Shareholder communication

Some ongoing corporate governance concerns

It has been a while since I contributed to OUP’s corporate governance blog, which I share with Professor Chris Mallin. So I thought that, rather than focusing on a single theme, I would comment on issues that are currently concerning directors and their professional advisers around the world.

In particular I will address shareholder communication, shareholder engagement, executive compensation, cyber security, and the challenges of cronyism and corruption.

Shareholder communication

Listed companies need to communicate with their shareholders. Market analysts, potential investors, regulators, and others in the market also need ongoing knowledge about the company.  Formal requirements for such information are found in company law and stock exchange rules.  But companies need to go beyond these regulatory, financially-orientated demands.

In the original model of the joint-stock, limited-liability company shareholders were individuals, their numbers small, and their needs for information tended to be similar. Directors could communicate quite easily with them; indeed in many cases they knew them personally. But that was 150 years ago!

Today, shareholders are no longer homogeneous. The shareholders of a listed company could include institutional investors actively involved in the company’s corporate governance issues, passive institutional investors, such as index-tracking funds with little interest in corporate information, dominant investors, perhaps the company’s founders or their family trusts, hedge funds, private equity investors, state owned corporations, sovereign funds, and of course retail shareholders – individuals, usually with relatively small holdings.

Clearly, the expectations of such investors, their levels of business sophistication, and their need for information differ. However, company law and stock exchange rules seldom recognize such differences.

Moreover, some listed companies may not be sure who some of their shareholders actually are. In the old days, details of a new investor were duly recorded in the share register and a hand-written share certificate provided. But in today’s scripless system, holdings are recorded centrally and may be deposited with brokers. So the shares may be held in the name of the broker or custodian participant, with the actual investor not registered as the shareholder. Ownership information can also get buried in the string of intermediaries.

So what information should a company provide?

In many jurisdictions today, the call is for narrative information to supplement the classical, financial reports. For example, the Hong Kong Companies’ Ordinance, which came into effect in March 2014, calls for the publication of a directors’ report for the financial year containing a business review including:

  • a review of the company’s business;
  • a description of the principal risks and uncertainties facing the company;
  • particulars of important events affecting the company that have occurred since the end of the financial year;
  • an indication of likely future development in the company’s business.

Further, to assist the understanding of the development, performance, and position of the company, a business review must also include:

  • an analysis using financial key performance indicators, which are factors that effectively measure the development, performance or position of the company’s business;
  • a discussion of:
    • the company’s environmental policies and performance;
    • the company’s compliance with the relevant laws and regulations that have a significant impact on the company;
    • an account of the company’s key relationships with its employees, customers and suppliers and others that have a significant impact on the company and on which the company’s success depends.

In the United States and the UK, calls are also continuing for more information on companies’ environmental, social, and governance policies and performance (frequently referred to as ‘ESG issues’).

However, the decision on exactly what information to provide and in what detail is challenging. Too little and commentators might register disapproval; too much and the company’s competitive position could be eroded or ongoing negotiations, for example over an acquisition, could be jeopardized. The danger is that, in meeting the regulatory and other expectations, companies’ statements contain more public relations commentary than hard fact.

The Hong Kong Institute of Chartered Secretaries (HKICS) is currently undertaking a survey (in which I am involved) exploring shareholder communications in companies listed on the Hong Kong Stock Exchange. The results are due to be published later this year, and will be linked to this blog in due course.

The HKICS published guidance notes in 2009, emphasizing the discretionary opportunities available to companies to communicate with their investors and the market. They cited press releases, corporate websites with dedicated investor relations pages, company presentations, group briefings, and meetings ‘one-on-one’ with individuals. Such opportunities could be used, the notes suggested, to ‘provide background to support the already publicly disclosed information, as well as to articulate:

  • long-term strategy;
  • organization history, vision, and goals;
  • management philosophy and the strength and depth of management;
  • competitive advantages and risks;
  • industry trends and issues;
  • key profit drivers in the business’

But there is an inevitable dilemma in discretionary communication. One-on-one communication is fraught with difficulty. To protect the integrity of their market, stock exchanges require information which might affect share prices to be given to the entire investment community at the same time. So, can meaningful information be given to one, or a few, shareholders without giving them undue advantage by disclosing price-sensitive information?

