The future direction of corporate governance – “Something must be done”

09 / 01 / 2017

We live in a time of transition. Old assumptions and alliances are being challenged. Calm, reasoned, rational debate is lost in the cacophony. British politicians state the case that “action is needed” to improve the legitimacy of business, to repair trust between business and society and to improve the state of corporate governance.

The parliamentary Business, Innovations and Skills Select Committee and the Department for Business, Energy & Industrial Strategy have been stepping on the toes of each other to demonstrate leadership.  The latest initiative is Greg Clarke’s (the new Secretary of State for Business, Energy & Industrial Strategy) and the Prime Minister’s recent Green Paper on Corporate Governance Reform (the CG Green Paper).

Much of the progression of the governance and transparency agenda over the last 10 years has arisen from the misdemeanours (and perceived misdemeanours) of three sectors: finance, the press and elected officials.  The challenge that well-governed companies face is that they become burdened by measures put in place to appease for the transgressions of the few. Excessive obligations do not deliver shareholder value, but they effectively form part of the cost of doing business.

What is wrong with the manner in which companies are governed and controlled today and the way in which directors make decisions? The sorry demise of BHS with a notable pension scheme deficit haunts the current debate, whilst the closed up doorways of its now empty stores haunt many of our high streets. If there is a problem with the law, it is for parliament to act to change the law, not to criticise business for their application of the law as determined by parliament.

Corporate governance is the body of behaviours, practices and structures which a company puts in place beyond that which is required by law.  It is, by its nature, a choice.

The CG Green Paper evidences that the Government recognises the broad canon of industry-led initiatives already in circulation (much of which already sits on the shelves of the House of Commons library). However, it also swiftly becomes apparent that senior ministers have not taken the time to read those publications and have failed to engage with companies and understand what actually happens in business. This appears to be both short-sighted and discourteous.  That stated, Greg Clarke asserts the determination of the Government to “make Britain one of the best places to work in the world” and the CG Green Paper does state that the Government believes businesses to be a force for good in society.

The key proposals of the CG Green Paper

The CG Green Paper focusses on three core areas:

  • further measures to restrict executive pay awards;
  • improving the stakeholder voice; and
  • whether mandatory corporate governance standards should be applied to non-listed companies.

The answers to any of these issues are not simple. However, we will seek to set out our high level views:

1.

Further measures to restrict executive pay awards

A comprehensive package of measures was put in place to address executive pay in 2013.  The 2013 regime has not yet fully worked through the system.  Whilst we think that there is some inevitability of an annual binding vote on pay awards for executives, we think that it would be best to allow the 2013 reforms to work through the system.

2.

Improving the stakeholder voice

The objective is laudable, but the Government seems to fail to appreciate than any director worth his or her salt will already be considering wider stakeholder issues and listening to appropriate internal or external voices.

3.

Whether mandatory corporate governance standards should be applied to non-listed companies

We believe that this would be very difficult and problematic for a number of reasons:

  • the FRC’s Corporate Governance Code is structurally focussed on listed companies and many provisions simply would not work in a private company context;
  • due to the agency deficit, corporate governance only really becomes relevant when the manager is not also the owner and if the company is not exposing third parties to risk, why should it be subject to additional rules; and
  • the whole point of corporate governance is that is represents an option for companies to comply or explain rather than be a mandatory requirement, often one learns the most from disclosures of non-compliance rather than textbook compliance.

How should business respond in today’s febrile climate?

Notwithstanding the apparent lack of understanding from Government, a business of whatever size which fails to engage in the current governance debate does so at its peril. There is a clear perception that the trust which exists between a company and its stakeholders (the most important of which are the members) has been eroded.  An erosion of trust is unhealthy for society.

Companies need to accept that they must respond positively to calls to improve the agency deficit and rebuild trust between companies (represented by their fiduciary managers (directors)) and the shareholders.  The interests of other stakeholders also need to be taken into account, as appropriate, from time to time. The board of directors of each company needs to take time to identify who its stakeholders are and the extent to which the interests of those stakeholders form part of the corporate strategy of the business.

At present, larger companies need to deliver detailed reporting of supply chain issue, environmental impact, treatment of suppliers, etc.  However, other than not taking action to harm their own interest, smaller companies do not need to do this and one SME can mistreat its SME supplier with a high level of impunity.  This cannot be right, but we have had a succession of moves to reduce corporate reporting by SMEs and to increase reporting by larger companies.

What we really need is corporate reporting which is better focussed and proportionate. A company which seeks to swim against the tide of political mood may struggle, but each company does need to make a powerful case to the politicians to ensure that political intervention is supportive and not destructive, focussing on highlighting good governance and not interfering with excessive regulation. In short, companies need to be bold about corporate governance.

The Government is always keen to receive the direct views of businesses, not just the advisory community.  Whilst we will be contributing to a number of industry responses, more weight will be added if you also respond to the CG Green Paper, which remains open for comment until 17 February 2017 by sending your comments to corporategoverance@beis.gov.uk.

The consultation itself is available here https://www.gov.uk/government/consultations/corporate-governance-reform.

For further information please contact Edward Craft at ecraft@wedlakebell.com.