A new corporate governance regime beckons

Tighter regulation and the need for companies to have a purpose wider than a mere commitment to making money have been key business themes in the decade since the 2008 financial crisis. Now they are being combined by the Financial Reporting Council (FRC) in a revised UK Corporate Governance Code placing much more stress on company culture and the roles of executives in shaping and leading it. It’s a development which might leave some communicators groaning about more red tape.

However, the revised UK Corporate Governance Code is a reality, taking effect in financial years beginning after 1 January 2019.

First published in 1992 by the Cadbury Committee, the Code originally defined corporate governance as the ‘system by which companies are directed and controlled’, with shareholders appointing boards and auditors and satisfying themselves that appropriate governance was in place.

The preface to the Code’s latest version states that this remains true today. However, the FRC argues that the environment in which companies, their investors and wider stakeholders operate is developing rapidly. In return for recognition that successful and sustainable businesses underpin the economy and society by providing employment and creating prosperity, companies now must build and maintain successful relationships with a wide range of stakeholders, not just investors.

To succeed and endure, the FRC says such relationships need to be based on respect, trust, and mutual benefit. And to engender those qualities, a company’s culture should promote integrity and openness, value diversity and be responsive to the views of all stakeholders. So, what is new in the revised Code?

Its main new provisions are that Boards now need to disclose how they have engaged with employees and wider stakeholders and how the interests of such groups have influenced board decision-making. Companies will have to state what methods they use to give the workforce a voice on the board, whether this involves a worker-director, an employee advisory panel or a non-executive director.

Where other mechanisms are in place, the board will have to explain why it considers these to be effective. Companies will also be expected to specify their broader social purpose beyond financial performance and demonstrate how their cultures are aligned with company purpose, values, and strategies.

Private companies will not escape the new regulatory net. Laid before Parliament in June, The Companies (Miscellaneous Reporting) Regulations 2018 will be augmented next month by publication for consultation of the Wates Corporate Governance Principles and Guidance for Large Private Companies.

All UK private companies with more than 250 employees will need to explain in the annual directors’ report how directors have engaged with employees and have shown regard to their interests. Companies must also state the effects of that regard, including the effects on the principal decisions made in the relevant financial year.

All this may sound like an administrative and compliance nightmare, but the wording of both public and private regimes is intended to tighten the net of accountability and force directors to go on the record, addressing who their company is being run for, how it is benefiting them and other stakeholders and how it is engaging with employees.

A decade or so ago, such questions were easily deflected by reference to the mantra of shareholder value: the notion that companies exist primarily to give a financial return to those who own and fund their development. Yet, the financial crisis of 2008, with its huge write-offs and corporate wreckage, demonstrated how much value was being destroyed in this pursuit.

Professor David Grayson, head of the Doughty Centre at Cranfield University, says: ‘The idea that the purpose of business is solely to maximise shareholder value has been insidious. On the contrary, it is up to each business to do the serious work to define for themselves What is our purpose?’

Sallie Pilot, chief insight and engagement officer at stakeholder communication company Black Sun, believes the new Code’s emphasis on purpose reflects what is already happening in the corporate area. Black Sun’s research shows that 66 per cent of UK listed companies set out their purpose in their annual report this year, compared to 27 per cent two years ago.

Pilot explains: ‘Companies are starting to think about purpose as the lens through which they prioritise, operate and plan, and also as a compass to guide strategic analysis and decision-making.’ The new Code has been widely welcomed by employer organisations. The Confederation of British Industry believes many firms will specify employees as their most important stakeholders and views this new emphasis as ‘helpful’.

The Investor Relations Society is also a strong supporter, arguing that the revised corporate governance code and the FRC’s updated stewardship code, which is about to go through a consultation process, are both vitally important in well-functioning equity markets.

Chief executive Gary Davies says the Code promotes the need for ‘greater alignment and engagement’ between investors and companies and signals the importance of the role of investors in wider society. It is also hard to find public statements disputing the new order from anyone in the investment community since Larry Fink, chairman and chief executive of BlackRock, the world’s largest asset manager, wrote to the bosses of the world’s biggest companies in January.

Headed A Sense of Purpose, his letter stated that the disparity between capital-rich companies and individuals and people at the bottom of the financial food chain is now ‘a major source of the anxiety and polarisation that we see across the world’.

‘To prosper over time, every company must not only deliver financial performance but also show how it makes a positive contribution to society,’ wrote Fink. ‘Companies must ultimately benefit all of their stakeholders.’

