Boards need ability not diversity

Corporate governance thinking does not evolve: it skips from one topic to the next.  Ideas in corporate governance are like memes: they convey ideas just as genes convey physical characteristics, as I wrote on this blog some time ago.  These memes permeate thinking, and with today’s instant communication flash around the world, become the conventional wisdom.

A couple of years ago the theme was risk.  Cadbury and the early corporate governance codes had nothing to say about risk. Now boards needed to recognize their responsibility for identifying their company’s risk profile, assessing long-term strategic risk, and ensuring that appropriate risk policies were in place and working.  Risk had become a central issue in corporate governance.

More recently, it was culture- although commentators seemed unable to agree on what they meant by culture.  In March this year, I wrote in this blog that culture ‘can be thought of as the beliefs, expectations and values that people share’.  Like the skins of an onion, culture has many layers – national, regional, corporate cultures, and the culture of the board room.  Recent commentary about culture in corporate governance thinking has focused on board-level culture, which sets the tone throughout the organization and provides its moral compass.  Board-level culture reflects the experience, beliefs and expectations of the board members, particularly the leadership style of the board chairman and the effect of any dominant personalities on the board.

Introducing the concept of culture into corporate governance adds new dimensions, with behavioural, political, and psychological aspects that are difficult to identify, let alone quantify.  In February 2017, the UK Department for Business, Energy, and Industrial Strategy (BEIS) published a report on corporate governance reform that identified culture as ‘the central tenet of good corporate governance (which) should be embedded in the culture of all companies, so that it permeates activity at every level and in every sphere.’  Fine: but what does that actually mean?  What are boards expected to do to make the concept operational?

On board diversity

Now the focus has shifted again: board diversity has come into the spotlight. Again, however, ideas differ on what board diversity means.  The time has come for some clearer thinking.

It seems that most people, when talking about board diversity, mean gender diversity: the need to have more women directors.  That case seems clear and, around the world, efforts are being to increase the proportion of women on boards through mandatory quotas or voluntary targets. The challenge is to increase the pool of women with executive management experience. The BEIS report, mentioned above, recommends that ‘the UK Government should set a target that from 2020 at least half of all new appointments to senior and executive management level positions in all listed companies should be women’.

To others, however, board diversity means something quite different.

The UK’s Financial Reporting Council; welcoming the Hampton/Alexander report in November 2016, wrote that it:

‘looked forward to working with the review team to improve reporting on diversity. In light of the current public debate on corporate governance, we stand ready to revise the UK Corporate Governance Code following the Government consultation. Our work on succession planning this year suggested that nomination committees should take a more active interest in talent management, in particular that initiatives are in place to develop the talent pipeline and to promote diversity in board and executive appointments. To better inform boards about the link between diversity, strategy and developing the business, more consideration should be given to the nature, variety and frequency of interaction between the board and aspiring candidates at all levels.’
The BEIS report also refers explicitly to ‘ethnic diversity’ and recommends further measures ‘to ensure that diversity is promoted at all stages of careers to broaden the pool of talent at the executive level.’  The report further calls for ‘companies [to] recruit executive and non-executive directors from the widest possible base’. The report concludes with a rallying cry: ‘Overall, [our] recommendations are aimed at permanently ingraining the values and behaviours of excellent corporate governance into the culture of British business.’

Before we all rally to this banner, more clarity of thought is needed.

 

What is the purpose of the board of directors?

The role of the board of directors, indeed the role of the governing body of every organization, is to govern.  To put it in the vernacular, corporate governance means ensuring that the enterprise is being well run and that it is running in the right direction.  This is quite different from managing the business, as I have written many times in this blog. In essence, the governance of a company includes overseeing the formulation of its strategy and policy making, supervision of executive performance, and ensuring corporate accountability. Overall, the purpose of the board is to ensure that the company meets its objectives.

But that exposes a deeper question: what is the real purpose of a profit-orientated company?  The answer has not changed since the classical nineteenth century model of the joint-stock limited-liability company was invented: to create wealth, by providing employment, offering opportunities to suppliers, satisfying customers, and meeting shareholders’ expectations.

Companies meet their societal obligations by paying taxes, adopting socially responsible policies, and obeying the law of the lands in which they operate. Companies should not be seen as vehicles for social engineering.  The board does not need to reflect the structure of society.

Admittedly, the UK Companies’ Act does call for companies to recognize the interests of other stakeholders, including employees, suppliers and customers: though it is hard to see how a company could survive by ignoring them.   Stakeholder Senates, which I suggested in this blog preciously, could provide employee, market, and societal input to board deliberations, could include representatives of young and old, poor and rich, ethic and other minorities.

