On the 16th July, the FRC launched the latest version of the UK Corporate Governance Code. In the 26 years since it was published, its various iterations have been lauded for boosting transparency and gaining insight into the behaviour and performance of company boards.
When investing in a business, or continuing to, it is imperative to consider whether the board is capable of fulfilling its responsibilities. You must also be sure that it sets the standard of behaviour for the rest of the business, and that this is instilled and seen at all levels.
Governance reporting should effectively demonstrate the way the board operates, but in reality, corporate governance reports don’t always provide sufficient clarity to understand how a business is being run.
Too often we have seen examples of catastrophic business failures as a result of poor corporate governance. We’re forced to ask whether transparency and good governance have really been prevalent in the past 25 years, and more importantly, why these failures went unchecked and so ineffectively managed.
The updated Code comes into force in January 2019 and is principles-based. In its own words, it broadens the definition of governance and emphasises the importance of:
- Positive relationships between companies, shareholders and stakeholders
- A clear purpose and strategy aligned with healthy corporate culture
- High-quality board composition and diversity
- Remuneration which is proportionate and supports long-term success.
It is significantly shorter than its predecessor and offers flexibility for issuers to truly reflect their governance culture over and above tick-box regulation. With that said, there are some specific demands, especially around workforce representation and influence on Board discussions and Board evaluation, Chairman tenureship and more clarity around remuneration.
To celebrate the 25th anniversary of the Code last year the ICSA asked a selected group of commentators to provide a view of its success. The article I wrote challenged whether it had actually been successful, looking at multiple corporate failures over the past 25 years.
So, revisiting these, can we see the new Code answering some of the fundamental issues that caused some of the UK's largest corporate failures?
In 1995, Nick Leeson – a department lead at Barings Bank – was trading futures, signing off on his own accounts and plummeting the bank into debt which ultimately lost it £827 million.
The bank’s London board of directors were deemed unfit to run a company and disqualified as a result of allowing Leeson to settle his own trades, with little to no governance leadership. Leeson claimed that this lack of oversight and risk management was as much to blame as his own actions.
One of the new Code’s biggest changes is ensuring the Board engages effectively with its workforce through one or a combination of the following methods:
- A director appointed from the workforce;
- A formal workforce advisory panel;
- A designated non-executive director.
If the Board has not chosen one or more of these methods, it should explain what alternative arrangements are in place and why they are equally as effective.
This change in the Code is laudable – if not slightly watered down from the original green paper – and encourages a more explicit link between the Board and its workforce. A better understanding of what is driving employee culture should allow the Board to recognise failings and influence positive and ethical practices.
MG Rover Group
An analysis of MG Rover’s collapse by Cambridge-MIT, entitled ‘Who killed MG Rover?’ said: ‘Its decline from the 1960s was because of a range of ignored factors: an ill-conceived product strategy, a failure to integrate various elements of the business, multiple ownership changes and a lack of capability to develop new products for key markets.’
Instead of a failure on one management team’s part, it was the failure to address serious issues facing the company by its various owners which eventually caused it to collapse. They attempted to paper over the cracks, which had started to form over 50 years prior to its administration in 2005.
The question of whether the business was fit-for-purpose was never sufficiently challenged.
The new Code re-emphasises the importance of independence and the constructive challenge of the Boardroom, and clear succession planning. Much of MG Rover’s failings were down to an ‘over closeness’ of the management team. A more effective and independent view could have identified the lack of innovation and development across the group, and maybe a very different Rover group would exist today.
The financial crisis could have been avoided had it not been for the complexity of financial instruments overtaking the ability of boards to govern their businesses effectively.
Board evaluation has existed in the Code for some time, but the new version is encouraging higher quality external evaluations, emphasising the evaluators’ direct contact with the Board and individual directors. Ultimately, the point of evaluation is to ensure the Board is fit-for-purpose with the correct skills and experience to run the business. The financial crisis was caused by management not truly understanding the changing environment in which they were operating. While financial success was the norm, the need to tighten governance was either overlooked or, even worse, ignored. Hopefully, more effective evaluation will help avoid similar ineffective Board structures.
An article looking at corporate failure cannot ignore Carillion. It is the example of our time, how corporate culture and governance failed to the detriment of thousands of jobs. This is not really an example of a Code failure, more an example of a lack of a code or culture at board and management level. It is also a clear example of how audit and external evaluation fundamentally failed in their duties.
All of the examples above demonstrate fundamental faults in the approach to governance, culture and evaluation. I believe the new Code’s principles and priorities attempt to provide a structure that will avoid these failings. Ultimately it is down to boards and management to recognise these principles as the fundamentals of a strong culture and effective governance.
A code is a code. It is guidance, not regulation, but I truly hope businesses recognise the power of its principles and apply them effectively to create long-term success for their stakeholders. And let’s hope investors call out companies to raise the standard.
Brett Simnett, Senior Investor Engagement Consultant