Companies need policies on the conduct of meetings with analysts and how to respond to questions about future earnings, if necessary correcting forecasts they might have made about the company and its prospects. Companies could consider publishing their formal disclosure policy, which needs to be in line with their overall corporate governance strategy.

Bob Tricker, May 2016
(for more on Professor Tricker’s publications and videoed lectures see www.BobTricker.com)

On shareholder engagement

Some ongoing corporate governance concerns

It has been a while since I contributed to OUP’s corporate governance blog, which I share with Professor Chris Mallin. So I thought that, rather than focusing on a single theme, I would comment on issues that are currently concerning directors and their professional advisers around the world.

In particular I will address shareholder communication, shareholder engagement, executive compensation, cyber security, and the challenges of cronyism and corruption.

On shareholder engagement

Few institutional investors in the United States involved themselves directly in the governance of companies in which they invested prior to the failure of Enron, Waste Management and others in the early 2000s, and the collapse of Lehman Brothers and the bailout of financial institutions a few years later. Subsequently many felt the needed to be more committed. Many commentators also urged them to do so.

Involvement by shareholders in corporate matters can take many forms, for example:

  • submitting resolutions for decision at shareholder meetings;
  • rigorously voting shares at every opportunity;
  • campaigning on company matters though the media;
  • lobbying corporate regulators on company issues;
  • initiating a dialogue with the company.

Recent topics for shareholder engagement in the US and the UK have included:

  • alleged excessive levels of executive compensation;
  • executive incentive schemes that emphasize short- term performance;
  • de-emphasizing quarterly earnings to swing the strategic focus from short-term to longer-term;
  • calling for information on longer-term corporate strategies;
  • separation of the roles of chief executive and board chairman (still combined in some US corporations);
  • the composition and diversity of the board.

Recent surveys by IRRC, the Investor Responsibility Research Center in the United States (2011, revised 2014) reported that the level of engagement between investors and publicly-traded U.S. corporations had reached an ‘all time high.’ By ‘engagement’, the IRRC survey meant ‘direct communication between the corporation and investors on specific topics’.

Companies, it seemed, tended to view shareholder engagement as a series of discrete conversations. Investors, on the other hand, saw it as an ongoing process whose success depended on subsequent concrete action by the company.

Companies said they were devoting more resources to shareholder engagement, often through an executive team, with investment relations officers and representatives of the CFO and the Corporate Secretary. In some cases, directors were personally involved, including the board chairman, the senior outside (non-executive) director, and the chairmen of the board’s audit or compensation committees.

The IRRC report concluded that ‘evidence suggests that overall engagement levels will continue to trend upward, as investors seek to better understand, and mitigate risks at companies they intend to hold for the long term, while issuers seek to win support for company proposals, ward off activists, and keep shareholders happily invested in the stock.

A recent development (press reports March 2016) has been major institutional investors, such as Blackrock, Fidelity, and Schroders forming an Investment Association to engage with companies, challenging poor performance, excessive pay deals, or calling for information on longer-term corporate strategies rather than emphasizing quarterly results. This potential of ‘collective engagement’ increases the power of large shareholders to hold companies to account.

The pioneers of shareholder engagement were radical groups and religious organizations who used their shareholder votes to encourage change in corporate policies such as trading in weapons, tobacco, or alcohol. The movement to encourage corporate social responsibility followed, seeking to align business practices with desirable societal expectations in the interest of all stakeholders affected by the business activities.

Some writers argue that the more a company engages with its stakeholders, the more socially responsible it must be and the better its chances of long-term sustainability and improved shareholder value. However, research[1] on the topic has challenged that notion. More reporting does not necessarily lead to better relationships. Many other factors influence interactions between companies and their investors.