To fulfil the company’s primary purpose of creating wealth, a board does not need to reflect society. It needs people who can contribute effectively to its governance. In other words, the qualities needed to be a director are the experience, knowledge, and ability relevant to governing that company, backed up in a fast-moving business environment with the ability to continue to learn and adapt. Companies are often competing with other companies around the world, whose directors are experienced professionals, in China for example.

Attempts by the UK’s FRC to revise the corporate governance code needs to be clear on the proper role of the board of directors.  Ability at board level is vital for corporate success; social diversity has nothing to do with it.

Bob Tricker, October 2017

The views expressed in this blog are those of the author and are not necessarily those of the Oxford University Press, or fellow blogger Professor Chris Mallin.

 

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British Airways loses IT – a case study

British Airways (BA) used to be called ‘the worlds favourite airline.’  Not any more.   On May 27 2017, a world-wide systems failure grounded all BA flights.  Check-in desks at London’s Heathrow and Gatwick and other airports around the world were unable to access passenger details.  470 flights were cancelled in London and a further 183 on the following day, with many more flights stranded around the world. Tens of thousands of passengers were left standing around for hours with no information, until being told to ‘come back tomorrow’.  BA airport staff seemed unprepared for the huge numbers of stranded passengers. BA web sites and inquiry operators had little information, other than that all flights had been cancelled. Passenger baggage piled up and did not reach them for days.  Compensation claims for delays and lost baggage were estimated at over £100 million.   The reputation loss for BA was immeasurable.

Although some immediately thought this must be a cyber attack, it was not.  BA’s initial explanation for the systems breakdown was loss of power to servers on the central reservation system. Other systems reliant on access to passenger data, including the flight loading system and the baggage handling system, then shut down.

IT experts suggested that with such sophisticated systems, BA must have included back-up power supplies.  Indeed they had, but it emerged that the power had failed totally because a maintenance worker had turned it off.  The back-up systems, a generator and batteries were working perfectly.  Then, once power was restored, efforts to re-boot the systems were bungled.

Some BA ex-employees, who had been laid off as a result of a head office cost cutting drive, suggested that the heart of the problem was a decision to out-source IT work to an Indian company.  ‘The BA system is a legacy system that has evolved over generations of equipment and software changes,’ they said. ‘The inter-relatedness of the systems and the complexity of the data is immense.  BA needed people who had grown up with the system.  This is not the first time the system has failed this year.’  BA denied this suggestion.

British Airways, once the country’s flag-carrier, is now a subsidiary of the International Airline Group (IAG), a Spanish company, which also owns Iberia, the Spanish airline.  IAG’s shares had risen significantly in the previous year and suffered only a small fall following the BA systems saga.

The CEO of IAG, Willie Walsh (who had previously headed BA) did not appear during the crisis, leaving the situation to be handled by BA’s CEO, Alex Cruz.  They were both criticised for delays in offering explanations or apologies.  An official raised a storm by suggesting that passengers would receive full refunds on their tickets, but BA would not pay for the cost of missed connecting flights, alternative travel arrangements, or accommodation.

Subsequently, BA apologised to its customers and commissioned an independent inquiry.  The British airlines’ regulator, the Civil Aviation Authority, was also called on to examine the case.

At the previous AGM of IAG, shareholders had received a letter from a corporate governance advisory group that ‘the board should consider bolstering the IT experience of its non-executive cohort: only one of the serving non-executive directors has IT experience.’

 

Discussion questions:

  1.  Who was responsible for this debacle?
  2. How might such a situation have been avoided?

New Developments in UK Corporate Governance

New Developments in UK Corporate Governance

In previous blogs, I discussed the Department for Business, Energy & Industrial Strategy (BEIS) Green Paper on Corporate Governance Reform issued in November 2016 and the BEIS report which detailed its recommendations and conclusions based on the consultation of this Green Paper.  On 29th August 2017, the UK Government published ‘Corporate Governance Reform, The Government Response to the Green Paper Consultation’, available at: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/640631/corporate-governance-reform-government-response.pdf

In the Executive Summary, it states that ‘The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver the long-term success of a company. It involves a framework of legislation, codes and voluntary practices.  A key element is protecting the interests of shareholders where they are distant from the directors running a company. It also involves having regard to the interests of employees, customers, suppliers and others with a direct interest in the performance of a company. Good corporate governance provides confidence that a company is being well run and supports better access to external finance and investment.’

The Executive Summary goes on to say that there are nine headline proposals for reform across the three specific aspects of corporate governance on which they consulted, ‘these being executive pay;  strengthening the employee, customer and supplier voice; and corporate governance in large privately-held businesses. It also takes into account the need for effective enforcement of the corporate governance framework.’

