Increasing ownership by ‘rest of the world’
At the end of 2012, the UK stock market was valued at £1,756.3 billion. The ownership of UK shares has changed dramatically over a 40 year period. The Office of National Statistics (ONS) surveys indicate that the ownership of UK shares by individuals has fallen from 54% in 1963 to under 11% in 2012. On the other hand, the ‘rest of the world’, which held just 7% of UK shares in 1963, now own over 53% of UK quoted shares. This decrease in individual share ownership and increase in the ‘rest of the world’ ownership is perhaps the most notable change in the overall share ownership figures reported by the ONS in its publication ‘Ownership of UK Quoted Shares, 2012’ which is available at:
The ONS analysis of the ‘rest of the world’ shareholding of 53% of UK quoted shares finds that some 48% of this is owned by investors in North America, just under 26% by European investors and around 10% by investors in Asia. The balance is made up of investors from various regions including Africa and the Middle East.
Corporate governance activism
One of the possible implications of the increase in ‘rest of the world’ ownership, and particularly ownership by investors in North America, is in relation to corporate governance activism. Such investors may tend to be more pro-active than many UK institutional investors have traditionally been and may engage more in their investee companies especially where these are underperforming or where there are corporate governance issues. The California Public Employees’ Retirement System (CalPERS) is a well-known example of a US pension fund which actively engages with underperforming companies and/or with those where there are corporate governance issues. In years gone by its strategy was to ‘name and shame’ with its focus lists but these days it concentrates more on a particular issue, for example, executive remuneration, and engages privately with the company to try to bring about improvements before then progressing to any more public approach.
Improved Investor Engagement
Nonetheless the UK’s ‘vanguard’ institutional investors including Hermes, Aviva, and Standard Life all have a high corporate governance profile and actively engage with their investee companies. Moreover the Investment Management Association (IMA) reported increased levels of monitoring and engagement in June 2013 in their survey of ‘Adherence to the FRC’s Stewardship Code, At 30 September 2012’, available at:
The report indicated that more institutional investors monitor all their investee companies; that more resources are being put into the stewardship role and that there is ongoing integration of stewardship into the wider investment process. Investors are also prioritising engagement on key issues. Furthermore there has been an increase in voting level with the decision of how to vote the shares being made independently of proxy agencies.
The UK’s Stewardship Code set the standard in terms of providing a framework for institutional shareholders to monitor, and engage with, their investee companies. There have been a number of encouraging signs that shareholder engagement is on the increase in a number of countries. In her article, ‘Shareholder campaigns more than double in three years’ (FT, Page 20, 11th November 2013), Sam Jones points out that ‘the past 12 months have seen more than 415 instances of corporate activism across the world, up from 172 in 2010’. This trend is expected to continue as institutional investors, with sensitivities highlighted in the aftermath of the financial crisis, increasingly seek to ensure that their investee companies both have appropriate standards of corporate governance and sustainable returns.
Chris Mallin 5th December 2013
The use of independent, outside auditors is a cornerstone in every model of corporate governance. Yet auditing world-wide is dominated by just four firms – PwC, Deloitte, KPMG, and Ernst and Young. This colossal four used to be the ‘Big Five, until the collapse of Enron brought down its auditor, Arthur Andersen.
These four accounting firms are vast, international, and concentrated. They are major businesses, with products, market shares, business solutions, and profit performance as watchwords. Partners are judged by fee generation and growth. Client income from non-audit work sometimes exceeds the audit fee.
Companies seldom change their auditor: some major listed companies have used the same auditor for generations. Close relationships inevitably grow between the audit staff, particularly the audit manager, and the client’s finance department. Moreover, in some companies the finance director and other finance staff have graduated from the company’s auditor.
Such closeness between auditor and client has raised questions about auditor independence. Some have called for the audit manager to be changed regularly, to avoid undue familiarity. The big audit firms responded that the loss of efficiency, with new staff having to form new relationships and learn about the business, would be considerable. Over the years, suggestions have also been made that the stranglehold of the big four should be forced open by imposing a mandatory limit to the number of years that an auditor can audit a large company’s accounts. The audit firms argued that the loss of efficiency and cost would be even greater.
So the recent decision by Britain’s Competition Commission not to impose such a limit is significant and reinforces the hold of the big four firms. Instead the Commission decided to require large companies to put their audits out to tender periodically. Their hope is that such enforced tendering for audits will force open the market. However, it could have the opposite effect, reinforcing the position of the incumbent auditor as the firm is re-elected.
Why I resigned from my membership of the accountancy profession
I became a chartered accountant in 1955. In 2002, I resigned that membership of the Institute of Chartered Accountants in England and Wales, feeling that auditing had ceased to be a profession and had become a business. What follows is the explanation I gave at the time for my resignation A version was published in the June 2002 edition of Accountancy.
‘When I was 16 the headmaster of my grammar school told my father “this lad has school certificate and higher school certificate; you want him to be a chartered accountant; so don’t waste his time going to university, get him articled straight away.” Typical of those times, my opinion was not thought necessary.
So I was articled to a chartered accountant in Coventry, Phil Mead, whom I now realise, was a remarkable man. A director of Coventry City Football Club, he was also a partner in Daffern and Co., a five partner firm of Chartered Accountants. In retrospect, I learned more from him of real value than I subsequently learned at Oxford University or Harvard Business School.
Preparation for the examinations of the Institute of Chartered Accountants, in those days, was by correspondence course and practical experience. Phil Mead was a great principal to his articled clerks: he personally supervised our work and our development. He continually gave us just a little more responsibility that we were ready for, but watched over the results closely. At eighteen I was preparing and explaining the accounts to a workingmen’s club; at 19 was responsible for auditing the subsidiary of a public company, and the year I qualified at 21, I presented the accounts to the directors of a listed company, albeit a small one.