[1] Greenwood, Michelle, Stakeholder Engagement: beyond the myth of corporate responsibility, Journal of Business Ethics (2007) 74:315-317, Springer

Bob Tricker, May 2016
(for more on Professor Tricker’s publications and videoed lectures see www.BobTricker.com)

Executive compensation

Some ongoing corporate governance concerns

It has been a while since I contributed to OUP’s corporate governance blog, which I share with Professor Chris Mallin. So I thought that, rather than focusing on a single theme, I would comment on issues that are currently concerning directors and their professional advisers around the world.

In particular I will address shareholder communication, shareholder engagement, executive compensation, cyber security, and the challenges of cronyism and corruption.

Executive compensation

Alleged excessive director level rewards remain one of the most contentious issues in corporate governance. Shareholder demands for a ‘say- on-pay’ have increased, although such intervention continues to be exhortatory rather than binding on companies.  A growing disparity between the wealth and rewards of the few at the top of society and the rest has swung the focus onto executive compensation. The subject also provides a flash point for activists challenging the role of capitalism society.

The traditional solution of the board-level remuneration committee, made up of independent, outside, non-executive directors, does not seem as effective as it was when the late Sir Adrian Cadbury included the idea in the first corporate governance code (1992). For one thing, those outside directors may well be executives from other companies, with their own interests in setting high remuneration levels. For another, industry norms for total remuneration seem to have been rising, thus setting bench-marks for levels needed to attract and hold the best people. Professional firms offering pay level advice tend to reinforce high levels industry-wide.

But new approaches have been appearing. The relationship between reward and performance has come under the spotlight, particularly where the reward seems to be unrelated (or worse inversely related) to performance. Some companies have adopted ‘claw-back’ terms that penalize top earners if they fail to meet set performance goals in the longer term. In Canada, institutional investors have called for the idea to become governance best practice. Other companies have used peer reviews of reward systems in their business sector.

Remuneration decisions should not be made piecemeal. Boards need to establish the underlying basis of their remuneration policy. Moreover, that policy needs to be disclosed to shareholders and other interested parties. Whilst maintaining an appropriate level of individual privacy, decisions on top level remuneration benefit from transparency.

Bob Tricker, May 2016
(for more on Professor Tricker’s publications and videoed lectures see www.BobTricker.com)

Cyber risk and security

Some ongoing corporate governance concerns

It has been a while since I contributed to OUP’s corporate governance blog, which I share with Professor Chris Mallin. So I thought that, rather than focusing on a single theme, I would comment on issues that are currently concerning directors and their professional advisers around the world.

In particular I will address shareholder communication, shareholder engagement, executive compensation, cyber security, and the challenges of cronyism and corruption.

Cyber risk and security

It is now widely recognized that strategies for identifying corporate vulnerabilities and managing risk are part of the corporate governance responsibility of every board. Although some boards could usefully spend more time assessing the potential of strategic risks faced throughout their group.  (BP’s Deepwater Horizon oil rig disaster and the Fukushima Daiichi power station disaster for Tokyo Electric Power come to mind). An interesting idea adopted by a few boards is the creation of ‘play-books,’ which develop scenarios of possible strategic risks and chart the company’s planned response should they arise.

The growing risk of cyber attack or IT system breakdown is recognized by many boards but cyber governance is still in its infancy. Cyber warfare could strike a company in a number of ways, for example through:

  • communication failure between parts of the business or its supply chain;
  • loss of service to customers;
  • espionage to extract confidential information or trade secrets;
  • hacking to obtain personnel or customer records;
  • intentional destruction of records or communication systems;
  • fraud to divert funds from the company or hide fraudulent transactions;
  • deliberate destruction or falsification of records;
  • destruction of company correspondence files.

No doubt a thoughtful board will identify other possibilities, not least the risk of providing the board papers online. To ensure that they fulfil their fiduciary duty, boards need to ensure that their risk management strategy fully covers the risk of cyber attack and IT systems breakdown. Supporting policies covering, for example, stand-by facilities, back-up data storage, and recovery systems need to in place, tested, and regularly reviewed.

In an ever-interconnected business world, dependent on the internet and modern telecommunication, the threat of significant loss to profits, markets, or indeed to survival is real. Cyber governance is an increasingly significant part of a board’s corporate governance portfolio. It needs to have the right tools in its corporate governance tool kit.