Of particular note are that all listed companies will have to reveal the pay ratio between bosses and workers; all listed companies with significant shareholder opposition to executive pay packages will have their names published on a new public register;  and new measures will seek to ensure employee voice is heard in the boardroom.

https://www.gov.uk/government/news/world-leading-package-of-corporate-governance-reforms-announced-to-increase-boardroom-accountability-and-enhance-trust-in-business

 

George Parker highlighted the emphasis on boardroom pay in his article ‘May maintains focus on boardroom pay’ (Financial Times, 26th/27th August 2017, page 2). The High Pay Centre welcomes the requirement for all listed companies to publish their pay ratios ‘Most significant of all, from our point of view, was the announcement that the pay ratio between the CEO and the average UK employee will now have to be published by every listed company. We have never claimed that this measure will solve the problem of excessive pay at the top, nor that it will suddenly halt and reverse a trend that has developed over 20 years and more. Unfair or misleading comparisons between pay ratios in very different businesses or organisations should not be made. But finally we will have a meaningful way of tracking the gap in pay between the top and the average employee. Shareholders and other stakeholders will be able to scrutinise these gaps and apply pressure to close them. And this can be done, of course, not just by restraining pay at the top but raising pay for those lower down the scale.’ (Stefan Stern September Update, High Pay Centre).

The Financial Reporting Council (FRC) will be undertaking a consultation on a fundamental review of the UK Corporate Governance Code later this year as the 25th anniversary of the UK Corporate Governance Code approaches later in 2017.

 

Chris Mallin

September 2017

On board culture and diversity

Corporate governance thinking and practice seems to evolve either as regulators respond to corporate failings or directors adopt the prevailing conventional wisdom.  A year or two ago, the call was for boards to recognize their responsibility for identifying their company’s risk profile, assessing long-term risk, and ensuring appropriate risk  strategies and policies were in place and working appropriately.   Cadbury and the other early corporate governance codes had nothing to say about risk: now it has become a central issue.

Today, the conventional wisdom is focusing on board culture and board diversity.  But commentators seem unable to agree on what is actually meant by culture or diversity.  The time has come for some clearer thinking.

In March this year, I wrote in this blog that culture ‘can be thought of as the beliefs, expectations, and values that people share.  Like the skins of an onion, culture has many layers – national cultures, regional cultures, the culture of a company, and the culture in a board room.’  Much of the recent commentary about culture in corporate governance has focused on board level culture and its reflection on the culture of the company. so that it permeates activity at every level and in every sphere.

In its February 2017 report on corporate governance reform[1], the UK Department for Business, Energy and Industrial Strategy identified culture as ‘the central tenet of good corporate governance (which) should be embedded in the culture of all companies, so that it permeates activity at every level and in every sphere.’  Now what does that actually mean?  What do directors need to do to make it operational?

Board level culture depends on the experience, beliefs and expectations of those involved and, in particular on the leadership of the bard chairman and any other dominant personalities on the board.

Composition of boards

Companies should recruit executive and non-executive directors from the widest possible base.

The Report supports the recommendations of recent reviews on gender and ethnic diversity but recommends further measures ‘to ensure that diversity is promoted at all stages of careers to broaden the pool of talent at the executive level. To this end, the Government should set a target that from May 2020 at least half of all new appointments to senior and executive management level positions in the FTSE350 and all listed companies should be women.’ Overall, the Report’s recommendations are aimed at permanently ingraining ‘the values and behaviours of excellent corporate governance into the culture of British business.’

 

[1] For more information see the most recent blog from Professor Chris Mallin on this website.

The Way Forward for UK Corporate Governance

In a previous blog, I discussed the Department for Business, Energy & Industrial Strategy (BEIS) Green Paper on Corporate Governance Reform issued in November 2016. I mentioned that there were 14 Green Paper questions with six relating to executive pay, three to strengthening the employee, customer, and wider stakeholder voice, and five relating to corporate governance in large, privately-held businesses. The consultation closed on 17th February 2017 and subsequently the BEIS has published a report which details its recommendations and conclusions based on the consultation, available at: https://www.publications.parliament.uk/pa/cm201617/cmselect/cmbeis/702/70209.htm

It is worth noting that the Report continues to support the ‘comply or explain’ basis of UK corporate governance. However the Report does propose a number of reforms aimed at ensuring that directors take their duties more seriously and comply with both the law and the UK Corporate Governance Code. These reforms include ‘requirements relating to more specific and accurate reporting, better engagement between boards and shareholders, and more accountable non-executive directors. Crucially, to combat what are currently very weak enforcement mechanisms, we recommend a wide expansion in the role and powers of the Financial Reporting Council, to enable it to call out poor practice and engage with companies to improve performance.’

