There is growing concern about the efficacy of corporate governance.
Conceived in the early 1990s as a system to prevent financial wrongdoing, it has evolved into a system whose stated purpose in the introduction to the UK Corporate Governance Code is “to facilitate effective, entrepreneurial and prudent management that can deliver the long-term success of the company”.
The introduction goes on to say that “corporate governance is about what the board of the company does and how it sets the values of the company”.
Given the failure of several banks in 2008 and the litany of scandals since, such as mis-selling, money laundering and Tesco’s accounting, it is difficult to argue that the code is achieving its purpose or ensuring companies operate with suitable values. A change of emphasis is needed.
Curiously at least one board of a failed bank did not associate its demise with governance. The UK Parliamentary Commission on Banking Standards in 2013 into the failure of HBOS was surprised to learn that the board thought it was doing an excellent job of governance. The Commission dryly concluded: “We are shocked and surprised that, even after the ship has run aground, so many of those who were on the bridge still seem so keen to congratulate themselves on their collective navigational skills.”
Neither, it seems, did regulators associate governance with bank failure. The Financial Services Authority (FSA) concluded in December 2010, in its first inquiry into the failure of RBS, that there was no evidence of governance failure on the part of the board. An FSA review also assessed the governance of Barclays Bank as “best in class” while LIBOR rigging was taking place.
Good governance is much more than compliance with the code. It is about ensuring a successful and sustainable business that satisfies the ethical standards of society.
The code’s preface highlights the importance of ethics and the board ensuring the right culture: “One of the key roles for the board includes establishing the culture, values and ethics of the company. It is important that the board sets the correct ‘tone from the top’.
“The directors should lead by example and ensure that good standards of behaviour permeate throughout all levels of the organisation. This will help prevent misconduct, unethical practices and support the delivery of long-term success.”
So the beginning of the code says the right things. Unfortunately there is not enough follow-through in the rest of the Code. The principles start promisingly though. The first main principle (A1) says: “Every company should be headed by an effective board which is collectively responsible for the long-term success of the company”. This is followed by two supporting principles:
(i) “The board’s role is to provide entrepreneurial leadership of the company within a framework of prudent and effective controls which enables risk to be assessed and managed. The board should set the company’s strategic aims, ensure that the necessary financial and human resources are in place for the company to meet its objectives and review management performance. The board should set the company’s values and standards and ensure that its obligations to its shareholders and others are understood and met.”
(ii) “All directors must act in what they consider to be the best interests of the company, consistent with their statutory duties.”
These principles are the essence of corporate governance. Boards that apply them well will have good governance and most of the remaining principles and provisions should be redundant.
The Listing Rules require companies to state how they have applied the main principles. The Comply or Explain section of the code emphasises the importance of the principles saying: “The principles are the core of the code and the way in which they are applied should be the central question for a board as it determines how it is to operate according to the code.”
There is though no requirement for boards to disclose how they apply these supporting principles, and company reports on how the main principles have been applied tend to be superficial. The focus instead is on disclosure of whether or not companies comply with the code provisions and on 26 disclosure requirements in Schedule B.
There is no requirement for companies to say anything about culture, ethics or values even though they are precisely the things the beginning of the code says are most important. This should be corrected. Recent developments at Volkswagen highlight the importance of having a sound ethical culture. UK boards should be wondering if they too have any ticking time bombs in their own companies.
The FRC is about to review the code again: it should make sure the disclosure requirements reflect the importance of ethics, values and culture. This could be achieved by adding a provision to Section A saying: “The annual report should include a statement of how the board sets the values and standards of the company and ensures that the culture throughout the company reflects these values and standards.”
To ensure that appropriate values and standards are reflected in the culture will require careful assessment. It will require an understanding of what sort of values and standards are best for the company. What might be a good culture for one part of the company may not be appropriate in another part of it, therefore boards will need to satisfy themselves they have appropriate sub-cultures throughout their companies. How to do this will be the subject of another article.
If you look at the 26 disclosure requirements you may struggle to see how many of them relate to whether or not a company will be successful. Only six of them really bear on whether the board is doing a good job. The rest are about structural and process matters such as meetings, details of directors and consultants and workings of committees. There must be scope for pruning.
The code would be more effective in achieving its stated purpose if it put greater emphasis on companies giving qualitative disclosures on ethics and values and of how they apply the first main principle and its supporting principles.
Paul Moxey is visiting professor of corporate governance at London South Bank University and chairman, since 2000, of the CRSA Forum, a network of practitioners established in 1994 for advancing good practice in the behavioural and cultural aspects of risk, governance and organisational performance.