Bob Tricker, May 2016
(for more on Professor Tricker’s publications and videoed lectures see www.BobTricker.com)

Cronyism and corruption

Some ongoing corporate governance concerns

It has been a while since I contributed to OUP’s corporate governance blog, which I share with Professor Chris Mallin. So I thought that, rather than focusing on a single theme, I would comment on issues that are currently concerning directors and their professional advisers around the world.

In particular I will address shareholder communication, shareholder engagement, executive compensation, cyber security, and the challenges of cronyism and corruption.

Cronyism and corruption

Most major companies operate through subsidiary and associate companies, with supply chains, business operations, and marketing systems around the world. For the board of the holding company in, say, New York or London that can present a significant challenge.

Of course, boards expect those around the world who report to them to stay within the laws and regulations of their respective countries. But cultures and business traditions differ. The way business is done and the expectations of key players may be significantly different from Western norms. Government contracts may traditionally be awarded only after the decision makers are rewarded. Cronies may get preferential treatment. Buyers or sellers may expect bribes or look for reciprocal rewards.

Corruption remains a basis of business in some places, as can be seen in recent corruption scandals in Brazil and Malaysia. China, India, and Nigeria also suffer from endemic bribery and corruption, although their respective leaders are making significant efforts to root it out. A recent study by UK law firm Eversheds (Times, 9 May 2016) found that almost two thirds of UK directors believed that their anti-corruption policies did not work, and recognized that this was an important issue for their company.

The moral compass of companies is set at the top. Establishing and maintaining the corporate culture is an essential part of the governance of every corporation. That means more than just publishing codes of business ethics and corporate procedures.   It is reflected in the decisions the main board itself makes. For example, what is the board’s attitude towards aggressive tax avoidance and the movement of group funds through tax havens?

An important corporate governance duty of every director is to ensure that the company sets appropriate standards of business behaviour and confirms that they are followed everywhere that the company does business. The chairman of the board has a vital leadership role.

Bob Tricker, May 2016

(for more on Professor Tricker’s publications and videoed lectures see www.BobTricker.com)

FRC Annual Report on Developments in Corporate Governance and Stewardship 2015

In the Introduction and Overall Assessment to its Annual Report ‘Developments in Corporate Governance and Stewardship 2015’ (https://www.frc.org.uk/Our-Work/Publications/Corporate-Governance/Developments-in-Corporate-Governance-and-Stewa-(1).pdf), the UK’s Financial Reporting Council (FRC) highlighted that 2015 was a year of consolidation for the UK Corporate Governance Code (the Code) which had some significant changes made in 2014. Companies’ explanations improved in quality and there was a high level of compliance with the Code ‘with 90 per cent of FTSE 350 companies reporting compliance with all, or all but one or two, of its provisions’. The FRC’s ongoing strategy for 2016/19 is to give time for recent changes to embed and not to consider further changes – other than those arising from the implementation of the EU Audit Regulation and Directive – to the Code until 2019.

The importance of culture is recognised as the Code makes it clear that there is a role for the board in ‘establishing the culture, values and ethics of the company’ and in setting ‘the tone from the top’. The FRC plans to publish findings of a study looking at the role of boards in shaping and embedding a desired culture in the summer of 2016.

In relation to the Stewardship Code, the FRC intends to make a public assessment of the reporting of signatories – again in the summer of 2016 – as it is of the view that ‘the reporting of too many signatories does not demonstrate that they are following through on their commitment [to the Stewardship Code]’.

The next section of the Annual Report on the Governance of Listed Companies details how the UK Corporate Governance Code has been implemented during 2015 and provides an assessment of the quality of reporting on corporate governance. There is an interesting summary of the top 10 areas of non-compliance and ‘Code provision B.1.2, which states that at least half the board (excluding the chairman) should be independent, remains the lowest rated in terms of compliance among FTSE 350 companies’. In 2015, 42 FTSE 350 companies did not comply with this provision although the FRC note that ‘as with last year just under half had returned to having more than 50 per cent of the board as independent non-executive directors at the time their annual report and accounts was published. On the whole non-compliance was usually as a result of retirements rather than a specific wish not to comply.’ As well as overall compliance rates, this section of the Annual Report covers the quality of explanations for non-compliance; Code changes in 2012 including audit tendering, audit committee reporting, boardroom diversity, the ‘fair, balanced and understandable’ aspects of the company’s annual report and accounts; and Code changes in 2014 relating to risk management and internal control, remuneration, and shareholder engagement.