 

 Importance of company culture

Culture is seen as an important aspect ‘the central tenets of good corporate governance should be embedded in the culture of all companies, so that it permeates activity at every level and in every sphere. It is cultural evolution, in line with the spirit of the Cadbury Report, that should be the long-term goal of Government, investors and companies.’

 

Promoting good corporate governance

There are a number of recommendations aimed at promoting good corporate governance.  These include, inter alia, that directors should provide more informative narrative reporting in relation to their duties under Section 172 of the Companies Act 2006 including explaining how they have considered each of the different stakeholder interests, such as employees, customers and suppliers and how this has been reflected in the company’s financial decisions; that the Financial Reporting Council (FRC) should work with companies to develop a new corporate governance rating which would publicise ‘examples of good and bad practice in an easy to digest red, yellow and green assessment; companies would be obliged to include reference to this rating in their annual reports’; the Financial Reporting Council should be given additional powers to engage and hold company directors to account in respect of their duties. Enhancing the dialogue between boards and investors is discussed as is the relationship between the board and the company’s stakeholders.

 

Private companies

A new governance Code should be developed for the largest private companies which are subject to weaker reporting requirements. The new Code should include a complaint mechanism so that any complaints raised about compliance with the Code could be followed up with the individual companies concerned.

 

Pay

A simpler pay structure is recommended, the constituents being salary, bonus relating to stretching targets, and payment by means of equity over the long-term. Complex long-term incentive plans which may have unintended consequences would be abolished. An option for employee representation on remuneration committees would be included in the Code, furthermore the Report states that it expects leading companies to adopt this approach.

 

Composition of boards

Companies should recruit executive and non-executive directors from the widest possible base.

The Report supports the recommendations of recent reviews on gender and ethnic diversity but recommends further measures ‘to ensure that diversity is promoted at all stages of careers to broaden the pool of talent at the executive level. To this end, the Government should set a target that from May 2020 at least half of all new appointments to senior and executive management level positions in the FTSE350 and all listed companies should be women.’ Overall, the Report’s recommendations are aimed at permanently ingraining ‘the values and behaviours of excellent corporate governance into the culture of British business.’

 

Consultation responses

Originally it was thought that the responses to the consultation would be made available in collated format and the anonymity of individual responses would be retained. However, individual responses to the consultation are listed at: https://www.publications.parliament.uk/pa/cm201617/cmselect/cmbeis/702/70214.htm

and individual responses can be viewed at: http://www.parliament.uk/business/committees/committees-a-z/commons-select/business-energy-industrial-strategy/inquiries/parliament-2015/corporate-governance-inquiry/publications/

 

Chris Mallin

July 2017

Corporate Governance in China

 

In a recent posting on this blog, I wrote about the Chinese government’s attempt to exert more control over state owned enterprises (SOEs).   That led to some questions about how SOEs were actually governed.  Since I am currently involved in an ongoing study of corporate governance in China with a Hong Kong colleague, Dr Gregg Li, a brief summary of the evolution of corporate governance ‘with a Chinese face’ may be of interest.

 

The People’s Republic of China (PRC) was established in 1949, by Mao Tse Tung, following the defeat of the Nationalist Army under Chiang Kai Shek and its retreat to Taiwan.   Mao founded the PRC and remained Chairman of the Chinese Communist Party from 1949 until his death in 1976.

 

Over that period, the state proclaimed ownership of the means of production, prohibited private property, and banned incorporated companies.  In 1958, Chairman Mao initiated the Great Leap Forward, relocating millions of farmers, peasants, and city workers. Massive economic dislocation and famine resulted. The Cultural Revolution began in 1966 and lasted a decade. Communes were reorganized and state-owned enterprises (SOEs) were created, most relying on state subsidies.

 

In the 1970s, Mao’s successor as paramount leader, Deng Xiao Ping, introduced a pragmatic form of market economy, whilst still maintaining an orientation towards a centralized communist state.  The industrial SOEs, which were large bureaucracies, continued to receive their production and distribution orders from state planners.  Employees of the SOEs received housing, medical care, and schooling for their children.  Deng stood down in 1989, and is now recognized as the initiator of the changes that led to the subsequent incredible economic growth up to the present day.

 

In 1988, the State Council of the PRC, advised by experts from the Organization for Economic Co-operation and Development (OECD), produced a set of corporate governance directives for SOE reform.  In September 1999, the Fourth Plenary Session of the 15th Chinese Communist Party’s Central Committee took a vital decision on enterprise reform, in what was termed a ‘strategic adjustment’ of the state sector, it was agreed that that ‘the state should be withdrawing from what should be withdrawn’.  Interestingly, corporate governance was recognized as being at the core of the modern enterprise system.

