It's more than ticking boxes Article icon

It's Oliver Parry, head of corporate governance at the Institute of Directors, on the findings from its annual report 

Oliver Parry has had a busy week when we sit down to meet on a Friday afternoon. The head of corporate governance at the Institute of Directors has thrown the proverbial cat among the pigeons with the release of a new report The 2016 Good Governance Report that ranks British American Tobacco as the company within the FTSE 100 index that best demonstrates corporate governance.

Languishing at the bottom of the league table is supermarket group Tesco, still paying the price for its accounting scandal, just below homebuilders Berkeley Group and engineering company Rolls Royce. All pretty predictable, but a tobacco company at the top?

Indeed, such was the surprise at BAT’s ranking that one industry commentator highlighted the IoD in its weekly round up of bad PR.

Therein lies the problem. There may be a fine line between them, but corporate governance is not a proxy for corporate reputation. A perception study conducted in tandem with the governance report, in which respondents such as company secretaries were asked to rank FTSE 350 companies in terms of corporate governance, placed engineers Smiths Group, consumer packaging business Rexam and Auto Trader at the top. BAT languishes at the 42nd position while Tesco earns a mild reprieve, achieving 99th place.

However, Parry concedes they are ‘intrinsically linked’, adding ‘ultimately poor corporate governance leads to poor corporate reputation while a poor corporate reputation often demonstrates underlying issues with corporate governance’.

‘The interesting thing about perception is that you have to make sure that people aren’t measuring the company in terms of their views of its corporate reputation, so that they are actually taking a view on the effectiveness of its corporate governance,’ he adds.

‘We’ve tried to create a survey that moves beyond this. In last year’s survey, we did have a feeling that some people were measuring on the basis of reputation.’ Tobacco companies, he adds, recognise that they have issues around corporate reputation and hence tend to take corporate governance very seriously.

Imperial Tobacco also scored relatively well in the survey. ‘In general, tobacco companies take the environmental, social and governance aspects of their day-to-day work quite seriously,’ he says. Despite the criticism and the flurry of calls, particularly from those companies ranked in the middle, Parry is adamant that the report’s findings are based on a rigorous methodology.

‘We’re not saying that the system is absolutely perfect but it is a continuation of last year’s debate,’ he explains. ‘We are saying to practitioners Take this away, have a look at it and let us know what you think. We hope that this report will get corporate governance discussed around the boardroom table.’

It is more than 25 years since Sir Adrian Cadbury, chairman of the eponymous chocolate company, produced the world’s first report into corporate governance, in the wake of scandals such as the collapse of FTSE 100 conglomerate Polly Peck and banking group BCCI and the raiding of the pension fund of Mirror Group by tycoon Robert Maxwell.

The Cadbury Report paid scant attention to the quality of financial reporting. Instead, it recommended that the roles of chairman and chief executive be separate, boards should have at least three non-executive directors (two of whom should be totally independent) and each board should have an audit committee, comprising non-executive directors.

Its recommendations were incorporated into the Combined Code, which is now administered by the Financial Reporting Council, but in recent years greater attention has been paid as to whether boards also need to focus on the governance of culture as well as behaviours, and whether this may link to long-term business performance.

Parry explains: ‘The purpose of this report is to get under corporate governance and to ask two crucial questions. Firstly, can you measure corporate governance, and, secondly, what matters in corporate governance. I don’t think we have fully answered the first question but we have attempted to show that there are ways that you can measure it, through perception (for example, what journalists or directors think) and an analysis of risk factors, readily available information in the marketplace that you and I would associate with good corporate governance.’

It is also an attempt to highlight those companies that view corporate governance as a box ticking exercise, rather than a means to improve the integrity and financial sustainability of a business.

‘I think that the UK Corporate Governance Code 2016 is an excellent document. It is a full-bodied document. The problem is that it is, in many cases, being interpreted in terms of compliance. Governance is so much more than compliance. Companies are not living their behaviours,’ says Parry.

Five years ago Ken Olisa, now deputy chairman of the IoD, served as a non-executive director of Eurasian Natural Resources Company (ENRC). It was a company mired in scandal, even before it listed on the London Stock Exchange in 2007 and joined the FTSE 100.

‘He sat around the board table and knew that there was something wrong with corporate governance. The majority shareholder [Kazakhmys, a Kazakhstanbased mining company which held 26 per cent] dominated the board. Ken would attend the board meetings and say Look, we have a problem here. The corporate governance for this company, a FTSE listed company, is not acceptable,’ says Parry. ‘But the Kazakhstan chair and the lawyers would say But Ken, we tick all these boxes of the Code. And what happened? It had to delist. So effectively, you can comply with all the principles of the UK Corporate Governance Code but still face long-term structural corporate governance problems.