Now, so many years later, I contrast that early experience with the state of auditing today. Post Enron, some believe that auditors should not undertake non-audit work for clients, others argue that auditors should be changed regularly, or that the lead audit partner should rotate every few years. I suspect the issues go deeper. The real question is whether auditing is a profession or a business.
In the 1950s ours was a professional practice. It provided service for a fee. The number of partners was limited. Globalisation was for the future, though we did have one client with a subsidiary in Australia. The phrase ‘corporate governance# had yet to be coined. In those days the accounting profession consisted mainly of relatively small firms. Of course, our partners were keen to be successful. They did not want to lose clients to other firms. In their community they were respected and well to do; but they were not rich. Neither would they compromise their principles. They would not sign an audit report, stating that the client’s account’s showed a true and fair view, unless the partner was personally convinced that they did. Better to lose a client than your integrity. This was a profession, after all. The audit process demanded absolute objectivity of thought and total independence from the client.
When I began my accounting career, the Institute of Chartered Accountants was at the head of a self-regulating profession. Today, as the world-wide Anderson saga showed, the market place regulates, not the profession. Indeed, auditing has ceased to be a profession: it has become a business.
Of course the business world has changed too. Nostalgia has no place in strategic thinking. There is no going back to the profession of half a century ago. But I suspect that, unless auditing rediscovers what it means to be a profession and returns to its roots, state regulation of the audit process will be imposed to protect creditors, investors and the wider community.’
Bob Tricker, 24 July 2013
Corporate governance has gained a much higher profile in the last two decades in the wake of various corporate scandals and collapses. Corporate social responsibility (CSR) is now becoming much more a part of mainstream corporate governance as there is a recognition that a company cannot – in the long-term – operate in isolation from the wider society in which it operates. This view is encapsulated by Sir Adrian Cadbury: ‘The broadest way of defining social responsibility is to say that the continued existence of companies is based on an implied agreement between business and society’ and that ‘the essence of the contract between society and business is that companies shall not pursue their immediate profit objectives at the expense of the longer-term interests of the community’ (Sir Adrian Cadbury, 2002).
Directors, Shareholders and other Stakeholders
In the UK, directors are accountable to shareholders but should consider the views of other stakeholders. The Companies Act (2006) expects directors to disclose more information relating to the risks affecting the company, an analysis of the performance of the company over the year, and consideration of shareholder and stakeholder interests. Stakeholders, including employees, customers, suppliers, local community, interest groups, government, etc. may lobby directors, shareholders, governments, etc.
In terms of what investors might be looking to avoid when they invest overseas, the Organisation for Economic Co-Operation and Development stated: ‘In the global economy, sensitivity to the many societies in which an individual corporation may operate can pose a challenge. Increasingly, however, investors in international capital markets expect corporations to forego certain activities – such as use of child or prison labour, bribery, support of oppressive regimes, and environmental disruption – even when those activities may not be expressly prohibited in a particular jurisdiction in which the corporation operates.’ (OECD, 1998).
Institutional shareholders in the UK are guided in their relationship with investee companies by the Stewardship Code (2012) ‘instances when institutional investors may want to intervene include, but are not limited to, when they have concerns about the company’s strategy, performance, governance, remuneration or approach to risks, including those that may arise from social and environmental matters’ (Guidance to Principle 4).
CSR and corporate philanthropy
Both CSR and corporate philanthropy can help define a company’s reputation and image and create goodwill with its stakeholders. However CSR is generally more about the core business functions of a company. Shareholders will often be more understanding about a company spending money on CSR related to the core activities, rather than on peripheral activities. The wider stakeholder community is also making increasing demands that companies be held accountable for the social and environmental impacts of their operations.
Philanthropic giving is often in the form of donations to favourite charities or causes, sometimes via a foundation established by the company. Whilst philanthropic giving may involve a select group within the company, e.g. the directors, a company’s CSR is more company-wide and therefore effective implementation of CSR often requires a much higher level of commitment and engagement beyond that which is required for corporate giving programs.
A darker side?
Companies often genuinely engage in CSR, for example, Ben and Jerry’s uses hormone-free milk and cage-free eggs in its ice-cream; Puma places a lot of emphasis on its environmental impact and produces an environmental profit and loss account. However sometimes companies may use CSR more as a public relations exercise, or there may be something of a mismatch between what companies say and do, hence CSR may have a darker side.
Shell’s Sustainability Report 2012: ‘As we work to help meet the world’s growing energy needs, we aim to reduce the environmental impact of our operations.’ However Shell has polluted the Niger Delta and seems to fight against taking responsibility for oil spills. Monsanto’s CSR/Sustainability Report 2011 states it ‘is working for a better tomorrow by putting the right tools in the hands of farmers today. By equipping growers with better seeds, we can help protect our natural resources, fight hunger, improve nutrition and provide economic benefits to everyone involved in an improved system of agriculture.’
However their products have included Agent Orange, dioxin, recombinant bovine growth hormone (rBGH), and genetically modified seeds.
CEOs and corporate giving
There is mixed evidence regarding CEOs’ approach to CSR/corporate philanthropy, as the following two recent studies indicate. Shapira (2012) finds that whilst cash donations can signal the company’s financial strength, corporate philanthropy can decrease firm value when corporate governance mechanisms are co-opted (neutralised or over-ridden), eg. when companies donate to charitable causes affiliated with independent directors. Recently Masulis and Reza ( 2013) found that the choice and level of corporate giving is positively associated with CEO personal ties to charities and negatively associated with the strength of corporate governance; donations may be used to support CEOs’ preferred charities or those of independent directors (thereby strengthening social ties with them). It is perhaps not surprising then that they also find a negative price reaction to charity donation disclosures where executives/directors have personal ties.
Corporate governance and corporate responsibility are intertwined. There is increasing influence from shareholders, other stakeholders, and also government/international legislation. Nonetheless it is worthwhile to note Devinney (2009), who astutely observed ‘The notion of a socially responsible corporation is potentially an oxymoron because of the naturally conflicted nature of the corporation.’