The following section of the Annual Report covers Stewardship and Engagement. The FRC points out that the quality of signatory statements varies considerably and that they would like to see improved reporting by all signatories across the seven principles of the Stewardship Code. The FRC will be contacting signatories individually to outline where their statements need to improve and will tier signatories publicly: ‘Tier 1 signatories will be those that meet our reporting expectations and provide evidence of the implementation of their approach to stewardship. We will pay particular attention to information on conflicts of interest disclosures, evidence of engagement and the approach to resourcing and integration of stewardship. Tier 2 signatories will be those where improvements are needed.’ As mentioned earlier, they will announce the outcome in the summer of 2016. This section of the Annual Report also covers engagement in the 2015 AGM season; company and investor expectations and reporting; collective engagement; proxy advisors; and voting and ownership.

The penultimate section of the Annual Report covers Other Corporate Governance and Stewardship Developments including Audit Regulation and Directive; Lord Davies Report on diversity (highlighting that FTSE 100 companies now have over 26% of the directorships held by women, and that whilst in 2011 there were 152 all male boards in the FTSE 350, now there are only 15 companies left with all male boards, all within the FTSE 250); the European Commission’s recommendation on the quality of corporate governance reporting (the ‘comply or explain principle’); the review of the OECD’s Principles of Corporate Governance; the European Commission’s Shareholder Rights Directive; the European Securities and Markets Authority (ESMA) Call for Evidence; fiduciary duties; the ICGN Global Stewardship Code consultation; other Stewardship initiatives; and the Capital Markets Union.

The final section of the Annual Report summarises the Corporate Governance and Stewardship Work for 2016/17. As well as mentioning the main activities, the FRC points out that its work in the ‘areas of governance and stewardship overlaps with that of many others, and we continue to work closely with market participants, representative organisations, service providers, regulators and Government departments.’

The Annual Report therefore provides both an interesting position paper in terms of where we are now in UK corporate governance and also highlights areas which the FRC will be focussing on for improvement.

As the AGM season is upon us, it will be interesting to see how companies deal with corporate governance hot topics such as the perennial executive remuneration issues – now very much in the headlines at BP and WPP – and how investors respond in terms of their stewardship role.

Chris Mallin, April 2016

Move Away from Short-Termism?

There has been a long-standing debate about short-termism versus the longer-term, with companies often appearing to focus on short-term earnings to the detriment of the longer-term sustainable value of the firm. Seminal works such as Paul Marsh’s ‘Short-Termism on Trial’, published by the Institutional Fund Managers’ Association in 1990, pointed out that directors might focus on the short-term, believing, perhaps erroneously, that this is the focus that shareholders wish them to take.

Over two decades later, the ‘Kay Review of UK Equity Markets and Long-Term Decision Making Final Report (July 2012)’ published by the Department for Business, Innovation and Skills stated “Overall we conclude that short-termism is a problem in UK equity markets, and that the principal causes are the decline of trust and the misalignment of incentives throughout the equity investment chain.”… “We must create cultures in which business and finance can work together to create high performing companies and earn returns for savers on a sustainable basis.”

Subsequently, David Oakley highlights how the UK’s National Grid had ceased to provide quarterly reporting of results in his article ‘John Kay’s battle against short-termism reaps rewards’ (February 1st 2015, Financial Times). Reporting on quarterly results could increase any focus on the short-term by shareholders.