 

A new companies’ law was enacted in 1994, and revised in 2006. Two types of company were created:

  • a ‘limited liability company’ (LLC), with at least two and no more than 50 shareholders, somewhat similar to private companies in other jurisdictions
  • a ‘company limited by shares’, in other words a joint stock company (JSC) with some similarities to public companies in other jurisdictions.

Both types of company were defined as legal persons with shareholder liability for corporate debt limited, and with property rights as well as civil rights and duties.

 

Companies were given autonomy to run their businesses according to the market in order, as the Companies’ Act said: ‘to raise economic efficiency, improve labour productivity, and preserve and increase the value of assets.’  Companies were also called on by the new law ‘to conduct their business activities abiding by the law and by business ethics, strengthen the construction of socialist spiritual civilization and accept the supervision of the government and the public.’  Companies were allowed to invest in other companies and to create groups of companies with subsidiaries and branches.

 

China’s corporate governance rules were influenced by Western experience, including the advice from the OECD, drawing principally from practice, pioneered in countries including the USA, the UK, Germany, and South Africa.  Typically, these countries are democracies with independent judiciaries. In developing and emerging economies, including Russia, Latin American countries and India, corporate governance still tends to be emergent, with the state playing a more significant role, and corruption sometimes being endemic.

 

China stands out as a case on its own.  Government is an oligarchy, exercising considerable central control.  The PRC has developed an innovative corporate governance regime, and in the process became one of the worlds leading economies.

 

The SOEs include vast companies in the oil, telecoms, steel, finance, and other major sectors. In some cases, a minority of their shares are quoted on stock exchanges in Shanghai, Shenzen, or Hong Kong, with a few being floated in London or New York.

 

Although influenced by Western experience, the governance of SOEs is unique.  Separate boards of supervisors and boards of directors were formed, partly reflecting the German two-tier board system, but with independent directors on the board of directors, as in the USA and UK.

 

For decades governance was left to companies, under the overall supervision of the State-Owned Assets Supervision and Administration Commission (SASAC) and the China Securities Regulatory Commission (CSRC).   State involvement at a higher level tended to be distant.  Some felt that the Communist Party’s leadership had been undermined.  But central authorities have recently sought to reassert Party influence over the SOEs, as mentioned in a recent blog.

 

Although SOEs remain central to China’s economy, other types of enterprise evolved with diverse ownership structures and governance practices.  Many of these firms are family businesses but others are run as village or township entities.

 

Although Hong Kong is now part of the PRC, the governance of companies there reflects a quite different story.  Since the mid-nineteenth century, Hong Kong had been a British Protectorate under a lease from Mainland China.  That lease ended In 1997 and Britain transferred its rights over Hong Kong to the PRC, which deemed it a Special Administrative Region of China.

 

Under the British influence, Hong Kong developed its own legislature, an independent judiciary based on UK-style common law, and its own currency linked to the US$.  The Hong Kong Stock Exchange began life in 1891, and now oversees the Hong Kong Corporate Governance Code.  Institutions for company registration and regulation were created, and strong professions were formed – legal, audit, accountancy, finance, and company secretarial.

 

This infrastructure and these institutions remained after the 1997 handover; as the Joint Agreement between the PR: and the UK put it – ‘one country two systems.’ But as the business worlds of China and Hong Kong grow together, some Hong Kong institutions are coming under China’s influence.

 

To reach its present economic and political significance in the world, China has travelled a unique road.  This historical and cultural context means that corporate governance in China has developed a distinct ‘Chinese face,’ unlike anywhere else in the world.  Exploring and understanding the special features of Chinese corporate governance and the challenges they might present in the future is an ongoing project

 

Bob Tricker

May 2017

Shareholder Committees

In a previous blog post, I discussed the Department for Business, Energy & Industrial Strategy (BEIS) Green Paper on Corporate Governance Reform issued in November 2016.

One of the options suggested in the Green Paper in relation to shareholder engagement on pay, was to ‘Establish a senior “shareholder” committee to engage with executive remuneration arrangements’. According to para 1.36, ‘A complementary or alternative way to enable greater shareholder engagement on pay might be to establish a senior Shareholder Committee to scrutinize remuneration and other key corporate issues such as long term strategy and directors’ appointments. The full implications of adapting any such model in the UK, however, would need careful consideration given its potential impact on our long-established unitary board structure.’

The idea of a shareholder committee received support from some organisations including a joint response to the Green Paper from The UK Shareholders’ Association (UKSA) and the UK Individual Shareholders’ Society (ShareSoc).  Both of these organisations represent the interests of private shareholders who invest directly or indirectly via nominee accounts in public companies or in other forms of equity-based investment.