Cadbury Sir Adrian (2002) Corporate Governance and Chairmanship: A Personal View, Oxford University Press, Oxford.
Devinney Timothy (2009) Is the Socially Responsible Corporation a Myth? The Good, the Bad, and the Ugly of Corporate Social Responsibility, Academy of Management Perspectives, May 2009, Vol. 44. Available at SSRN: http://ssrn.com/abstract=1369709
Financial Reporting Council (2012) UK Stewardship Code, FRC, London.
OECD (1998) Corporate Governance: Improving Competitiveness and Access to Capital in Global Markets. Report to the OECD by the Business Sector Advisory Group on Corporate Governance, OECD, Paris.
Shapira, Roy, Corporate Philanthropy as Signaling and Co-Optation (2012), Fordham Law Review, Vol. 80, No. 5, 2012. Available at SSRN: http://ssrn.com/abstract=2061080
Chris Mallin 6th June 2013
On 19 March 2013, the Global Corporate Governance Forum* published a paper by Ivan Choi, who is a Hong Kong based colleague of mine, in their publication Private Sector Opinion.
Ivan invited me to write a foreword to his paper, which follows. The paper itself can be accessed at:
The financial crisis and its rippling effects on the wider corporate sector have prompted companies to rethink how they govern and manage risk. This paper discusses the board’s role in the governance of risk and the benefits of establishing a separate board-level risk-management committee – a need that applies to financial and nonfinancial institutions, as well as large and small companies.
All business decisions involve risk. The challenge to boards and senior management is to balance risk with acceptable reward, to create value without hazarding the enterprise. This means understanding the corporate exposure to risk, determining how those risks are to be faced, and ensuring that they are handled appropriately.
There are four possible responses to a business risk:
1. Avoid the risk. Abandon the proposed project.
2. Mitigate the risk. Make capital investments or incur on-going expenditures – for example, by obtaining standby equipment, duplicating critical components, investing in staff training – plus establish risk policies, such as requiring top executives to travel separately in case of an accident.
3. Transfer the risk. Spread the exposure to other parties. Insure against the risk, although some risks may be uninsurable. Hedge the risk by negotiating long-term contracts. Create derivative instruments, agreements with financial institutions that transfer the risk to third parties.
4. Retain the risk. In other words, accept the risk. This is often the only available solution for strategic risks.
Risk is often handled well at the operational level, taking appropriate precautions and insurance against, for example, fire, theft, employee accidents, and vehicle damage. Risks internal to the organization are usually recognized.
Risks at the managerial level tend to be less well-handled. These risks are not so obvious: product liability, loss of profits following an incident, failure of computer-based systems, reputational loss following a media allegation of corporate bribery, for example.
But risks at the strategic level may not be recognized at all, even by top management. Consider, for example, the massive fines that international banks had to pay for the Libor rate-rigging scandal, the market disaster and product liability that Boeing faced with the failure of the batteries on its 787 Dreamliner airplane, the loss of life and horrendous cost to BP of the collapse of the Deepwater Horizon oil rig, or Tokyo Electric Power’s disaster at the Fukushima Daiichi atomic power station. These examples cover catastrophic costs and huge reputational damage, but every company faces strategic risks that could threaten its existence. Many strategic plans fail to consider risk. Directors and senior management need to face up to the unexpected “what if…” questions.
This paper goes to the heart of these issues.
Crucially, it argues that successful organizations should focus on risk management at every level. But the responsibility for risk management starts with the board. The paper advocates that a board-level risk management committee, separate from the board-level audit committee, offers a sound basis for enterprise-wide risk management.
Many corporate failures can be attributed to the board’s inability to recognize the underlying risks faced by the company and to take appropriate mitigating actions.
Corporate governance and enterprise-wide risk management are interconnected. Risk management, like corporate governance, involves both conformance and performance aspects: ensuring that past and present issues are well handled while also looking to the future.
This paper differentiates the roles of the audit committees and the risk-management committee. The risk-management committee has an oversight role in developing, updating, enforcing, and monitoring the implementation of the risk-management policy on behalf of the board. Usefully, the paper makes specific recommendations on the duties of such a committee and realistically sets the benefits against the costs.
All company decisions involve risk. Sound risk management starts with board-level responsibility. This paper has important messages for board chairmen and directors, both executive and nonexecutive. The paper will also provide valuable insights for chief executives and senior management responsible for implementing the board’s risk policies. Staff involved in risk management, including the CFO and finance staff, the company secretary and secretarial staff, and the risk function if there is one, will also find this paper relevant to their work.
*The Global Corporate Governance Forum is part of the International Finance Corporation’s Corporate Governance Group. The Forum is a donor-supported facility, co-founded in 1999 by the World Bank and the Organisation for Economic Co-operation and Development (OECD) and supports corporate governance reforms in developing countries, promoting good practices in corporate governance. It also supports director training organizations engaged in implementing corporate governance reforms. Private Sector Opinion is one of their many publications. http://www.gcgf.org/wps/wcm/connect/Topics_Ext_Content/IFC_External_Corporate_Site/Global+Corporate+Governance+Forum
Bob Tricker 23 March 2013
Board diversity, and in particular the presence of women in the boardroom, has seen a number of developments in recent months. There have, for example, been significant developments in the European Union (EU).
Back in March 2012, the European Commission (EC) publication “Women in economic decision-making in the EU: Progress report” http://ec.europa.eu/justice/newsroom/gender-equality/opinion/files/120528/women_on_board_progress_report_en.pdf
highlighted that, whilst progress had been made in increasing the number of women on corporate boards, nonetheless a quarter of the EU’s largest companies (25%) still had no women on their top-level board.
