Over the past few decades, corporate governance has shifted from the wings to a prominent, centre-stage position, evolving against a backdrop of increasingly global business, a growing number of scandals and the rise of public and investor concern.
The UK has been an important contributor to governance development, and rolled out its first corporate governance code in 1992 with the Cadbury Report at a time when scandals such as Polly Peck, the Bank of Credit and Commerce International, and the collapse of Robert Maxwell’s empire came to light. The code, and successive versions, set out the bedrock of best corporate practice and played a pivotal role in influencing governance across Europe.
In the past 15 years, the European Commission has become a driving force in raising the bar for corporate governance across EU member states, rolling out regulatory initiatives and reforms to ensure that companies are better run and shareholders more responsible. Its early measures also came in the wake of huge corporate scandals such as Enron in 2001, Parmalat in 2003, and the financial crisis in 2008.
“Corporate governance really took off in Europe when the European Commission became involved in 2003, with its first action plan on modernising company law and enhancing corporate governance in the Europe Union,” says Béatrice Richez-Baum—director general of ecoDa, the European Confederation of Directors’ Associations, which represents the views of 55,000 directors.
At the same time, national institutes of directors began to emerge, aiming to improve board professionalism and promote independent board members, she adds.
One of the early milestones in governance reform came into force in 2006, when the commission required listed companies in the EU to include a corporate governance statement on structures and practices in their annual reports to shareholders.
The 2017 revision of the Shareholder Rights Directive, which aims to boost responsible, long-term shareholder engagement, curb short-term excessive risk-taking, and give shareholders more rights such as the “say on pay” of directors, has shaken up governance standards further.
But the road to good governance is far from smooth. Compliance over the past decade or so has been patchy, and attempts to achieve consistent standards across 28 member states has been an uphill task—not least because of the disparity of standards and rules across Europe and insufficient monitoring.
“We have seen positive developments in corporate governance in Europe,” says a European Commission spokesperson.
“However, progress has not been equal and there is no clear tendency towards European common standards in many key areas yet. Corporate governance is also very much shaped by national, historical and cultural determinants such as [the] strong role of the state or [the] strong power of families.”
The UK has been a strong influence in EU governance policy, supporting national codes, corporate disclosure and a soft-law comply-or-explain approach, rather than a prescriptive EU federal code.
Over the past 25 years, governance has grown from being a narrowly defined focus on company financial reporting and accountability, to a much broader arc of corporate behaviour.
This has been driven by a number of critical issues and societal needs such as climate change, gender and inequality, human rights, and the threats of cybercrime.
Concern from institutional investors and the public about the effects of industry on the environment, and excessive executive pay for poor performance, have contributed to a widening of governance.
In spite of this wider scope and reforms to governance, though, scandals continue to break out across Europe, highlighting corporate governance failings. Volkswagen’s cheating on diesel emissions triggered outrage around the world. Over the past few years scandals have affected many other companies, including HSBC, Tesco, Rolls-Royce and GlaxoSmithKline.
Sweden, with its well-regarded Nordic model of corporate governance, has also seen examples of corporate misconduct.
Some academics and commentators believe that the corporate governance system needs a total overhaul to make it work.
“In Europe the corporate governance model is not effective,” says Professor Bob Garratt, a corporate governance expert, visiting professor at Cass Business School and author. He dislikes corporate governance codes and the overload of compliance from the European Commission.
“I can’t find a single corporate governance model that works well,” he adds. “Should it be supervisory and management or should there be executives and non-executives, or something else?”
The recent collapse of debt-laden Carillion, the listed construction and outsourcing company, has raised questions and scrutiny of the way the business has been run, pushing the need for governance further up the agenda. It also adds to the debate on what needs to be done to current governance models.
Professor Garratt believes the answer is to focus more on the duties of directors as they are set out in the 2006 UK Companies Act. These include ensuring the future health and success of the company, independence of thinking among directors, taking care, skill and diligence on board decisions, and declaring interests.
He puts forward a corporate governance framework that not just places more weight on directors doing their job responsibly and professionally, but also brings in regulators, legislators and, “in a time of great outrage”, a public oversight committee. Based on such an approach, he says he is “an optimist about how corporate governance will develop in the future around social capitalism that will include a social audit.”
There is no shortage of diverse views from shareholders, stakeholders, boards, regulators and non-governmental organisations on how to shape future corporate governance. Institutional investors, who have been stepping up pressure on companies to engage on governance issues from executive pay to transparency and sustainability, are keen for more change in governance.
A blend of reforms
At Aviva Investors, Mirza Baig, head of investment stewardship, would like to see “a blend of legislative and market-based reforms”. One area where he particularly wants to see change is in “the mismatch of time horizons between players”.
Boards discuss long-term sustainability but shy away from discussing this with investors, who cannot look beyond a 12-month or three-year-maximum horizon because of market pressure, Baig says. “There needs to be a more genuine conversation on long-term sustainable capital markets,” he adds.
The EU has recently moved ahead on this. At the end of January, the EU High-Level Expert Group on Sustainable Finance published its recommendations for a financial system that supports sustainable investments, and provides a roadmap for a greener and cleaner economy.
Promoting long-term investment perspectives and sustainable values is one of the priority policies identified by the ICGN (International Corporate Governance Network, the global network of institutional investors), which believes it is essential for effective future governance. George Dallas, policy director, says this is best achieved through changing investor thinking.
“It needs a mindset and behavioural change rather than legislation, and not allowing short-term perspectives to dominate.”
