In the UK, the debate about corporate governance has been running since the Cadbury Code of 1992. Since those early days, a number of corporate scandals have provoked various revisions of the code. The latest iteration has just been issued in July 2018 by the Financial Reporting Council (FRC). There is no requirement to follow the Code, but the Code operates a principle of “comply or explain”. This is clearly rather more dirigiste than just leaving companies to decide whether to follow it or not, though there is only one mention of compliance throughout.
There are five elements of the revised Corporate Governance Code, with related principles. All are ones which should form part of the overall system of governance of a company, but there are others, some elements of the Code do not sit well with each other, and other areas are omitted entirely. Let’s take a look:
1. Board Leadership and Company Purpose
A. A successful company is led by an effective and entrepreneurial board, whose role is to promote the long-term sustainable success of the company, generating value for shareholders and contributing to wider society.
B. The board should establish the company’s purpose, values and strategy, and satisfy itself that these and its culture are aligned. All directors must act with integrity, lead by example and promote the desired culture.
C. The board should ensure that the necessary resources are in place for the company to meet its objectives and measure performance against them. The board should also establish a framework of prudent and effective controls, which enable risk to be assessed and managed.
D. In order for the company to meet its responsibilities to shareholders and stakeholders, the board should ensure effective engagement with, and encourage participation from, these parties.
E. The board should ensure that workforce policies and practices are consistent with the company’s values and support its long-term sustainable success. The workforce should be able to raise any matters of concern.
The place to start is with the vision for the organisation and its rationale. It is extremely difficult to work out what to do effectively if the corporate destination is unknown. Start with “Why?” Once current and future locations are known, the company’s mission is far easier to set. The final part of setting a governance structure is culture. This is also vital from an intellectual property perspective. Whilst products and services can be copied, and values mimicked, culture is almost impossible to steal. Clarity on the above is the foundation upon which the other elements referred to can be built and operated.
2. Division of Responsibilities
F. The chair leads the board and is responsible for its overall effectiveness in directing the company. They should demonstrate objective judgement throughout their tenure and promote a culture of openness and debate. In addition, the chair facilitates constructive board relations and the effective contribution of all non-executive directors, and ensures that directors receive accurate, timely and clear information.
G. The board should include an appropriate combination of executive and non-executive (and, in particular, independent non-executive) directors, such that no one individual or small group of individuals dominates the board’s decision-making. There should be a clear division of responsibilities between the leadership of the board and the executive leadership of the company’s business.
H. Non-executive directors should have sufficient time to meet their board responsibilities. They should provide constructive challenge, strategic guidance, offer specialist advice and hold management to account.
I. The board, supported by the company secretary, should ensure that it has the policies, processes, information, time and resources it needs in order to function effectively and efficiently.
The best starting point for the above is to map an organigram of the organisation, both in its current state and future desired end state. Go through it to ensure all business functions are included. Next, check against all potential conflicts of interest, and assess ideal reporting lines, finally checking the balance between all elements and ensuring against a 50/50 lockout.
3. Composition, Succession and Evaluation
J. Appointments to the board should be subject to a formal, rigorous and transparent procedure, and an effective succession plan should be maintained for board and senior management. Both appointments and succession plans should be based on merit and objective criteria and, within this context, should promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths.
K. The board and its committees should have a combination of skills, experience and knowledge. Consideration should be given to the length of service of the board as a whole and membership regularly refreshed.
L. Annual evaluation of the board should consider its composition, diversity and how effectively members work together to achieve objectives. Individual evaluation should demonstrate whether each director continues to contribute effectively.
Diversity is an interesting topic. The assumption appears to be that diverse boards and organisations produce better decisions than those which are not so diverse. A word of warning, however, to avoid diversity for diversity’s sake. Ensuring that the necessary skills, knowledge and experience exist and work well together is one thing. Ending up with a Tower of Babel where the decision making process is mired in correctness and there is no effective organisational culture is quite another. Getting people who align with the culture will be more of a key to success. A warning on evaluation settings too, as these can take over a decision making process and heavily distort success. Make sure they are useful, and aligned with organisational culture.
4. Audit, Risk and Internal Control
M. The board should establish formal and transparent policies and procedures to ensure the independence and effectiveness of internal and external audit functions and satisfy itself on the integrity of financial and narrative statements.
N. The board should present a fair, balanced and understandable assessment of the company’s position and prospects.
O. The board should establish procedures to manage risk, oversee the internal control framework, and determine the nature and extent of the principal risks the company is willing to take in order to achieve its long-term strategic objectives.
Avoidance of bias and conflict is crucial, as indicated above. Yet this needs to be applied to other functions of the organisation than audit. Remember that risk is not necessarily a bad thing. No risk, no action. No action, no success. Carry out a benefit cost analysis, not a cost benefit analysis.
P. Remuneration policies and practices should be designed to support strategy and promote long-term sustainable success. Executive remuneration should be aligned to company purpose and values, and be clearly linked to the successful delivery of the company’s long-term strategy.
Q. A formal and transparent procedure for developing policy on executive remuneration and determining director and senior management remuneration should be established. No director should be involved in deciding their own remuneration outcome.
R. Directors should exercise independent judgement and discretion when authorising remuneration outcomes, taking account of company and individual performance, and wider circumstances.
This element has become highly politicised, essentially since remuneration multiples have increased as between the highest and lowest paid in organisations in recent years. What might be more useful is to avoid taking on the corporate “surfers”. These are easy to spot as they are the directors who move on every two years, are really only in it for themselves, almost guaranteed to be a drag on your organisation’s success, usually massaging results by cutting vital elements of the organisation’s services to improve profitability with no thought to the future (as they will be gone within two years anyway).
The latest version of the Code thus has some useful elements, but do not view them as comprehensive, and do not ignore the practicalities behind organisational success. It would be interesting to gain your views on the new Code and what has been set out above. Do not hesitate to get in touch!