Roger L. Martin writes an interesting article with a US perspective, ‘Yes, Short-termism Really Is a Problem’, (9th October 2015, Harvard Business Review), and states that “The executives I work with speak openly about the market pressures for short-term performance. Though my perspective might be colored [by] my empathy toward them, I would say that to a person, they want to ensure that their companies do as well as possible in the long run. But they believe the capital markets place unrealistic and unproductive constraints on them.”

Two recent articles, one in The New York Times and another in the Financial Times, mention the recent activities of Larry Fink, co-founder and chief executive of BlackRock. The New York Times (1st February 2016) article ‘Some Heresy on Wall Street: Look Past the Quarter’ by Andrew Ross Sorkin, details how Larry Fink wrote to 500 chief executives asking them to stop providing quarterly earnings estimates, stating that “Today’s culture of quarterly earnings hysteria is totally contrary to the long-term approach we need”. However, Mr Fink believes that companies should still report quarterly results which provide transparency (but not be so focussed on earnings per share). Moreover, he is asking CEOs and corporate boards to provide “a strategic framework for long-term value creation”. He is also asking companies to consider environmental, social, and governance (ESG) issues as core to their business rather than as an afterthought.

Brooke Masters in her article ‘Governance Rules Need to be Set by Objective Parties’ (6th/7th February 2016, Financial Times), highlights the involvement of Larry Fink in a meeting of large asset managers brought together by James Dimon, JPMorgan Chase’s Chief Executive, with the aim of producing “governance principles for public companies to encourage long-term thinking and reduce friction with shareholders”. However Brooke Masters points out that some of the asset managers in the meeting (BlackRock aside) were amongst the least likely to vote against management on contentious issues. She concludes that any governance principles produced should not weaken the power of activist investors and “more shareholder pressure rather than less would seem to be the solution”.

It remains to be seen whether CEOs and corporate boards are able to move away successfully from the short-term emphasis to one of longer-term sustainable value. However, a more long-term focus by investors is key to this, and directors embracing ESG as core to the business is another necessary step in this direction.

Chris Mallin, February 2016

Tax avoidance

Recent developments in corporate governance policies and practices

Since the third edition of Tricker – Corporate Governance: Principles, Policies, and Practices published in February 2015, the subject has continued to evolve in regulation, policy, and practice. Some of the more significant developments include:

Tax avoidance

The notion of aggressive tax avoidance, in which corporate groups generating profits around the world transfer profits made in high tax regimes to low-tax havens, was addressed in case 15.2 (3E, p404). This topic has continued to excite interest.

In the UK, Facebook was criticised for paying less than £5,000 in tax, despite having UK sales of more than £100 million. Facebook (UK) channels profits to its international headquarters in Ireland, which then moves them to the Cayman Islands, avoiding corporation tax. Google, Apple, and other multinational groups were also criticised for using tax avoidance devices, such as charging intellectual property and brand image rights to their subsidiaries in high tax countries, transferring the proceeds to regimes with low or no corporate taxes.

Companies resident in the USA are taxed on their global profits at relatively high rates. Some US-based companies, generating taxable profits around the world, have sought opportunities, often through M&A activity, to shift their headquarters and their tax domicile to other countries which have less demanding tax rules. Known as ‘tax inversion,’ international groups re-organize to reduce their exposure to tax. Though strictly legal, such manoeuvres are, predictably, frowned upon in the US.

Tax avoidance that exploits loop holes in the international tax system are typically compliant with local tax law, but considered by many to raise ethical questions. However, for anti-tax avoidance measures to work, nations need to cooperate. In October 2015, the G20 and the OECD, institutions representing developed nations, published a set of new measures in an attempt to stop companies exploiting tax avoidance opportunities. The OECD’s ‘base-erosion and profit-shifting project’ tries to bind multi-nationals with a set of global tax rules. Sceptics, though, wonder whether nations will be prepared to harmonize their tax laws. For example, the UK introduced a scheme in 2013, which taxed the transfer of intellectual property rights, such as patents, at a substantially lower rate. Ireland and the Netherlands have similar, but different schemes. See www.oecd.org/ctp/first-steps-towards-implementation-of-oecd-g20-efforts-against-tax-avoidance-by-multinationals.htm

The European Union has also produced a blacklist of tax haven countries, but the rather arbitrary grounds on which countries have been included has been challenged.