He believes that the key to achieving this change in thinking is to get institutional investors to provide better stewardship, a factor that is increasingly seen as part of shareholders’ responsibility. According to the ICGN, this should include a long-term perspective on markets and society, as well as investment horizons.
“Stewardship codes are a good starting place to achieve this in markets around the world,” says Dallas.
The Netherlands is currently taking steps to bring out a stewardship code. Following the Shareholder Rights Directive revision, Eumedion, the Dutch corporate governance forum for institutional investors, is poised to roll out the final version of the first Dutch stewardship code.
Evolving national codes
National governance codes, which often influence the wider EU governance framework, are also evolving. At the end of 2017, the Financial Reporting Council (FRC), the UK’s accountancy and corporate governance regulator, revised the non-mandatory governance code to make it “shorter and sharper and fit for purpose,” according to its chairman, Sir Win Bischoff.
The revision proposals give shareholders more power to contest excessive executive pay, require companies to consider wider stakeholders, such as employee views, and place more responsibility on boards to embed good culture.
Corporate culture is becoming a much bigger part of effective governance. “You can have the most successful strategy in the world but without a good corporate culture, it will be difficult to achieve the long-term success of the company,” says David Styles, director of corporate governance at the FRC.
There are expectations that corporate governance will gain more muscle in the next decade as investors become increasingly active on the voting front. Fiona Reynolds, managing director of the UN Principles for Responsible Investment, expects to see more investors voting against contentious issues put forward by boards.
“You see a lot of engagement around companies but when it comes to voting it seems to be more in line with management on issues such as pay,” she says. “Sometimes you have to send a strong signal. This is what companies need to sit up and take notice [of],” she says.
Change is clearly needed. In its 2017 Corporate Governance Review of FTSE 350 companies, Grant Thornton revealed that investor engagement continues to decline. Only a third provided informative insights of their engagement with shareholders, down from 64% in 2014; and just 12.5% of companies reported that they had face-to-face meetings with shareholders on executive pay.
Reynolds says there is also a need for investors to engage more with companies on new issues such as cybersecurity, and for boards to be better prepared with informed, transparent answers to their questions. In order to drive change on many issues, she believes regulation is needed.
“If you want to see change in corporate governance, then legislate,” says Reynolds. She points to the success of mandatory disclosure for companies in Europe, and mandatory quotas for women on boards in Norway.
Not everyone agrees that hard law is the answer. Lutgart Van den Berghe, director of the Belgian Governance Institute and extraordinary-professor at the University of Ghent and Vlerick Business School, says: “You can’t legislate for everything at EU level. Some flexibility is needed to tailor governance to the challenges companies face. It is about getting the right balance.”
She prefers to see better self-regulation and points to a growing trend in Belgium, where companies are pressuring peers to follow governance codes and improve practice. Van den Berghe hopes that such developments will help to rebuild trust in boards in the future.
In addition to toughening up the existing framework, governance must expand to tackle the challenges of new issues that companies now face, including cybersecurity and the shift to digital.
“Digitalisation is changing everything and we are all years behind in the way we do our business models,” says Suzanne Liljegren, communications advisor to ecoDa and a director at the Swedish Academy of Board Directors. “We risk throwing our business models out of the window unless we tackle this.
“If we don’t do something about this through self-regulation then the regulator will step in.”
Last year  cyber-criminals breached the data systems of Equifax, one of the biggest credit-checking groups, triggering an investigation by the UK’s Financial Conduct Authority and US regulators and prosecutors.
In the near future, Liljegren expects to see more employee representation on boards, since the issue has already been raised in the EU Parliament. Germany and Sweden already have this in place, and she expects EU institutions will take action at EU level.
The UK is also taking steps to deal with the issue. In its revised corporate governance code, companies are required to choose one of three ways to bring employee views into the workplace, including putting an employee on the board.
Views and policies differ considerably on how to improve governance, although there is little disagreement that more needs to be done. From an EU standpoint, the Commission would like to see a more even playing field in future governance.
“From shareholders’ and other stakeholders’ point of view it would be desirable to ensure that the level of corporate governance is the same across the EU,” says a European Commission spokesperson. “We want key elements of corporate governance agreed on at the EU level to be applied consistently.”
In spite of the diverse opinions, approaches and compliance levels of the wide range of players, there is cautious optimism that governance is heading in the right direction. “We are not there yet but moving there…” says Aviva Investors’ Baig. “There are positive developments but [we are] a long way off sustainable corporate governance in companies.”
Boards are still far from being perfectly run, but as the corporate governance framework sharpens up to become fit for purpose, it has—more than ever—become a driving force in business.
EU governance timeline
2006 EU Directive on accounts and corporate governance
This directive required all listed companies in the European Union to publish a “corporate governance statement” providing information about policies “actually” applied. It also called for companies to report on an analysis of “environmental and social aspects necessary for an understanding of the company’s development, performance and position”.
2007 Shareholder Rights Directive
Minimal requirements for shareholder meetings in the EU were set out under this directive.
2014 EU Non-Financial Reporting Directive
This offered guidelines on reporting measures to protect the environment, treatment of employees and human rights, anti-corruption and bribery policies.
2016 EU High-Level Expert Group on Sustainable Finance
Established to find ways to encourage capital to back sustainable investments, the group is also looking at protecting the financial system from environmental shocks and encourage financial institutions to do likewise.
2017 Revised Shareholder Rights Directive
Gives shareholders the right to binding votes on executive remuneration. The directive also places responsibilities on institutional investors to reveal how they invest.