Subsequently, in November 2012, the EC adopted a law which sets a minimum objective of “40% of the under-represented sex in non-executive board-member positions in listed companies in Europe by 2020, or 2018 for listed public undertakings”, see IP/12/1205 http://europa.eu/rapid/press-release_IP-12-1205_en.htm and MEMO/12/860 http://europa.eu/rapid/press-release_MEMO-12-860_en.htm
The main elements of the draft law include that a company which does not have 40 per cent of women on its supervisory board will be required to introduce a new selection procedure for board members which gives priority to qualified female candidates (note the emphasis on qualification, i.e. no one would be appointed to the board just because they are female). It is worth noting that the law only applies to the supervisory boards or non-executive directors of publicly listed companies, due to their economic importance and high visibility (small and medium enterprises are excluded). However, alongside this, there is a provision for a “flexi quota” which is an obligation for companies listed on the stock exchange to set themselves individual, self-regulatory targets regarding the representation of both sexes among executive directors; this flexi quota to be met by 2020 (or 2018 in case of public undertakings), and with companies reporting annually on the progress made.
In order to become law, the Commission’s proposal needs to be adopted by the European Parliament and by the EU Member States in the Council. On 15 January 2013, the draft law successfully passed the Subsidiarity Check (this is where national parliaments give opinions about whether it is appropriate to tackle an issue at EU level or whether it is best left to the Member States).
On 25th January 2013, an EU Press release “Regulatory pressure gets the ball rolling: Share of women on company boards up to 15.8% in Europe” http://europa.eu/rapid/press-release_IP-13-51_en.htm showed an increase in the number of women on boards to 15.8%, up from 13.7% in January 2012. This comprised an average of 17% of non-executive board members and 10% of executive board members with an increase in the share of women on boards in all but three EU countries (Bulgaria, Poland and Ireland).
Countries with quota legislation are in the vanguard of these increases. For example, Italy recently adopted a quota law that requires listed and state-owned companies to appoint one third women to their management and supervisory boards by 2015; and France, which introduced a quota law in 2011, has become the first EU country to have more than one woman on the top-level board of all of its largest listed companies.
However Scheherazade Daneshkhu and James Boxell in their article ‘Evolution not revolution in French companies’ (FT, Jan 2013) point out that none of the CAC 40 (France’s largest companies) are currently headed by a woman. In Germany, the DAX 30 companies all operate voluntary schemes for promoting women but, as Tony Barber points out in his FT article ‘Germany shifts the debate about women on boards’ (January 2013), ‘the rising proportion of women on German supervisory boards – at 16 per cent, a bit above the EU average – obscures the fact that a majority are workers’ representatives, not career executives’.
It seems clear that there is increasing board diversity in various countries and that whilst the pace of change may be slower than some would like, nonetheless change is occurring. Furthermore, developments at both national and international levels should facilitate more board diversity in the future.
Chris Mallin 6th February 2013
Executive remuneration (compensation) is always a hot topic, and the remuneration committee is often focussed upon as the key corporate governance mechanism in setting executive director remuneration (although recently the ‘say on pay’ has seen a growth in shareholder influence over executive pay packages as discussed in this blog and elsewhere).
The UK Corporate Governance Code (2012) states that ‘The board should establish a remuneration committee of at least three, or in the case of smaller companies two, independent non-executive directors. In addition the company chairman may also be a member of, but not chair, the committee if he or she was considered independent on appointment as chairman. The remuneration committee should make available its terms of reference, explaining its role and the authority delegated to it by the board. Where remuneration consultants are appointed, they should be identified in the annual report and a statement made as to whether they have any other connection with the company (para D.2.1). http://www.frc.org.uk/Our-Work/Publications/Corporate-Governance/UK-Corporate-Governance-Code-September-2012.aspx
Remuneration committees may draw on the advice of specialist remuneration consultants when constructing executive remuneration packages. The UK’s High Pay Centre (2012) publication ‘The New Closed Shop: Who’s Deciding on Pay?’ http://highpaycentre.org/files/hpc_dp_remco.pdf states that remuneration consultants are ‘normally hired by the remuneration committee. The voluntary guidelines for remuneration consultants state that if they are engaged by the remuneration committee they cannot also work for the executive, whose pay they are determining. The advice they provide varies, but typically includes designing new remuneration plans, and drawing up a comparator group against which the executive pay can be benchmarked’.
Remuneration Consultants Group (RCG) Voluntary Guidelines
The voluntary guidelines to which the High Pay Centre refers were published by the Remuneration Consultants Group (RCG) which was formed in 2009 and represents the vast majority of executive remuneration consultancy firms advising UK listed companies. In fact the RCG’s website states that ‘Any consulting firm, or individual acting as a sole trader, named in the relevant Directors’ Remuneration Reports of at least one FTSE350 company is eligible to become a registered member of the RCG. If a parent firm has separate legal entities acting as Remuneration Consultants then only one of the family of firms may be such a member of the RCG’.
The RCG published the Voluntary Code of Conduct in Relation to Executive Remuneration Consulting in the United Kingdom in 2009 and it is revised every two years , the most recent edition was published in 2011. The Code states that ‘Executive remuneration consultants, comparable with other business professionals, should comply with the fundamental principles of transparency, integrity, objectivity, competence, due care and confidentiality. They should also ensure that, whether or not part of a larger consulting group providing a wider range of services, their internal governance structures promote the provision of objective and independent advice. The full Code is available at: http://www.remunerationconsultantsgroup.com/assets/Docs/December%202011%20Code%20of%20Conduct.pdf
The effectiveness of the Code was reviewed in 2012, see http://www.remunerationconsultantsgroup.com/assets/Docs/Annual%20Review%20including%20Code%20Effectiveness%20Review%20December%202012.pdf In early 2013, following on from the 2012 review, the RCG urged remuneration committees to cite use of the Code to show external audiences that they have followed due process with regard to executive remuneration.
