As movie remakes go, Return of the Corporate Governance Box-Tickers hardly screams box office. Actively discouraging high-ego actors, it also lacks big-ticket disasters to rival the collapses of Enron and WorldCom before the last corporate governance boom nearly two decades ago.
Despite that, it looks set for a long run. Corporate governance is back, with a widened remit and a new energy. This year will mark the first full reporting year for most public companies under the Financial Reporting Council’s revised Combined Code of Corporate Governance. Investors have been operating under a strengthened UK Stewardship Code since 1 January, while private British companies with more than 250 employees are still getting to grips with the Wates Corporate Governance Principles, which took effect last year. The FRC itself is to be replaced by the Audit, Reporting and Governance Authority (ARGA), with beefed-up powers to police wrongdoings. Elsewhere, The Institute of Directors is launching the IoD Institute of Corporate Governance as a new forum for the greater interest it is seeing in the issue.
Definitions of corporate governance are certainly changing. G has long appeared the most boring initial in the ESG acronym for environmental, social and corporate governance. However, some commentators now see a new confluence between environmental activism, social responsibility and corporate governance’s traditional tempering of boardroom excesses.
The rise in importance
'Corporate governance has become an all-encompassing term that now means a lot of different things to different people,’ says Carum Basra, corporate governance policy adviser at the Institute of Directors. ‘At the IoD historically, we have focused on boardroom governance, articles of association, how you minute a meeting and all those kinds of technical, dry aspects. But, increasingly, it is now attached to the E and S of environmental and social governance.
‘Another reason it has come to the fore is because government has been unable to deliver over the last two and three years as it has been unable to legislate. Because it is soft law, corporate governance is seen as a way to gently nudge corporates to act.’
David Shammai, cross-border director for corporate governance at consultancy Morrow Sodali, agrees that environmental and social responsibility decision-making can no longer be boxed off from board governance.
‘Over the last few years, we’ve seen sustainability, especially climate change, become very important,’ he says. ‘Last year was a tipping point in terms of the public debate. ‘What’s happened is that now when we’re asking whether companies have the right system for general, corporate decision-making, we’re also asking if they have the right system to make the right decisions to make the progress we need to make on these issues. Previously, corporate governance was a bit technical. Now it’s also being seen as the way to put forward an agenda that the public wants to see in terms of action on sustainability and climate change.’
Similarly, Charles Lewington, chief executive of Hanover Communications, which recently published a report on the Government’s target for the UK to go ‘Carbon Net Zero’ by 2050, believes that environmental and social governance and purpose are now ‘mainstreamed’ alongside corporate governance on boards.
‘Business can and should be tying decarbonisation and sustainability as well as all other corporate governance activities into strategies, political engagement and communications,’ he says.
Such developments arguably make corporate governance more important than ever and regulators are responding accordingly. The Combined Code’s revision brought new provisions requiring boards to disclose how they have engaged with employees and wider stakeholders and how the interests of such groups have influenced board decision-making.
Companies also now have to specify the mechanisms employed to give the workforce a voice on the board. Where such methods do not involve worker-directors, employee advisory panels or non-executive directors, boards need to detail why they are considered to be effective.
Firms are also expected to specify their broader social purpose beyond financial performance and demonstrate how their cultures are aligned with company purpose, values and strategies. For privately-owned businesses with more than 250 employees, the Wates Principles require an explanation in the annual report as to how directors have engaged with employees and shown regard to their interests. Companies must state the effects of that regard, including the effects on the principal decisions made.
‘We removed a lot of the detail that drives the box-ticking culture and really focused in on the principles of what companies are about,’ says FRC director of corporate governance and stewardship David Styles. ‘What’s the purpose of a company? We really tried to broaden the definition of what corporate governance is. What happens in the boardroom is crucial but you can’t make those decisions without taking into account shareholders and a wider range of stakeholders, such as customers and suppliers. For the first time, the code really recognised that.’
Engagement will be key
Styles also believes that the new Stewardship Code, which will require to submit statements from next year, constitutes a ‘revolution’ in the ground rules for investors, committing them to telling clients and beneficiaries how fund managers have engaged with the companies they invest in and detailing the outcomes.
‘Corporate governance is back in vogue,’ comments Rupert Younger, director of Oxford University’s Centre for Corporate Reputation, ‘because people are trying to understand how to govern a multi-stakeholder corporate world, as opposed to a much easier, simpler, clearer governance world of just shareholders.