Their joint response stated ‘We strongly support the concept of Shareholder Committees, provided that they represent the interests of all shareholders, including private investors and investors in employee share plans.’ They are of the view that ‘Shareholder  Committees  are  a  core  part  of  the  solution  to  the  problems  of  corporate  governance. There are many  other elements of governance and control that can be improved and we have commented  in  our  response  on  those  where  we  have  specific  knowledge.  However, without Shareholder  Committees,  and  concomitant  reform  to  restore  the  rights  of  individual  shareholders, other changes to corporate governance are unlikely to produce meaningful change.’

However, certain organisations, for example, Tomorrow’s Company, are wary of widening the scope to include issues such as remuneration.  Tomorrow’s Company’s website states that ‘The original idea proposed by Tomorrow’s Company in 2010 was for a Shareholder Committee which would involve shareholders large (and small) in the most important single governance decision – who represents them on boards. Later variants, like this one and that by Chris Philp MP, have widened the scope to involving investors in discussions about remuneration.’ Tomorrow’s Company then points out that ‘The risk of this more complicated approach is that it compromises the clear leadership responsibility of the board.’

 

Royal Bank of Scotland

A case in point is that of the Royal Bank of Scotland (RBS).  With over 70% ownership by UK taxpayers, there is a very real argument that its governance is of interest to the public more generally.  Aime Williams in her article ‘Shareholders clash with RBS’, (1st April 2017, Financial Times) reports that ‘About 160 individual investors are pushing RBS to form a shareholders’ committee, which would allow retail investors to have a formal say on RBS proposals, such as executive pay, company strategy and director appointments.’

However, RBS’ preference is for a stakeholder committee which would allow a wider stakeholder group to have a voice and air any concerns to directors.  A key difference though, is that a stakeholder panel would have less power and therefore would likely be less effective than a shareholder committee, which would be able to wield more influence.

The RBS Annual General Meeting will be held on 11th May 2017.  It will be interesting to see the outcomes of various resolutions, especially on potentially contentious issues such as executive remuneration, and whether a shareholder committee is established in the future.

 

 

Chris Mallin

April 2017

Corporate governance is not management

For many years, I have said that the major focus of business throughout the 20th century was professional management – new management theories, management schools, management consultants, and management gurus – whereas the focus for the 21st century would be governance.   I think we can safely say that this has happened.

Unfortunately, in the process some people are now conflating the two quite different concepts: ‘management’ and ‘governance.’  There is talk about ‘the importance of governance in the NHS’ when the issue is mainly management.  Even the UK government’s consultation on the green paper on the review of corporate governance (see Chris Mallin’s most recent blog) writes: ‘The purpose of corporate governance is to facilitate effective, entrepreneurial, and prudent management that can deliver the long-term success of a company.’

If ‘management’ and ‘governance.’  are used interchangeably, the fundamental distinction between the two  is lost.  The notion of management as a hierarchy is commonplace: the classical management pyramid showing a chief executive officer, or managing director, with overall managerial responsibility and the reporting relationships of the managers down the management hierarchy.  Authority and responsibility are delegated downwards, with matching accountability expected upwards.

The board of directors seldom appears- because the board is not part of the management structure; nor is it a hierarchy.  Each director has equal responsibility and similar duties and powers under the law. There is no executive ‘boss’ of a board.  In a unitary board, that is a board with both executive and non-executive outside directors, the executive directors hold managerial roles in addition to their responsibilities as directors.   As executives, they are employees of the company and employment laws apply.  Directors, as such, are not employees and company laws apply.  Executive directors, of course, wear two hats: and are subject to both company law and employment law.

In the two-tier board structure, the executive board consists entirely of executives and is responsible for management.  The supervisory board consists entirely of outside members and is responsible for governance, including the hiring and firing of management.

In other words, management is responsible for running the business.  The board is responsible for its governance, ensuring that the corporate strategy is appropriate and being achieved, that corporate policies are in place, overseeing management’s performance, and being accountable to investors and other legitimate stakeholders.   Briefly, management runs the business; the board ensures that it is being well run and achieving is objectives. The concepts and the responsibilities of management and governance are quite different.  To conflate the two invites confusion.

-Bob Tricker, 2017

Culture and corporate governance [1]

 

Commentators frequently mention the importance of culture in corporate governance.  They recognize that the ‘comply or explain’ regime of adherence to corporate governance codes does not capture the reality of corporate behaviour,   But there seems to be some confusion about what is meant by culture  and why it is really relevant to corporate governance.

What is culture?

Culture can be thought of as the beliefs, expectations and values that people share.  Like the skins of an onion, culture has many layers – national cultures, regional cultures, the culture of a company, and the culture in a board room.

