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adjustment’ of the state sector, it was agreed that that ‘the state should be withdrawing from what should be withdrawn’.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

Developing a shareholder strategy

A survey of shareholder communications in more than 400 companies listed on the Hong Kong Stock Exchange (HKSE) was published recently by the Hong Kong Institute of Chartered Secretaries (HKICS).   Since the HKSE ranks third equal with the Singapore Stock Exchange in world rankings (behind London and New York), it is likely that the findings have a wider significance.

The report, which I drafted, suggested that effective shareholder communications rest on an understanding of the shareholder base and their information needs. A key conclusion was that whilst some listed companies recognize that shareholder communications are vital, the majority do not and have some way to go to be effective.

Some of the key findings in the study were that:

  • A sizeable proportion of listed companies did not know much about their shareholders – the survey results showed that a third of respondent companies did not know who their shareholders were. They did not regularly or routinely monitor their shareholder base.
  • Some listed companies were not even bothered to find out – 5% of respondents said that they felt that they should be routinely monitoring who their shareholders were but did not: and a further 15.5% said they should be monitoring them on an ad hoc basis but did not.
  • The majority of listed companies lack a shareholder communication strategy

–  58.3% of respondents recognized that their communications with their shareholders were inadequate or ‘somewhat inadequate’.  Most saw the need for improvement.  But 8.6%, although they recognized that their communications were inadequate, saw no need for change. Only 33.1%% thought that their shareholder communications were adequate.

  • The vast majority did not think that all shareholders should be treated equally – Whilst respondents strongly believed that shareholders should be engaged more effectively, only a few (92) felt that all shareholders should be involved, whilst the majority (269) felt that engagement should only be with institutional investors and long-term shareholders. However, respondents believed that these investors had a stewardship role to proactively engage with the company.
  • There is little accountability for shareholder communications at the CEO or board levels – Many companies (172) report information on their shareholder profile to senior management, the board, or board committees. But more companies (241) did not report the data or did not know how it was used.
  • The company secretary is a source of help on investor relations profiling the shareholder base in 52.5% of the companies responding, followed by the Head of Investor Relations (21.0%). Companies reported devoting more resources to investor relations activities including shareholder communication and engagement, with increasing significance for an investor relations function.

Five ‘imperatives’ were developed to give practical and effective guidance to the board of directors and senior management to enhance shareholder communications and investor relations for listed companies, namely to:

  1. Develop an investor relations strategy within the corporate strategy
  2. Know and regularly review the shareholder base
  3. Formulate and regularly review shareholder communication policies
  4. Formulate and regularly review shareholder engagement policies
  5. Review the responsibility and accountability for investor relations

‘The full report can be read at: https://www.hkics.org.hk/index.php?_room=10&_action=detail&_page=3

(Click for the English or Chinese versions)

-Bob Tricker, 2017

 

Ethnic Diversity on UK Boards

There has been much emphasis on the importance and value of board diversity. However the focus has generally tended to be on gender diversity, for example, in the UK the Davies Report (2011) recommended that representation of women on FTSE 100 boards be increased to at least 25% by 2015. By 2015 this 25% target had been exceeded with FTSE 100 boards having 26.1% of women on the board.

Various corporate governance codes and guidelines have stated that firms should have a ‘balanced board’. In 2014, when updating the UK Corporate Governance Code, the Financial Reporting Council pointed out that constructive and challenging debate on the board can be encouraged ‘through having sufficient diversity on the board. This includes, but is not limited to, gender and race. Diverse board composition in these respects is not on its own a guarantee. Diversity is as much about differences of approach and experience, and it is very important in ensuring effective engagement with key stakeholders and in order to deliver the business strategy’.

‘A Report into the Ethnic Diversity of UK Boards: Beyond One by ’21’

Earlier this month The Parker Review Committee, chaired by Sir John Parker, issued ‘A Report into the Ethnic Diversity of UK Boards: Beyond One by ’21’.