Pros and cons of remuneration consultants
The fourth edition of ‘Corporate Governance’ (Mallin, 2012), discusses the role of remuneration consultants, identifying academic literature in the area highlighting both potential benefits and downsides of remuneration consultants. Various studies are considered but to mention two here, Voulgaris et al. (2010), in a study of 500 UK firms from the FTSE 100, FTSE 250, and the Small Cap indices, find that compensation consultants may have a positive effect on the structure of CEO pay as they encourage incentive-based compensation. On the other hand, Murphy and Sandino (2010) examine the potential conflicts of interest that remuneration consultants face, which may lead to higher recommended levels of CEO pay. They find ‘evidence in both the US and Canada that CEO pay is higher in companies where the consultant provides other services, and that pay is higher in Canadian firms when the fees paid to consultants for other services are large relative to the fees for executive-compensation services.’
In the US, the Stock Exchange Commission has approved new corporate governance listing standards for the New York Stock Exchange (NYSE) and the NASDAQ. The standards generally apply to any company with listed equity securities.
The provisions include that, from 1st July 2013, compensation committees have to conduct an independence assessment of advisers including compensation consultants and legal counsel from whom they wish to seek advice. A non-independent adviser may still be used but the independence assessment must still be carried out. There are also new, stricter independence criteria for compensation committee members.
Weil, Gotshal & Manges LLP give a useful summary of the new standards in their Alert ‘New NYSE and Nasdaq Listing Standards on Independence of Compensation Committees and Their Advisers: It’s Time to Prepare’ (January 28, 2013, Weil Alert) http://www.weil.com/news/pubdetail.aspx?pub=11491
The role of remuneration consultants and their potential influence on executive remuneration packages has become the focus of more attention in recent years. The new US standards relating to the independence of compensation committees and their advisers go much further than in many countries, including the UK. Time will tell whether other countries follow suit and introduce tougher recommendations and guidelines.
1st February 2013
On Friday 28 September 2012, fellow blogger Christine Mallin and I were on High Table at Clare, the Cambridge college founded in 1326. We were there to celebrate the twentieth anniversary of the refereed research journal Corporate Governance – an International Review.
The current editor1, William Judge (Old Dominion University, Virginia) recognizing the high standing of the journal in academic circles for its rigour, expressed the hope that in the future corporate governance research could become more relevant to the policies and practice of the subject.
Chris Mallin (Norwich Business School, University of East Anglia), who was editor from 2001 to 2007, described the heavy workload involved in editing a refereed journal, the challenge to meet deadlines, and the important contribution of referees.
Having been the founder-editor in 1993, I told stories of the early years. The genesis of the journal had come many years earlier. In the 1970’s audit committees of independent outside directors had become popular in the United States, not least as a hedge against potential litigants, who eyed auditors’ insurance-backed ‘deep pockets’ for damages. In 1978, Deloittes in London had asked me to consider the relevance of audit committees to the UK. I discovered that, although in principle they might be a good idea, in practice they would not work in Britain because the concept of independence among non-executive directors was unknown. The resultant report was published as The Independent Director2.My interest in boards and directors had been kindled.
But that spark was fanned by my experiences as Director of the Oxford Centre for Management Studies, a company limited by guarantee, whose governing body consisted of an equal number of heads of Oxford colleges and leaders of British business. I was astounded by the incredible behaviour of some members, who wielded power, with prejudice and passion. This was not the rational decision-making or analytical management theory we were teaching in the management centre. I realised that governance was different from management. It was about power.
The opportunity to explore the subject came with a subsequent five year research fellowship at Nuffield College, Oxford. I titled the resultant book Corporate Governance3, but wondered about that phrase ‘corporate governance’; after all I had called the trust set up to fund the research the Corporate Policy Group. My worries were not resolved when I sat next to a visitor at High Table in Nuffield, whom I learned later was a professor of ancient English. Commenting, rather stupidly, that I had just written a book, he asked the title. “Corporate Governance”, I said. “You mean corporate government?” he queried. “No,” I replied, “its corporate governance. I looked the word up.” “My dear fellow,” he said, “governance, good gracious, governance, that word has not been used since the time of Chaucer.” It turned out that was not strictly true, but I did lose some confidence. Subsequently, Sir Adrian Cadbury was gracious enough to say that the book had introduced him to the phrase, which he used for his seminal report4, which, of course, was the forerunner of corporate governance codes around the world.
The Oxford publisher Blackwells then approached me to edit an academic journal on the subject. The first edition of Corporate Governance – an International Review was published in January, 1993. Members of the distinguished editorial board included Adrian Cadbury and other authors who would make major contributions to the subject including Thomas Clarke, Philip Cochran, Ian Hay Davison, Ada Demb, Charles Handy, Jay Lorsch, Fred Neubauer, Bernard Taylor, and Steven Wartick.
On a less anecdotal note, I hoped that in the future, Corporate Governance – an International Review could become a conduit to link today’s parallel universes of corporate governance research and corporate governance practice. I concluded with thanks and best wishes for every success to the publishers, subscribers, editors, members of the editorial board, reviewers, and, of course, the contributors, for the next twenty years.
10 October 2012
1 From 1 January 2013, Alessandro Zattoni (Bocconi University, Italy) and Praveen Kumar (University of Houston, USA) will become joint editors. William Judge will remain on the Editorial Advisory Board
2 Tricker, R. I., The Independent Director, Tolley, London, 1978
3 Tricker, R. I., Corporate Governance – practices, procedures and powers in British companies and their boards of directors, Gower, Aldershot, UK, 1984
4 Cadbury, Adrian (Chairman of the Committee), The Financial Aspects of Corporate Governance, Gee, London,1992
Serious study of corporate governance is relatively new. Early books on the work of directors and boards date back no more than forty years and the subject only acquired its title in the mid 1980s. Throughout the 20th century, the focus of attention was not on corporate governance but on management. Marketing, production, finance, operations research, and management information systems were at the forefront of interest. Organizational studies forged ahead, but the board of directors seldom appeared on the organization chart.
Now corporate governance has become the focus for the 21st. century. True, the US Securities and Exchange Commission had existed since 1934, promoting sound corporate regulation and reporting practices. But that was before the collapse of Enron, the world-wide implosion of Arthur Andersen, and the sub-prime financial catastrophe. Corporate scandal and collapse in the 1980s led to the first corporate governance code: the UK’s Cadbury Report. This seminal work soon led to codes in other countries around the world.