The culture of a country is influenced by its social, economic and political heritage, its geography, and its religion.  Culture is moulded by situations that affect relations between individuals, institutions, and states.   Culture is influenced by law, is reflected in the language, and is passed on by experience in families, schools, and organizations.  It is culture that determines what is thought of as acceptable, important, and right or wrong.  Culture affects how people think and act.  It is fundamental to understanding corporate governance.

In the late twentieth century, when ideas about corporate governance began to be discussed, much of the thinking and practice was influenced by countries that shared Anglo-American cultures – a belief in the rule of law; the importance of the rights of individuals to personal freedom and the ownership of property, in the context of accountable, democratic institutions, including an independent judiciary.

In the United States, corporate governance practices stemmed from the rule of company law laid down by state jurisdictions and at the Federal level by regulation from the US Securities and Exchange Commission.

In the UK, and subsequently in most Commonwealth countries associated with the UK, the governance of companies was determined by Companies Acts and, for listed companies, by corporate governance codes, reinforced by Stock Exchange rules, which required companies to report compliance with the code or explain why they had not.

The influence of religion on corporate governance 

Religious beliefs are part of the culture of every country and affect personal values, relationships, and attitudes to authority.  They influence morality, ethical standards, and what business behaviour is considered acceptable.  Under-pinning beliefs are reflected in the way business decisions are made, corporate entities operate, and corporate governance practices develop in different countries.

The United States was founded by Puritans seeking religious freedom.  The founding fathers, the majority of whom were lawyers, placed great emphasis on their constitution, the rule of law, and democratic rights.   Those same traits are reflected in the governance of American companies to this day.  Legal contracts, litigation, and shareholder rights are still at the forefront of business issues.

In the United Kingdom, on the other hand, the approach to corporate governance was more flexible, less rule-based and litigious, reflecting the broader traditions of Britain’s religious inheritance.  The Church of England, rejecting control from Rome, established a freedom of expression and tolerated other non-conformist religious traditions, which became embedded in British culture. The voluntary approach to corporate governance – ‘conform or explain why not’ – reflects this more flexible, voluntary approach.

Other countries influenced by Britain during the days of the British Empire (including Australia, Canada, South Africa, other countries in Africa and the West Indies, as well as Hong Kong and Singapore, shared these corporate governance influences.

In Germany, the teachings of Martin Luther, 500 years ago, shaped the country’s language and changed its way of life.  Luther influenced belief in the moral imperative to seek principle and order, to be prudent with money, and to avoid debt.  Southern European nations, on the other hand, influenced by Roman Catholicism, took a less austere approach: a distinction that is still being played out among the nations that adopted the Euro as their national currency.

Northern European nations were also affected by the teaching of John Calvin, which emphasized the importance of working for the community, not just for their families and themselves.  Germany’s co-determination laws view companies as partnerships between labour and capital. In the two-tier board governance structure, the supervisory board contains representatives of workers as well as investors.

The influence of religion on corporate governance practices can be seen strikingly in Japan.  Buddhism and Shinto, the national religion, have been dominant religious influences.  Even though relatively few Japanese now identify with either religion, belief in spirits is widespread.  Shrines to spirit deities are commonplace.  Social cohesion is a dominant feature of Japanese business life, with high levels of unity throughout the organization, non-adversarial relationships, lifetime employment, enterprise unions, personnel policies emphasizing commitment, initiation into the corporate family, decision-making by consensus, cross- functional training, and with promotion based on loyalty and social compatibility as well as performance.

The Japanese Keiretsu networks connect groups of Japanese companies through cross-holdings and interlocking directorships, Chairmen and senior directors of companies in the keiretsu have close, informal relationships.   Although the paternalistic relationship between company and lifetime ‘salary-man’ is under economic pressure, boards still tend to be decision-ratifying bodies rather than Western style decision-making forums.

Although there have been recent efforts to require independent non-executive directors, as in the Western corporate governance model, Japanese top management remains rather sceptical.  Many Japanese do not see the need for such intervention ‘from the outside’.  Indeed, they have difficulty in understanding how outside directors function. ‘How can outsiders possibly know enough about the company to make a contribution,’ they wonder, when they themselves have spent their lives working for it?  How can an outsider be sensitive to the ingrained corporate culture?

Of course, the cultural significance of religion does not mean that religion or religious organizations played a part in the development of corporate governance norms.  Indeed in some countries, the UK, China, and Japan for example, many people no longer claim any religious affiliation.  But the religious culture provided the ethical context, the moral influence in creating law, running business, and influencing approaches to corporate governance.

Culture and the future of corporate governance

When corporate governance norms were first discussed in the 1980s, many thought that corporate governance in countries around the world would gradually converge with Western practices.  They believed that because these countries needed to raise capital, trade in securities, and do business globally they would adopt Western practices.   Institutions such as the World Bank and the OECD[2] put considerable effort into advising developing countries about modern corporate governance practice.