John O’Brien, European partner at One Hundred, Omnicom’s ethical purpose consortium, believes Fink’s intervention has been a game-changer for companies, investors and regulators.

Companies are starting to think about purpose as the lens through which they prioritise, operate and plan, and also as a compass to guide strategic analysis and decision-making

‘The real strength of this message came not just in its meaning but in who said it,’ he states. ‘Fink and BlackRock have set the level of expectation for what must be the minimum standard that any investor and society at large should be looking for.’

Another believer in the new reality is David Scott, founder and chairman of LGT Vestra, a wealth management firm set up in 2008 with 72 former staff of Swiss investment bank UBS. He explains: ‘Our aim is to create long term value for our four stakeholders: clients, employees, society, and the owners as we believe there will be mutual benefit in pursuing such a strategy compared to a focus on just one group.

‘I believe that a Board should report on how it delivers this in practice and the various points in the new Code go some way to delivering this. A focus on the wider stakeholder community ultimately creates a better and more sustainable business in the long-term. Anything that reduces the excessive short-term focus in the quoted sector is a benefit to everyone.’

So, what will the new regime mean in practice? The main controversy is that the new system will be self-policing. As with the existing Code, companies will either have to comply with it or explain why they are not doing so. While, the Code welcomes good employee engagement, it does not set out an external system for regulating or measuring that, even if it was deemed to be possible.

‘If companies want to ignore some, or even all of it, they are at liberty to do so,’ says James Moore, chief business commentator at The Independent. ‘All it takes is a note in the annual report.

‘It’s a bit like the police saying you can get away with burgling someone’s house if you just say why you think it’s necessary for you to do so.’

Companies are starting to think about purpose as the lens through which they prioritise, operate and plan, and also as a compass to guide strategic analysis and decision-making

The new Code also shies away from Prime Minister Theresa May’s vow two years ago to force companies to put workers on their boards, as is the case in much of Europe. May later backtracked on the pledge. The revised Code may herald a greater role for work councils, which have sometimes been viewed with suspicion by major corporates.

Yet, it is difficult to find a major company that has embraced them after the Code’s publication. All this led Trades Union Congress general secretary Frances O’Grady to proclaim that the FRC’s reforms are ‘a step in the right direction but they are not the shake-up of corporate Britain that Theresa May promised and the country needs’.

Commentators do expect a change in how companies organise themselves and divide up responsibility for their new obligations, however. ‘As company purpose and stakeholder engagement takes a more central role, we are seeing greater collaboration between the role of investor relations and other corporate roles, including the company secretary, human resources and internal communications,’ says Davies.

‘Over time, as these corporate governance code reforms take effect, we will see more engagement from investor relations in wider stakeholder communications.’ For communicators, meanwhile, a key question is what they will need to do differently.

‘Clear and concise communication is key and the new requirement should not result in adding layer upon layer of information, hindering effective communication,‘ says Samantha Trillwood, corporate communications analyst at consultancy Emperor.

She advises companies embedding the new Code to ensure that corporate information is understandable and engaging. There should be a clear and compelling narrative, discussing the organisation’s purpose, culture and values and the tone should be set from the very top, with personal messages from business leaders.

Case studies should be used where possible to provide examples of how the board is engaging with stakeholders and demonstrate its governance in action, while diagrams can provide greater insight into company processes, such as showing how diversity is considered in succession planning.

The key, says Trillwood, is to be able to link the governance and strategic reports, so it is clear how the board has performed its duty to promote the company’s long-term success. Pilot also believes that companies need to communicate their purpose journeys better.

‘Despite the progress that has been made, companies could do a bit more in telling an authentic story that truly communicates their distinctiveness and value creation in a way that builds trust with investors and other stakeholders,’ she says.

‘It is a challenge but effectively communicating with investors and wider stakeholder groups today require messages that are clearer and more consistent than ever before.’ The best way to judge the new Code, however, will be whether it proves any better than the last one at preventing corporate scandals.

Here, the recent track record is poor. As O’Brien points out, a key weakness has been that companies exposed by scandals such as those at Volkswagen, Barclays and Enron, have demonstrated excellent corporate social responsibility credentials. ‘The problem is that these companies had CSR initiatives sitting on the periphery of corporate leadership,’ he says. ‘The challenge is to put them at the centre. It will not be long before the new Code faces its first test.’