‘Similarly, the Code was in existence during the financial crisis but the banks still failed. They experienced a huge failure in corporate governance. HBOS and RBS are both examples of governance failings. Why? You can point to the huge personalities leading those banks.’ He adds: ‘I am quite sure that, if Sports Direct were with us right now, they would say We tick all the boxes, don’t we?

The report, which is conducted in association with Cass Business School, considers a range of 34 variables across five areas of governance: board effectiveness, audit and risk, remuneration and reward, shareholder relations and stakeholder relations. The choice of these variables is not set in stone, and may alter next year according to feedback.

Parry says: ‘The survey results inform our thinking about what factors are important to corporate governance. We are taking the views of participants to rank certain factors, whether that is audit and risk or boardroom effectiveness.’

Unsurprisingly perhaps, when a trade body as influential as the IoD attempts to rank companies, there have been calls to remonstrate. ‘The first point of contact is usually the press office, the corporate comms guys, who want to know why and to understand their rankings. Then it escalates to the company secretary and if they are not happy, we get calls from the chairman and the board,’ says Parry.

Many have challenged the criteria. ‘They say Hang on, we didn’t do that, we did this or Women comprise 25 per cent of our board, why have you marked us down for that? The issue is not that we have made lots of mistakes,’ says Parry. ‘The issue is down to the publicly available information. We don’t have the time or resource to research 100 annual reports. We draw information from two sources – FAME and Morningstar – and if that is not up-to-date, we will draw the wrong conclusions. These companies need to ensure that their information is up-to-date.’

But surely reviewing 100 annual reports takes no longer than sifting through information on investor databases, I argue. Parry is unconvinced. Annual reports can be unwieldy beasts which carry information in an unstructured manner with information on executive remuneration, for example, spread across multiple pages, with little linkage or attempt to explain the ultimate package.

‘To dive into an annual report and get the correct information on remuneration policy is a tough job to do. Companies often give a single figure for remuneration, but the problem is understanding the mechanism behind it, even before you look at the performance over the last 12 months or three years. Shareholders at BP were angry about [chief executive] Bob Dudley’s pay because the performance had been so bad. Yet he [Dudley] hit all the performance targets. Diving into that report and calculating what the remuneration policy was so impossible that I had to give up,’ he says. ‘The information that companies supply in annual reports needs to be clear and transparent. But the information they do supply, while it looks generous, is almost nonsensical.’

According to the report, motor insurance company Admiral Group, while 22nd overall in the corporate governance rankings, is the best when it comes to remuneration and reward, scoring 969 points out of a possible 1,000. Its annual report is also clear on the subject, however, with bar charts showing what ‘minimum’, ‘on-target’ and ‘maximum’ performance would mean in monetary terms for the chief financial officer. (The salaries for the chief executive and chief operating officers never vary, despite performance, as the board assumes that, as founding directors, their significant personal shareholdings ensure their interests are aligned with that of the company.)

Drinks giant Diageo, which comes in at a respectable ninth place in the rankings, leads the way on audit and risk governance, while Unilever, third in the rankings, leads the way on board effectiveness. Royal Mail, which floated into the FTSE 100 index just three years ago, ranks second in the corporate governance ratings, but first when it comes to stakeholder relations.  And BAT, first overall, is also top for shareholder relations, scoring a whopping 967 out of 100.

‘Last year, a bank called me and said We scored really low on the perception table, but high on the analysis of our corporate governance. How is that? So I told them: the perception is that banks are not well run. How do we tackle that?’ says Parry. ‘It is all about communication. It is all about engagement. It is not about seeing your shareholders once a year at a set piece AGM. It is about engaging with them regularly. It is about engaging with journalists and other stakeholders. It is about showing, throughout the financial year, that you are really living and breathing your corporate governance principles. It is not about copying and pasting a corporate governance statement every year. Chief executives have got to start thinking about How can we communicate to the marketplace that we do more than the minimum required, to show that effective corporate governance is integral to our business.’

And the stakes are high, perhaps higher than ever. Prime Minister Theresa May has pledged to reform boardroom governance and restore trust in big business. ‘There is an opportunity here for business to grasp the nettle and make improvements,’ says Parry. ‘Because if they don’t, the Government will regulate.’