These codes, however, tended to concentrate on form rather than function, emphasizing the importance of independent outside directors, the need for audit, remuneration, and nomination committees of the board, and the separation of the role of the board chairman from the CEO. More recently, enterprise risk assessment, and corporate social responsibility have been added to the lexicon. Corporate governance reports were required confirming that public companies had complied with the code or, if not, explaining why. With the emphasis on structure, little concern was shown for the process of corporate governance: what actual goes on inside the board room, the leadership style of the chairman, internal political manoeuvres, and directors’ inter-personal behaviour when strong personalities meet.
Corporate governance is about the way power is exercised over corporate entities.
It involves the behaviour of boards and their directors, the interaction between the governing body and management, the company’s links with its shareholders and other players in the stock market, and the relations between the company and its many stakeholders. It involves strategy formulation and policy making on the one hand, and executive supervision and accountability on the other.
Corporate governance codes have been incorporated into the rules of many stock exchanges and compliance has become a requirement for listing. They have developed and reinforced good governance structures. But have they changed corporate behaviour?
Have the codes worked?
The corporate governance codes have certainly been a force for improving governance structures, procedures, and reporting. But the codes have not changed perceptions of corporate behaviour. Consider a few cases.
- BP, the oil company, published policies on corporate social responsibility and sustainability, yet lost over half its share value following the Deepwater Horizon oil-rig debacle in the Gulf of Mexico.
- Companies claiming to be good corporate citizens have been criticized for ‘aggressive’ tax avoidance by moving their profits, legally but questionably, through offshore tax havens.
Despite companies’ declared commitment to corporate social responsibility, publishing ethics codes and compliance reports, concerns about business ethics are widespread and serious. Around the world, the behaviour of companies, the attitudes of their directors and the actions of key executives have come under the public spotlight. Fraudulent management in Australia’s HIH Insurance, the world-wide collapse of auditors Arthur Andersen, corruption in Italy’s Parmalat, allegations of bribery against BAE Systems in Europe, the rigging of Libor interest rates by British banks and, of course, excessive risk taking by financial institutions around the world that sparked the global economic crisis, provide just a few examples.
Critics of business behaviour point to fraud, bribery and corruption. They allege price-rigging, pollution, and counterfeiting. They see arrogance, greed, and abuse of power by those at the top of companies. Some are cynical about business behaviour. How can you trust these people, they ask? Protestors challenge the basis of capitalism. For them, business ethics has become an oxymoron, citing corporate avarice, disparity of wealth, and excessive director remuneration that does not reflect corporate performance.
Yet business exists by satisfying customers, creating employment, and generating wealth. Business provides the taxes that society needs to function. Many companies accept a social responsibility to be sound corporate citizens. They recognize that they have a duty to respect the interest of all the stakeholders who might be affected by their actions. Many also seek a sustainable, environmentally friendly approach to their operations. To those who doubt whether modern business can be trusted, they point out that business dealings and the very concept of the limited-liability company are based on trust. Not everyone is convinced.
Since the 19th century, the underpinning of corporate governance has been company law, with ownership as the basis of power. Shareholder members of the company appoint directors, approve the directors’ reports and financial accounts, receive the report of the auditors, and approve dividends. The fiduciary duty of the directors is to be stewards for their shareholders’ interests. The reality, as we all know, is very different, particularly in large, international, listed companies. It is the directors, not the shareholders, who wield the power over the corporate entity, despite valiant attempts by institutional investors to regain the initiative.
Meanwhile, interest in business ethics seems to be at an all time high. The subject of business ethics has grown significantly, with interest focusing on corporate citizenship, companies’ social responsibilities, and their relations with stakeholders. More recently, green credentials and sustainability have been added to the agenda. But business ethics is not just about corporate citizenship: business ethics are basic to running successful business.
Ethics and the corporate governance codes
Ethics are hardly mentioned in the corporate governance codes, yet the examples just cited all raise ethical issues. They concern the way those companies were governed, how power was exercised over them, and the way business risks were taken. In other words, business ethics are inherently part of corporate governance. They are not an optional exercise in corporate citizenship.
Ethics involve behaviour. Business ethics concern behaviour in business and the behaviour of business. Decisions at every level in a company have ethical implications – strategically in the board room, managerially throughout the organization, and operationally in each of its activities. Ethical risks abound, whether decisions are at the strategic, managerial, or operational level.
Corporate entities, though granted many of the legal powers of human beings, have no moral sense. The board has to provide the corporate conscience. Directors set the standards for their organization, provide its moral compass. British-based Barclays bank was fined £290 million by US and UK regulators for colluding with other banks to rig the interest rates set for loans between them. Misstating the rate improved the financial standing of the bank and increased traders’ bonuses. The British regulator said that “the misconduct was serious, widespread and extended over a number of years…There was a cultural tendency to always be pushing the limits… a culture of gaming, and gaming us. The problem came from the tone at the top.” Every organization’s culture is fashioned by its board and top management.
Ultimately, the board of directors and top management are responsible for the ethical behaviour of their enterprise. The board of directors with top management are responsible for establishing their company’s risk profile, determining the acceptable level of risk. Some companies accept higher levels of risk than others. Determining the acceptable exposure to ethical risk needs to be part of every organization’s strategy formulation, policy making, and enterprise risk management.
With moral dilemmas in business it is often not a matter of right or wrong, but what’s best for all concerned, both in the company and among all those affected by its actions. Boards have to recognize issues and make choices. This is a function of corporate governance, which needs to be built on the bedrock of business ethics. It seems likely that future codes of corporate governance will find their foundations in ethics.
As reported in an earlier blog post (5th July 2010), the Financial Reporting Council (FRC) issued the UK Stewardship Code in the summer of 2010 with the aim of enhancing ‘the quality of engagement between institutional investors and companies to help improve long-term returns to shareholders and the efficient exercise of governance responsibilities’.