‘When you are suddenly faced with a whole set of questions about which shareholders matter, in what circumstances and with what particular feedback loops and input, all of that requires quite complex and thoughtful governance. It also necessitates a different set of governance structures and requirements within corporates who, over the last 50 years, have been focusing on a primary responsibility to shareholders with everything else a subsidiary to that. The question now is how you manage multi-stakeholder capitalism. Who should have a share of voice and on what issues?’
The nature of corporate governance itself is changing too. While media focus will remain on scandals, executive pay and shareholder rebellions, there are tensions among the corporate community about whether the new, powerful ARGA will herald a switch from Britain’s traditional ‘comply or explain’ culture to a more rule-bound model.
Edwin Morgan, the IoD’s director of policy, warned about this danger earlier this year, while fund manager Legal & General Investment Management is going on the offensive by applying at least one key aspect of the UK corporate governance handbook to its global investments. The firm says it will now vote against all re-election anywhere in the world of directors who combine the roles of chairman and chief executive – something frowned upon in the UK but still commonplace in the US and some other markets.
Changes suggested in Labour’s manifesto for last year’s general election may also still shape the corporate governance landscape, despite the Conservatives’ landslide victory.
They included giving directors a duty to run the company to benefit all stakeholders, not just shareholders, and encouraging much more non-shareholder participation accordingly.
Companies were also to have been allowed to adopt two-tier board structures like those in Germany, where there is both a management board and a supervisory board that includes employees.
Adonis Pegasiou, academic director of the European Institute of Management and Finance, notes in a recent blog that some of these proposals were also enunciated by Theresa May in her 2016 Conservative leadership campaign and may reappear on the agenda.
Poor governance at the heart of crises
Over recent years, there may also have been an uptick in corporate crises that illustrate or unveil governance issues. The emissions scandal at Germany’s Volkswagen, which the company initially blamed on others, is increasingly being regarded as a governance issue. The collapse of outsourcing group Carillion with liabilities of almost $7 billion in 2018 was meanwhile decried by a UK parliamentary inquiry report as a ‘story of recklessness, hubris and greed’ with a business model that was a ‘relentless dash for cash’ and directors who allegedly misrepresented the financial realities. Last year, an investigation into South Africa retailer Steinhoff International uncovered an alleged $7.4 billion accounting fraud, while in the UK the discovery of a major accounting black hole led to cake shops chain Patisserie Valerie going into administration.
An early contender for corporate governance scandal of 2020 is Abu Dhabi private hospitals group NMC Health, which saw its value plunge by more than 70 per cent after admitting that it did not know who owned large slices of its shares. The company’s chief executive and finance director resigned and the group has asked for a standstill in debt repayments while it tried to renegotiate about $2 billion of liabilities. But this week, NMC Health announced its debts had reached $6.6 billion, with a total of 75 debt facilities from more than 80 financial institutions, while investigators had also uncovered cheques totalling $50 million which may have been used as security for financing arrangements ‘for the benefit of third parties’.
‘Corporate governance does tend to get more limelight and receive more attention when there are major corporate scandals,’ says Shammai. ‘It is about how decisions are being taken in a company, so when a major company collapses, regulators and governments ask whether they need to tweak the system.’
Jason Stansbury, associate professor of business at Michigan’s Vanderbilt University and director of the Society for Business Ethics, sees such events combining with increased interest in governance from groups with other lobbying causes to put a brighter spotlight on boardroom decisions.
‘Corporate governance is essentially about giving people who care about business misconduct a way of communicating with organisations and holding them accountable,’ he says. ‘There was a diminution of interest in the topic when the scandals at the turn of the century faded in the memory and the public consciousness. But I think people who have engaged with environmental and social issues in detail are also interested in corporate governance because that’s where organisations can best be called to account.’
Some corporate governance specialists do not share the sense of change.
‘Environmental issues are more about sustainability,’’ says Hossam Zeitoun, associate professor of corporate governance at Warwick Business School. ‘Corporate governance and sustainability are connected and, yes, there is increasing interest in sustainability. Maybe in that sense there has been an increase in interest but corporate governance is always in the newspapers. There are often stories about shareholders rebelling against management and diversity on company boards. Every week there’s something. I wouldn’t say I have noticed it particularly going in and out of fashion.’
At the FRC, Styles says his focus in the next few years is to make the new codes and regulator work in practice. ‘The environmental, social and corporate governance activities of companies and investors are clearly very, very important, but I’m not that interested in whether people put them into compartments or put them together. Governance remains very important but, in order to do governance properly, you have to take into account the environmental and social factors. You can’t do the G without relying on the E and the S. Boards and investors need to take them all into account. It’s a broader definition of what governance is.’