board may be the creation of an advisory board.
Principle 3: The size and composition of the board should reflect the scale and complexity of the company’s activities.
Principle 4: The board should meet sufficiently regularly to discharge its duties and be supplied promptly with appropriate information.
Principle 5: Levels of remuneration should be sufficient to attract, retain, and motivate executives and nonexecutives of the quality required to run the company successfully.
Principle 6: The board is responsible for risk oversight and should maintain a sound system of internal control to safeguard shareholders’ investment and the company’s assets.
Principle 7: There should be a dialogue between the board and the shareholders based on a mutual understanding of objectives. The board has responsibility for ensuring that a satisfactory dialogue with shareholders takes place. The board should not forget that all shareholders have to be treated equally.
Principle 8: All directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge.
Principle 9: Family-controlled companies should establish family governance mechanisms that promote coordination and mutual understanding amongst family members, as well as organize the relationship between family governance and corporate governance.
Phase 2 principles (principles 10-14) are more sophisticated corporate governance measures that are relevant to larger or more complex unlisted companies, or enterprises with significant external financing. These principles should also be considered by unlisted companies that are planning for a future public listing.
Principle 10: There should be a clear division of responsibilities at the head of the company between the running of the board and the running of the company’s business. No one individual should have unfettered powers of decision.
Principle 11: Board structures vary according to national regulatory requirements and business norms. However, all boards should contain directors with a sufficient mix of competencies and experiences. No single person (or small group of individuals) should dominate the board’s decision-making.
Principle 12: The board should establish appropriate board committees to allow a more effective discharge of its duties.
Principle 13: The board should undertake a periodic appraisal of its performance and that of each director.
Principle 14: The board should present a balanced and understandable assessment of the company’s position and prospects for external stakeholders and establish a suitable program of stakeholder engagement.
Some code analyses how the core governance principles can be interpreted for small and medium enterprises (For example, IoDSA 2010). Some code considers the heterogeneity of enterprises and makes recommendations based on key characteristics of the organization, for example, HKIoD 2009.
Similar efforts have been made in other regions of the world, such as the corporate governance code for small and medium enterprises: Building the foundations for growth and sustainability in Dubai (SME Dubai and Hawkamah); Agenda for Improving the Corporate Governance of Unlisted Companies (Finland), Chamber of Commerce, April 2016; SME Governance Guidebook, International Finance Corporation, 2019.
Conclusion
MSMEs play an instrumental role in economic development. They are the growth engines of an economy. Thus, the establishment and promotion of MSMEs across the globe have assumed strategic importance. The established framework of corporate governance applicable to listed companies may not reflect the heterogeneous nature of MSMEs. However, MSMEs can replicate some of the good governance practices suitable to their organization. This level of self-discipline is vital for the strategic development of MSMEs. It must be noted that Corporate Governance is not an end but a means to achieve results. A good governance practice will lead to better decision-making and long-term growth of the MSMEs.
References:
https://msme.gov.in/sites/default/files/MSME_gazette_of_india.pdf
https://msme.gov.in/annual-report-2021-22
https://ecoda.eu/corporate-governance-guidance-for-unlisted-companies-in-europe/