The principles of the UK Stewardship Code are:
Principle 1: Institutional investors should publicly disclose their policy on how they will discharge their stewardship responsibilities.
Principle 2: Institutional investors should have a robust policy on managing conflicts of interest in relation to stewardship and this policy should be publicly disclosed.
Principle 3: Institutional investors should monitor their investee companies.
Principle 4: Institutional investors should establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value.
Principle 5: Institutional investors should be willing to act collectively with other investors where appropriate.
Principle 6: Institutional investors should have a clear policy on voting and disclosure of voting activity.
Principle 7: Institutional investors should report periodically on their stewardship and voting activities.
To what extent have asset managers, asset owners and service providers complied with the recommendations of the Stewardship Code? Several reports have been produced which detail the level of compliance.
Level of compliance
The FairPensions (2010) survey analysed 29 of the largest asset managers and found that 24 of these had published a formal statement/response with respect to the Stewardship Code. An additional four (Insight, Invesco, Morgan Stanley and State Street) had posted short statements on their website referring to the Code. FairPensions reviewed the 24 compliance statements to assess the quality of disclosures made with respect to the Code.
They were disappointed as they felt that the investors’ statements often gave ‘tick-box’ responses to the Stewardship Code principles whereas it was an opportunity to “tell their story” as to how they monitor companies and incorporate stewardship activity into their wider investment process. http://www.fairpensions.org.uk/sites/default/files/uploaded_files/whatwedo/StewardshipintheSpotlightReport.pdf
The Investment Management Association (IMA) (2011) survey of adherence to the Stewardship Code analysed the questionnaire responses from 41 asset managers, seven asset owners and two service providers. The questionnaire was developed with the oversight of a Steering Group chaired by the FRC’s Chief Executive. The IMA (2011) survey covered the period to 30 September 2010 and showed widespread adherence by 50 UK institutional investors to the best practice set out in the FRC’s Stewardship Code. The IMA reported:
“Over 90% of major institutional investors now vote all or the great majority of their shares in UK companies; nearly two thirds now publish their voting records.
At the time the survey was conducted, 43 out of 50 respondents had published a statement on adherence to the Code, and another six did so subsequently.
Over 1,300 people focusing on stewardship activities are employed by 43 of the respondents to the survey.”
The FRC (2011) published Developments in Corporate Governance 2011, The Impact and Implementation of the UK Corporate Governance and Stewardship Codes, FRC, London.
They reported that, as of December 2011 the Stewardship Code had attracted 234 signatories, including 175 asset managers, 48 asset owners and 12 service providers23. This level of take-up indicates that the concept of stewardship is being taken seriously. Importantly there has been a wide base of support for the Stewardship Code including from both large and small institutional investors.
There seems to be rather mixed evidence as to whether institutional shareholders are engaging more with their investee companies since the Stewardship Code was introduced. However over time it is to be expected that overall there will be a higher level of engagement.
Reasons for non-compliance
Organisations not complying with the Stewardship Code tend to fall into two groups: (i) those not signing based on their specific investment strategy, and (ii) those who do not commit to codes in individual jurisdictions.
The FRC proposes to make limited revisions to both the UK Corporate Governance Code and the Stewardship Code which, subject to consultation, will take effect from 1st October 2012. As far as the Stewardship Code is concerned, they FRC state that it is ‘not currently envisaged that new principles will be introduced but it may be helpful to clarify the language in certain places, for example on the different role of asset managers and asset owners.’
Areas where the FRC might consider strengthening the language include conflicts of interest, collective engagement, and the use of proxy voting agencies, and possibly a recommendation that investors disclose their policy on stock lending.
Finally a Stewardship Working Party has been formed consisting of Aviva Investors, BlackRock, Governance for Owners, Railpen Investments, Ram Trust and USS together with Tomorrow’s Company. They will determine whether it is possible to devise a “scale of stewardship” which would enable institutions to differentiate themselves.
Chris Mallin 8th March 2012
In September 2011, the Corporate Secretaries International Association (CSIA) hosted an international corporate governance conference in Shanghai, jointly with the Shanghai Stock Exchange. CSIA represents over 100,000 governance practitioners worldwide through its 14 company secretarial member organizations. Speakers and panellists from Africa, Australia, mainland China, Hong Kong SAR, India, the UK and the US plus delegates from the 14 CSIA member countries discussed the cultural dependence of corporate governance. For more information on CSIA see http://www.csiaorg.com
The conference considered whether corporate governance principles and practices around the world were converging. Would a set of world-wide, generally-accepted corporate governance principles eventually emerge? Or was differentiation between corporate governance practices inevitable because of fundamental differences in country cultures?
Speaking at the conference the writer of this blog suggested that:
“A decade or so ago, it was widely thought that corporate governance practices around the world would gradually converge on the United States model. After all, the US Securities and Exchange Commission had existed since 1934, sound corporate regulation and reporting practices had evolved, and American governance practices were being promulgated globally by institutional investors. But that was before the collapse of Enron, Arthur Andersen, the sub-prime financial catastrophe, and the ongoing global economic crisis. A decade ago it was also believed that the world would converge with US practices because the world needed access to American capital. That is no longer the case. So the convergence or differentiation question remains unanswered.
Forces for convergence
“Consider first some forces that are leading corporate governance practices around the world to convergence.
Corporate governance codes of good practice around the world have a striking similarity, which is not surprising given the way they influence each other. Though different in detail, all emphasise corporate transparency, accountability, reporting, and the independence of the governing body from management, and many now include strategic risk assessment and corporate social responsibility. The codes published by international bodies, such as the World Bank, the Commonwealth of Nations, and OECD, clearly encourage convergence. The corporate governance policies and practices of major corporations operating around the world also influence convergence.