Starting from the premise that UK boardrooms, including those of leading public companies, do not reflect the UK’s ethnic diversity nor the stakeholders that companies engage with (customers, employees, etc.), the Parker Report states that ‘ethnic minority representation in the Boardrooms across the FTSE 100 is disproportionately low, especially when looking at the number of UK citizen directors of colour’. For example, the Report highlights that of 1087 director positions in the FTSE 100, UK citizen directors of colour represent only about 1.5% of the total director population with 90 individual directors of colour (four hold two Board positions) whilst total directors of colour represent about 8% of the total (compared to 14% of the UK population). Some 53 FTSE 100 companies do not have any directors of colour. Seven companies account for over 40% of the directors of colour, interestingly five out of the seven companies have headquarters historically located outside the UK. In terms of the key board roles of Chair and CEO, only nine people of colour hold the position of Chair or CEO.

The Parker Report’s recommendations can be found at http://www.ey.com/Publication/vwLUAssets/A_Report_into_the_Ethnic_Diversity_of_UK_Boards/$FILE/Beyond%20One%20by%2021%20PDF%20Report.pdf and are as follows:

 

 

  1. Increase the Ethnic Diversity of UK Boards

1.1. Each FTSE 100 Board should have at least one director of colour by 2021; and each FTSE 250 Board should have at least one director of colour by 2024.

1.2. Nomination committees of all FTSE 100 and FTSE 250 companies should require their internal human resources teams or search firms (as applicable) to identify and present qualified people of colour to be considered for Board appointment when vacancies occur.

1.3. Given the impact of the ‘Standard Voluntary Code of Conduct’ for executive search firms in the context of gender-based recruitment, we recommend that the relevant principles of that code be extended on a similar basis to apply to the recruitment of minority ethnic candidates as Board directors of FTSE 100 and FTSE 250 companies.

  1. Develop Candidates for the Pipeline & Plan for Succession

2.1. Members of the FTSE 100 and FTSE 250 should develop mechanisms to identify, develop and promote people of colour within their organisations in order to ensure over time that there is a pipeline of Board capable candidates and their managerial and executive ranks appropriately reflect the importance of diversity to their organisation.

2.2. Led by Board Chairs, existing Board directors of the FTSE 100 and FTSE 250 should mentor and/or sponsor people of colour within their own companies to ensure their readiness to assume senior managerial or executive positions internally, or non-executive Board positions externally.

2.3. Companies should encourage and support candidates drawn from diverse backgrounds, including people of colour, to take on Board roles internally (e.g., subsidiaries) where appropriate, as well as Board and trustee roles with external organisations (e.g., educational trusts, charities and other not-for-profit roles). These opportunities will give experience and develop oversight, leadership and stewardship skills.

  1. Enhance Transparency & Disclosure

3.1. A description of the Board’s policy on diversity be set out in a company’s annual report, and this should include a description of the company’s efforts to increase, amongst other things, ethnic diversity within its organisation, including at Board level.

3.2. Companies that do not meet Board composition recommendations by the relevant date should disclose in their annual report why they have not been able to achieve compliance.

 

Chris Mallin

November 2016

Chinese Government re-asserts control of state owned enterprises (SOEs)

State-owned enterprises (SOEs) remain central to China’s economy. They include vast companies in the oil, telecoms, steel, finance, and other major sectors. In many cases a minority of their shares have been floated on the Hong Kong, Shenzen, or Shanghai stock exchanges.

The corporate governance of these enterprises has been significantly influenced by Western experience. For decades governance has been left to company’s boards of supervisors and boards of directors, under the supervision of the State-owned Assets Supervision and Administration Commission (SASAC) and the China Securities Regulatory Commission (CSRC). State involvement at a higher level had tended to be distant[1]. Some felt that the Communist Party had been pushed aside and the party’s leadership undermined.