Bob Tricker, January 2016

G20-OECD Principles of Corporate Governance

Recent developments in corporate governance policies and practices

Since the third edition of Tricker – Corporate Governance: Principles, Policies, and Practices published in February 2015, the subject has continued to evolve in regulation, policy, and practice. Some of the more significant developments include:

G20-OECD Principles of Corporate Governance

On 5 September 2015, the G20 Finance Ministers endorsed a new set of corporate governance principles developed by the OECD. The aims of these principles are to reinforce business integrity, improve trust in capital markets, unlock investment, and boost long-term economic growth. The intention is to provide governments and those who publish codes of corporate governance throughout the G20 nations and beyond with recommendations on shareholder rights, financial disclosure, executive remuneration, and the activities of institutional investors and stock markets.

The first OECD corporate governance principles were published in 1999 and updated in 2004 (3E, p129). Following the global financial crisis, which began in 2007, the OECD standards have been recognized as key to sound financial systems. The study leading to the 2015 revision began in 2013 and involved major international institutions including the Basel Committee on Banking Supervision, the Financial Stability Board (FSB), and the World Bank.

Details of the revised principles can be accessed at G20/OECD Principles of Corporate Governance. In launching the new principles, the authorities emphasized that ‘good corporate governance is not an end in itself, but a means to support economic efficiency, sustainable growth, and financial stability. It facilitates companies’ access to capital for long-term investment and helps ensure that shareholders and other stakeholders who contribute to the success of the corporation are treated fairly.’

Bob Tricker, January 2016

Corporate governance by principle or rule

Recent developments in corporate governance policies and practices

Since the third edition of Tricker – Corporate Governance: Principles, Policies, and Practices published in February 2015, the subject has continued to evolve in regulation, policy, and practice. Some of the more significant developments include:

Corporate governance by principle or rule

In its drive to create a single capital market, the European Commission (EU) has continued its quest to harmonize corporate governance rules across member states. Inevitably, it has had to face the dilemma (3E, p477) of whether corporate governance practices should be based on principles, as in the UK’s ‘comply or explain’ approach, or determined by rules backed by law, as in Germany and many other EU states.

This is not a new problem: in 1972, the draft 5th directive, from what was then the European Economic Community would have required major companies in all member states to adopt the German two-tier board system of corporate governance, with employee directors on the supervisory board. It failed, not least because of British commitment to their unitary board system. The EU is now working on a shareholder rights directive that would apply across all member states. If enacted, it would have to be enshrined in the laws of each member state.

Around the world, if any trends can be seen, they are towards corporate governance by rules backed by legislation; for example in the Sarbanes-Oxley and the Dodds-Frank Acts in the United States. Nevertheless, the UK remains strongly committed to the principles not rules approach. In other words, companies should comply with the corporate governance code or explain why they have not done so. Britain is trying to extend this approach to the rest of Europe.

Sir Winfried Bischoff, chairman of the UK’s Financial Reporting Council (FRC), wrote (September 2015): ‘The UK Corporate Governance code recognizes the collective role of the board and makes specific mention of board members and their responsibilities – chief executives, chairmen, and non-executive and executive directors. This is the UK approach and one that Europe is now coming round to. In the last 20 years corporate governance codes have emerged across Europe as public perceptions of boardroom behaviour has widened and come under increasing scrutiny. These codes set out best practice principles for boards and generally operate on a ‘comply or explain’ basis, on the assumption that good corporate behaviour can be accomplished through transparency rather than through hard rules and unnecessary (bureaucratic) burdens.’

The FRC wrote formally to the EU on 26 June 2015 explaining that the FRC sets the framework in the UK of codes and standards for corporate reporting, accounting, auditing, and actuarial and investor communities, including the corporate governance and stewardship codes. It explained how the stock exchange listing rules for major listed companies required them to follow the codes, under the supervision of the Financial Conduct Authority. Details of the work of the FRC and their latest report is available at www.frc.org.uk/About-the-FRC.aspx

Bob Tricker, January 2016

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