Securities regulations for the world’s listed companies are certainly converging. The International Organisation of Securities Commissions (IOSCO), which now has the bulk of the world’s securities regulatory bodies in membership, encourages convergence. For example, its members have agreed to exchange information on unusual trades, thus making the activities of global insider trading more hazardous.
International accounting standards are also leading towards convergence. The International Accounting Standards Committee (IASC) and the International Auditing Practices Committee (IPAC) have close links with IOSCO and are further forces working towards international harmonization and standardization of financial reporting and auditing standards. US General Accepted Accounting Principles (GAAP), though some way from harmonization, are clearly moving in that direction.
In 2007, The US Securities and Exchange Commission announced that US companies could adopt international accounting standards in lieu of US GAAPs. However, American accountants and regulators are accustomed to a rule-based regime and international standards are principles-based requiring judgement rather than adherence to prescriptive regulations.
Global concentration of audit for major companies in just four firms, since the demise of Arthur Andersen, encourages convergence. Major corporations in most countries, wanting to have the name of one of the four principal firms on their audit reports, are then inevitably locked into that firm’s world-wide audit, risk analysis and other governance practices.
Globalisation of companies is also, obviously, a force for convergence. Firms that are truly global in strategic outlook, with world-wide production, service provision, added-value chain, markets and customers, which call on international sources of finance, whose investors are located around the world, are moving towards common governance practices.
Raising capital on overseas stock exchanges, also encourages convergence as listing companies are required to conform to the listing rules of that market. Although the governance requirements of stock exchanges around the world differ in detail, they are moving towards internationally accepted norms through IOSCO.
International institutional investors, such as CalPers, have explicitly demanded various corporate governance practices if they are to invest in a specific country or company. Institutional investors with an international portfolio have been an important force for convergence. Of course, as developing and transitional countries grow, generate and plough back their own funds, the call for inward investment will decline, along with the influence of the overseas institutions.
Private equity funding is changing the investment scene. Owners of significant private companies may decide not to list in the first place. Major investors in public companies may find an incentive to privatise. Overall the existence of private equity funds challenges boards of listed companies by sharpening the market for corporate control.
Cross-border mergers of stock markets could also have an impact on country-centric investment dealing and could influence corporate governance expectations; as could the development of electronic trading in stocks by promoting international securities trading.
Research publications, international conferences and professional journals can also be significant contributors to the convergence of corporate governance thinking and practice.
Forces for differentiation
“However, despite all these forces pushing towards convergence, consider others which, if not direct factors for divergence, at least cause differentiation between countries, jurisdictions and financial markets.
Legal differences in company law, contract law and bankruptcy law between jurisdictions affect corporate governance practices. Differences between the case law traditions of the US, UK and Commonwealth countries and the codified law of Continental Europe, Japan, Latin America and China distinguish corporate governance outcomes.
Standards in legal processes, too, can differ. Some countries have weak judicial systems. Their courts may have limited powers and be unreliable. Not all judiciaries are independent of the legislature. The state and political activities can be involved in jurisprudence. In some countries bringing a company law case can be difficult and, even with a favourable judgement, obtaining satisfaction may be well nigh impossible.
Stock market differences in market capitalisation, liquidity, and markets for corporate control affect governance practices. Obviously, financial markets vary significantly in their scale and sophistication, affecting their governance influence.
Ownership structures also vary between countries, with some countries having predominantly family-based firms, others have blocks of external investors who may act together, whilst some adopt complex networked, leveraged chains, or pyramid structures.
History, culture and ethnic groupings have produced different board structures and governance practices. Contrasts between corporate governance in Japan with her keiretsu, Continental European countries, with the two-tier board structures and worker co-determination, and the family domination of overseas Chinese, even in listed companies in countries throughout the Far East, emphasise such differences. Views differ on ownership rights and the basis of shareholder power.
The concept of the company was Western, rooted in the notion of shareholder democracy, the stewardship of directors, and trust – the belief that directors recognise a fiduciary duty to their company. But today’s corporate structures have outgrown that simple notion. The corporate concept is now rooted in law, and the legitimacy of the corporate entity rests on regulation and litigation. The Western world has created the most expensive and litigious corporate regulatory regime the world has yet seen. This is not the only approach; and certainly not necessarily the best. The Asian reliance on relationships and trust in governing the enterprise may be closer to the original concept. There is a need to rethink the underlying idea of the corporation, contingent with the reality of power that can (or could) be wielded. Such a concept would need to be built on a pluralistic, rather than an ethnocentric, foundation if it is to be applicable to the corporate groups and strategic alliance networks that are now emerging as the basis of the business world of the future.
Around the world, the Anglo-Saxon model is far from the norm. A truly global model of corporate governance would need to recognise alternative concepts including:
- the networks of influence in the Japanese keiretsu
- the governance of state-owned enterprises in China, where the China Securities and Regulatory Commission (CSRC) and the State-owned Assets Supervision and Administration Commission (SASAC) can override economic objectives, acting in the interests of the people, the party, and the state, to influence strategies, determine prices, and appoint chief executives
- the partnership between labour and capital in Germany’s co-determination rules
- the financially-leveraged chains of corporate ownership in Italy, Hong Kong and elsewhere
- the power of investment block-holders in some European countries
- the traditional powers of family-owned and state-owned companies in Brazil
- the domination of spheres of listed companies in Sweden, through successive generations of a family, preserved in power by dual-class shares
- the paternalistic familial leadership in companies created throughout Southeast Asia by successive Diaspora from mainland China
- the governance power of the dominant families in the South Korean chaebol, and
- the need to overcome the paralysis of corruption from shop floor, through boardroom, to government officials in the BRIC and other nations.
The forces for convergence in corporate governance are strong. At a high level of abstraction some fundamental concepts have already emerged, including the need to separate governance from management, the importance of accountability to legitimate stakeholders, and the responsibility to recognize strategic risk. These could be more widely promulgated and adopted. But a global convergence of corporate governance systems at any greater depth would need a convergence of cultures and that seems a long way away.