Not any longer. In October 2016, China’s President, Xi Jin Ping, asserted that ‘the ultimate bosses of China’s state-owned enterprises must be China’s Communist Party organs’, according to the South China Morning Post (12 October 2016). The President told a high-profile conference of top officials and SOE executives that ‘after decades of fading into the background, Communist Party’s leadership must be boosted in SOEs’. The message was clear: the party will reassert its grip on the state sector.

The two-day work conference concluded that the Communist Party must increase its role, especially in ideology, oversight of personnel, and key decisions in the country’s biggest industrial and financial enterprises.

‘Leadership by the party was the root and soul and a unique advantage of China’s state firms, and any weakening, fading, blurring or marginalization of party leadership in state firms will not be tolerated’, Xi is quoted as saying. ‘We must unswervingly uphold the party’s leadership in state-owned enterprises, and fully play the role of party organs in leadership and political affairs. We must ensure that wherever our enterprises go, party-building work will follow’.

This was the first time that the country’s leadership had addressed a meeting specifically on the Communist Party’s leadership in state businesses; the first time in fact that they had shown any interest in corporate governance. Xi said that China’s state firms had to remain loyal to the party’s course to be ‘a reliable force that the party and the nation can trust’ and ‘an important force in firm implementation of the central leadership’s decisions’.

Since the 18th party congress four years ago, the leadership has called for SOEs to be companies ‘with Chinese characteristics’, which means ultimate leadership by the party. In the published comments, the president did not specifically mention boards of directors. He said the Communist Party’s should be ‘embedded’ in corporate governance. He also said the leaders of China’s state firms should be seen as communist cadres, serving party interests in the economic realm.

Why has China’s leadership chosen to reassert their ultimate control over SOEs? A number of reasons come to mind:

  • To reinforce the President’s sweeping anti-corruption campaign. Corrupt officials in SOEs, as well as the military and the government, have already been accused, but corruption remains endemic.
  • To reverse the slide towards Western capitalist thinking and reassert Communist values.
  • To improve performance of the SOEs and spur innovation as the country faces falling economic returns after many years of double digit growth. The government also launched a 200bn yuan (US$ 30bn) venture capital fund to foster SOE reform and spur innovation.
  • To build party loyalty and improve control over a huge population, whose relatively affluent middle class now has aspirations to greater independent thought. The existing control over the media, the internet, and public discussion would be reinforced if SOE management supported party ideals. Calls for independence from young people in Hong Kong cannot have improved this challenge.

 

Bob Tricker October 2016.

[1] For more on the corporate governance system for SOEs see Tricker 3e pages 297-303.

 

Worker directors – we’ve been here before

At the UK’s Conservative Party conference, in early October 2016, the Prime Minister, Mrs. Theresa May, raised some significant corporate governance issues:

‘So if you’re a boss who earns a fortune but doesn’t look after your staff, an international company that treats the tax laws as an optional extra…a director who takes out massive dividends while knowing that the company pension scheme is about to go bust, I’m putting you on warning…’

Each of these issues has been discussed in recent blogs. But she also suggested that workers should be appointed to boards of directors. As could be predicted, this suggestion was welcomed by the Trades Union Council but raised alarm in some British boardrooms.

But we have been here before. Extracts from Corporate Governance: Principles, Policies, and Practices (3rd ed., 2015, pages 12 and 85) explain why:

 ‘In the 1970s, the European Economic Community (EEC), now the European Union, issued a series of draft directives on the harmonization of company law throughout the member states. The Draft Fifth Directive (1972) proposed that all large companies in the EEC should adopt the two-tier board form of governance, with both executive and supervisory boards. In other words, the two-tier board form of governance practised in Germany and Holland, would replace the British model of the unitary board, in which both executive and outside directors oversee management and are responsible for seeing that the business is being well run and run in the right direction.

In the two-tier form of governance, companies have two distinct boards, with no common membership. The upper, supervisory board monitors and oversees the work of the executive or management board, which runs the business. The supervisory board has the power to hire and fire the members of the executive board.