Globalization became a dominant feature in world trade because some countries offered significantly lower costs to developed markets.  Some thought that globalization of the movement of goods, services, money, people, ideas  and information, would inevitably lead to a convergence of intellectual insights, politics, and ideology.  Such arguments are seldom heard these days. Capital can be raised in the East as well as the West.   Securities can be traded on many stock exchanges.[3]   The notion, which might be termed ‘globalism,’ seems unlikely to survive.  Attempts by countries to protect their own industry and labour markets, control the flow of people, money, and information across their borders challenge the onrush of globalization.

Now, as the 21st century moves forward, discussion about corporate governance increasingly recognizes the significance of culture – national, regional, corporate, and board-level – to successful corporate governance.. The governance of companies within a country needs to be consistent with that country’s culture.

Bob Tricker

March 2017

[1]  The material in this blog has been adapted from:  Corporate Governance in Modern China – principles, practices, and challenges; Bob Tricker and Gregg Li, to be published next year

[2] the Organisation for Economic Co-operation and Development

[3]  The stock exchanges of Singapore and Hong Kong now rank third and fourth in significance after London and New York

UK Corporate Governance Reform 2017

 

BEIS Green Paper on Corporate Governance Reform

In November 2016, the Department for Business, Energy & Industrial Strategy (BEIS) issued a Green Paper on Corporate Governance Reform.  The Green Paper states ‘The aim of this Green paper is to consider what changes might be appropriate in the corporate governance regime to help ensure that we have an economy that works for everyone’. It considers three specific areas of corporate governance which might be built on to enhance the UK’s current corporate governance framework.  These areas are:

– executive pay

-strengthening the employee, customer, and supplier voice

– corporate governance in the UK’s largest privately-held businesses.

There are 14 Green Paper questions with six relating to executive pay, three to strengthening the employee, customer and wider stakeholder voice, and five relating to corporate governance in large, privately-held businesses. The consultation closed on 17th February 2017 and responses to the consultation will be made available by BEIS around May 2017.  However, the responses will be made available in collated format and the anonymity of individual responses will be retained.  Nonetheless those who have responded to the consultation are free to publish their own responses or make them more widely available.

Executive remuneration

An interesting article by Aime Williams and Madison Marriage ‘Investors back UK drive to curb executive pay levels’ (Financial Times, 18/19 February 2017, page 17,www.ft.com/Executive_Pay) reports that ‘some of the UK’s largest investors have revealed support for government proposals designed to curb high executive pay in the latest pushback against the widening wealth gap between bosses and workers’. The article cites the views of investors including Old Mutual Global Investors and Fidelity International; also the Pensions and Lifetime Savings Association (PLSA) which has a membership including over 1,300 pension schemes; and the Confederation of British Industry (CBI). The publication of pay ratios received broad support whilst other areas mentioned included more robust consequences for companies whose directors’ remuneration is not approved by shareholders and also implementing an annual binding vote on pay.

Turning now to the High Pay Centre, an independent non-party think tank focused on pay at the top of the income scale. It is interesting to note that the High Pay Centre joined forces with the Chartered Institute of Personnel and Development (CIPD) to submit a joint response to the Green paper consultation, marking the commencement of a formal relationship between the two bodies, to ‘advocate fairer and more ethical approaches to pay and reward’. Their recommendations include:

  • All publicly listed companies should be required to publish the ratio between the pay of their CEO and median pay in their organisation.
  • All publicly listed companies should be required to have at least one employee representative on their remuneration committee
  • All publicly listed companies should be required to establish a standalone human capital development sub-committee chaired by the HR director with the same standing as all board sub-committees.
  • The Government should set voluntary human capital (workforce) reporting standards to encourage all publicly listed organisations to provide better information on how they invest in, lead, and manage their workforce for the long-term.

The CIPD/High Pay Centre joint response is available at: http://highpaycentre.org/files/CIPD_and_HPC_response_to_BEIS_Green_Paper_on_Corporate_Governance_%281%29.pdf

Pay ratios

Another High Pay Centre publication which is of particular interest in relation to pay ratios – which seem to be gaining increasing support from various quarters as we have seen earlier – is ‘Pay Ratios: Just Do It’ available at: http://highpaycentre.org/files/Pay_Ratios_-_Just_Do_it.pdf

Going forward

Just a few responses have been mentioned in this blog in relation to executive pay but it seems as though overall the 14 questions posed in the Green Paper will have stimulated wide-ranging debate on key issues which will likely lead to significant reform of the UK’s corporate governance system in the not too distant future.

Chris Mallin

February 2017