Moreover, in addition to the separation of powers, the draft directive included employee representatives on the supervisory board. In the German supervisory board, one half of the members represent the shareholders. The other half are chosen under the co-determination laws through the employees’ trades’ union processes. This reflects the German belief in co-determination, in which companies are seen as social partnerships between capital and labour.

The UK’s response was a Committee chaired by Sir Alan Bullock (later Lord Bullock), the renowned historian and Master of Saint Catherine’s College, Oxford. His report – Industrial Democracy (1977) – and its research papers (1976) were the first serious corporate governance study in Britain, although the phrase ‘corporate governance’ was not then in use. The Committee proposed that the British unitary board be maintained, but that some employee directors be added to the board to represent worker interests.

The Bullock proposals were not well received in Britain’s boardrooms. The unitary board was seen, at least by directors, as a viable system of corporate governance. Workers had no place in the boardroom, they felt. A gradual move towards industrial democracy through participation below board level was preferable.

Neither the EEC’s proposal for supervisory boards nor worker directors became law in the UK. Since then, the company law harmonization process in the EU has been overtaken by social legislation, including the requirement that all major firms should have a works council through which employees can participate in significant strategic developments and changes in corporate policy.’

Proponents of industrial democracy still argue that governing a major company requires an informal partnership between labour and capital, so employees should participate in corporate governance. Maybe an extension of the Shareholder Senate idea, suggested in a recent blog, called a Stakeholder Senate could provide another forum to inform, liaise with, and influence the board.

Bob Tricker October 2016

 

 

BHS – an ongoing corporate governance classic

On Sunday 29 August 2016, BHS (British Home Stores) closed the last of its 164 remaining stores, making around 11,000 employees redundant and jeopardizing the future of over 20,000 pensioners. The media took delight, at the same time, in showing the previous owner of BHS, Sir Philip Green, sailing around the Mediterranean on Lionheart, his new $100 million luxury yacht.

 The business of BHS

BHS was a department store business, with over 150 shops around the UK and others abroad. These stores sold a wide range of merchandise relatively cheaply–women, men, and children’s clothing; furniture and household goods; garden equipment; fashion accessories; toys, cameras, and wide range of other goods. Many also had a restaurant. In its heyday, BHS had a store on the high street of the most important towns in Britain.

But in recent years, high street shopping has been challenged by shopping malls, where specialist stores offered wider ranges of specific goods and, of increasing importance, free parking. Internet shopping then developed, bringing further challenges to department stores.The retail industry underwent a period of rapid challenges and growing competitiveness. BHS reflected a by-gone shopping era.

 Arcadia Group Ltd.

Founded in 1928, BHS traded successfully and grew around Britain for generations before being acquired by the Arcadia Group Ltd, an investment company running a network of subsidiary companies mainly in clothes retailing under the brand names of Topshop, Topman, Dorothy Perkins, Burtons Menswear, Wallis, Evans, Miss Selfridge, and Outfit. Arcadia had over 3,000 retail outlets and nearly 7 million square feet of space. The Arcadia accounts list seventy-seven wholly owned subsidiaries, some of them with their own chain of subsidiaries.

In 2014/15, the Arcadia Group turnover was £2,069 million, giving it an operating profit of £229 million. However, exceptional costs including pre-opening costs of overseas stores and pension fund adjustments, and a loss on the disposal of BHS (£311 million) led to an overall loss of £94 million. The 2014/15 accounts note that the UK Pensions Regulator was seeking information from the company in connection with the BHS pension schemes.

Arcadia Group Ltd is wholly owned by Taveta Investments (No.2) Ltd., the first link in a network of trusts and companies, with many registered in Jersey, a Channel Islands tax haven. The Arcadia Group is dominated by Sir Philip Green and its major shareholder, allegedly, is Green’s wife, Lady Tina Green, who is a British-born South African resident in Monaco, a Mediterranean tax haven. Neither Green nor his wife is now on the Arcadia board of directors. Green resigned from the board on 15 December 2015. Lord Grabiner QC also resigned from the Arcadia board on that day.

The Arcadia accounts and annual return for 2014/15, filed with the UK Companies’ Registry, show the Arcadia directors as:

Paul Budge,  Finance Director

Richard Burchill, Accountant (appointed 15 December 2015)

Ian Grabiner, Company Director

Gillian Hague, Group Financial Controller (appointed 15 September 2015)

Christopher Harris,  Company Director

Richard de Dombal (appointed 15 December 2015)

Directors’ remuneration for 2014/15 was £5,271,000, with the highest paid director receiving £1,955,000 (supposedly Ian Grabiner, who is said to be Green’s right-hand man).

Carmen Ltd, a property company owned by the Green family, received over £10 million in rent on BHS stores in 2014/15; and a further £20 million was paid to the family by BHS to repay loans.

PriceWaterhouseCoopers LLP are the Arcadia Group auditors. The 2014/15 accounts show audit fees for the Group and subsidiaries of £355,000 plus fees for non-audit services of £1,798,000 (including £1,151 million for ‘pension advisory services’).

Sir Philip Green

Green is a flamboyant and confrontational billionaire. Many reporters have experienced his explosive temper. He is not one to give interviews. So he was unlikely to provide information to your case writer, who has relied on company accounts, published reports, and newspaper commentary.

Over the years, Green built up a network of retail stores within the Arcadia Group, principally in clothing, both in Britain and abroad, through acquisition, merger, and re-structuring. He received his knighthood for contributions to retailing.

Green and his family own and dominate Arcadia Group, including BHS until its sale. Therefore, Green felt that Bhs was his own company: so he and his family were entitled to pay themselves substantial dividends and fees. He is reported to have said; ‘It’s my money, I can do what I like with it.’

The sale and collapse of BHS

However, BHS had made losses for the past seven years, which had to be funded by the Arcadia Group. In other words, Green family interests had funded BHS losses. But BHS was a private company. Corporate governance codes that cover public companies did not apply to BHS.

By 2015, BHS was struggling. In March 2015, the company was sold for a nominal £1 to Retail Acquisitions Ltd., a company owned by Dominic Chapell, a three times bankrupt former racing driver. The sale to Retail Acquisitions was negotiated by bankers Goldman Sachs.

According to the Guardian newspaper, Arcadia insisted on three protective covenants before selling BHS:

  1. All monies available to BHS at the time of sale shall be used for the day-to-day running of BHS.
  2. All proceeds realised from the sale of BHS properties shall be used to operate BHS as a going concern and to pay its debts.
  3. No steps are to be taken by the buyer that would adversely affect the ability of BHS to continue as a going concern.

Finance Director Budge explained that this was to ensure that all monies available to BHS should be used for that company’s business and not drawn down by the new owners.

The financial impacts of the BHS sale are clear in the Arcadia accounts for 2014/15. £216 million due to Arcadia Group Ltd were waived. Provisions relating to BHS disposal and cash transferred by Arcadia to BHS cost £88 million. The cash costs of the BHS disposal came to £2.3 million.

Administrators Duff and Phelps were appointed to administer BHS in April 2016. Unable to find a buyer, the closure of its stores followed in August, 2016.

The pension fund deficit

The deficit in the BHS pension fund was initially reported as being around £570 million. The stock market crisis in 2008 had reduced the fund’s value and subsequent losses at BHS had prevented funding the short-fall. In evidence to Members of Parliament, Chappell alleged that Green made a condition of any deal not to contact the Pensions Regulator.

The UK’s Pension Protection Fund can contribute to failed pension funds, but BHS pensioners would probably face reduced benefits. The UK’s Pensions Regulator has powers to call on Arcadia to contribute to the BHS pension fund deficit either through a financial support direction or a contribution notice. Green has claimed that he was ‘being tortured by the Regulator.’

 Green is reported to have made an informal offer of a £300 million contribution to the pension fund but only on condition that investigations against him be stopped and any legal action against him or his wife would be dropped.

Parliamentary probe into BHS sale

Members of Parliament from the Works and Pensions, and Business Innovation and Skills select committees called on evidence to probe the BHS collapse. The Chairman of the Works and Pensions Select committee, Frank Fields, suggested that Green, himself, should fund the deficit or risk losing his knighthood. Green responded aggressively claiming that he had offered to support the pension fund but his offer had been rejected. He also suggested that the Chairman, Field, was biased against him.

In his defence, Green said: ‘Any fair review of the BHS balance sheet would show the support we had provided to the BHS business throughout; It is clear that we invested substantially in the business. We lent substantial sums to the business and we gave Retail Acquisitions every chance, with a solid platform to take the business forward’.

The Chairman of the BHS pension fund trustees, Chris Martin, told the MPs that he had raised concerns about the deficit in the BHS pension fund after meeting Chappell. He felt that Retail Acquisitions had done little due diligence during their acquisition.

Business Select Committee member, Richard Fuller, called for an investigation by the Financial Reporting Council (FRC) of the conduct of directors and professional advisers involved. The FRC launched a probe into the involvement of BHS auditor one of the Big Four audit firms, PriceWaterhouseCoopers (PwC).

MPs called for Lady Tina Green to shed light on the complex web of companies registered in her name in tax havens, and their profits. They also wanted to know more about the relationship between Green and Goldman Sachs.

More critical comments

The Institute of Directors (IOD) commented that the action of Green ‘has the potential to be deeply damaging to British business. We spend a lot of time agonizing over the loss of trust in the business community and I think we can see why…When someone ends up behaving like this people think that is how business is: and it is not’.

The IOD also called on the UK’s Financial Reporting Council to investigate whether the board of Arcadia Group had failed in its duty to promote the success of a company it owned.

The Daily Mail said that Green had ‘obfuscated and dodged questions about the liabilities when he sold BHS to a former bankrupt, using a front page banner headline: ‘STRIP SIR SHIFTY OF HIS TITLE.’

Lord Myners, a corporate governance stalwart, asked the Attorney General whether the Serious Fraud Office was considering a formal criminal investigation into the collapse of BHS.

Although the SFO, the FRC, the Pensions Regulator and the administrator/liquidator have yet to report, the BHS case seems set to become a corporate governance classic. One is reminded of the Robert Maxwell case (page 25-26, Corporate Governance 3e, Tricker). Maxwell, a dominant entrepreneur, used funds from two public companies and their staff pension funds to prop up his private interests. Maxwell’s business empire finally collapsed leaving a £753 million deficit. He died of a heart attack having fallen from his yacht in the Mediterranean. But Maxwell had taken monies from two listed public companies, and their pension funds. BHS was a private company predominantly owned by the Green family.

 

Discussion questions

  1. Was anything wrong with the governance of BHS? This was a private company, wholly owned by another private company, itself in a network of overseas trusts and holding companies. No public company was involved.
  2. Should there be a corporate governance code for significant private companies, say those with sales revenues or employees over a certain figure? Should such significant private companies be required to have independent, non-executive (outside) directors or explain why they do not? Should they have audit committees, remunerations committees, and nomination committees with independent directors? Should the chairmanship of the board be separate form the CEO?
  3. Should independent auditors provide non-audit services and advice to their audit clients? (PWC were paid £355,000 in audit fees plus fees for non-audit services of £1,798,000).
  4. The UK Companies’ Act 2006 applies to all limited liability companies in the UK–public and private. It, therefore, applied to the Arcadia Group Ltd and to BHS Ltd. The Companies Act specifically spells out a statutory duty to recognise the effect of board decisions on a wider public, including ‘the interests of the company’s employees’, and ‘the need to foster the company’s business relations with suppliers, customers and others’. Did the decisions that led to the liquidation of BHS meet these requirements? If not, how might the Act be enforced?