Archive for May, 2010|Monthly archive page

Twenty Steps to Better Corporate Governance

Twenty steps to better corporate governance

 A new international corporate/company secretary organization was launched in March 2010 at the Headquarters of the Word Bank in Paris.

 The Corporate Secretaries International Association (CSIA) is an international federation of professional bodies formed to promote good governance and corporate secretary-ship. Member organisations include national representative organisations from Australia, Hong Kong/China, India, Kenya, Malaysia, New Zealand, Singapore, South Africa, the United Kingdom, the United States and other jurisdictions representing some 70,000 governance professionals in more than 70 countries.

 A research paper was presented at the launch of CSIA: Twenty Steps to Better Corporate Governance.  Corporate governance experts from around the world, including the two authors of this blog site – Professor Chris Mallin and Professor Bob Tricker – were asked for their opinions on possible corporate governance implications arising from the recent global financial crisis and the ongoing economic hiatus. 

The other contributors to the paper were (in alphabetical order):

  • Sir Adrian Cadbury, widely known for his chairmanship of the UK Committee on the Financial Aspects of Corporate Governance and the seminal corporate governance code of best practice that bears his name,
  • Dr John Carver, a corporate governance consultant, originator of the Policy Governance® model and author of Corporate Boards that Create Value, 2002, USA
  • Professor Gabriel Donleavy, Professor of Accounting, University of Western Sydney, Australia,
  • Professor William Judge, E.V. Williams Chair of Strategic Leadership, Old Dominion University and editor of Corporate Governance – an international review, USA,
  • Dr Gregg Li, Head of Governance and Risk Management, Aon Global Risk Consulting, Hong Kong,
  • Professor Jay W. Lorsch, Louis Kirstein Professor of Human Relations at the Harvard Business School, USA,
  • James McRitchie, CEO, Corporate Governance Network, USA.
  • Dr Shann Turnbull, Principal, International Institute for Self-governance, Australia.

 To read more about the CSIA go to http://www.csiaorg.com.

The full paperTwenty Steps to Better Corporate Governance can be accessed at http://www.csiaorg.com/pdf/research_paper.pdf

 Bob Tricker, 1 June 2010

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UK Corporate Governance Code

The Financial Reporting Council (FRC) has issued an updated corporate governance code for UK companies. Formerly known as the Combined Code, the newly issued UK Corporate Governance Code is a response to the financial crisis which caused shock waves around the world.

The FRC traces the roots of the UK Corporate Governance Code to the Cadbury Committee Report (1992) http://www.ecgi.org/codes/documents/cadbury.pdf and its successor reports. They recognise that ‘The Code has been enduring, but it is not immutable. Its fitness for purpose in a permanently changing economic and social business environment requires its evaluation at appropriate intervals’.

The UK Corporate Governance Code (hereafter ‘the Code’) continues to have at its heart the ‘comply or explain’ approach which was introduced in the Cadbury Committee Report. Sir Adrian Cadbury in his seminal book ‘Corporate Governance and Chairmanship, A Personal View’(2002) stated ‘The most obvious consequences of the publication of the 1992 Code of Best Practice was that it put corporate governance on the board agenda. Boards were asked to state in their reports and accounts how far they complied with the Code and to identify and give reasons for areas of non-compliance’. The flexible approach provided by the ‘comply or explain’ approach is a great strength and has been adopted in many countries.

Code structure

The Code has five sections being Section A: Leadership; Section B: Effectiveness; Section C: Accountability; Section D: Remuneration, and Section E: Relations with Shareholders. There is also currently a Schedule in the Code (Schedule C) ‘Engagement Principles for Institutional Shareholders’. This schedule contains three principles: dialogue with companies; evaluation of governance disclosures; and shareholder voting. However it will cease to apply when the Stewardship Code for institutional investors which is being developed by the FRC comes into effect.

Main changes to the Code

The FRC identifies six main changes http://www.frc.org.uk/press/pub2282.html as follows:

(i)     ‘To improve risk management, the company‘s business model should be explained and the board should be responsible for determining the nature and extent of the significant risks it is willing to take.

(ii)    Performance-related pay should be aligned to the long-term interests of the company and its risk policy and systems.

(iii)   To increase accountability, all directors of FTSE 350 companies should be put forward for re-election every year.

(iv)   To promote proper debate in the boardroom, there are new principles on the leadership of the chairman, the responsibility of the non-executive directors to provide constructive challenge, and the time commitment expected of all directors.

(v)    To encourage boards to be well balanced and avoid “group think” there are new principles on the composition and selection of the board, including the need to appoint members on merit, against objective criteria, and with due regard for the benefits of diversity, including gender diversity.

(vi)   To help enhance the board’s performance and awareness of its strengths and weaknesses, the chairman should hold regular development reviews with each director and FTSE 350 companies should have externally facilitated board effectiveness reviews at least every three years.’

Contentious changes?

The changes that seem most likely to be contentious and attract most debate relate to the annual re-election of directors and the move to encourage boards to consider diversity, including gender, in board appointments.

 

Annual re-election of directors

According to Rachel Sanderson and Kate Burgess, in their article ‘Directors must be re-elected annually’ (FT, page 17, 28th May 2010), the annual re-election of directors in FTSE 350 companies is the most controversial aspect of the Code. They state ‘Critics, including the Institute of Directors, have said it will encourage short-termism and be disruptive. Those in favour have said it will make boards more accountable to shareholders’.

The widespread concern about the underperformance of some UK board directors prior to, and during, the recent financial crisis no doubt led to increased support for the idea of the annual re-election of directors.

Diversity

Another potentially contentious change is the fact that boards are now encouraged to consider the benefits of diversity, including gender, to try to ensure a well-balanced board and avoid ‘group think’. Similar provisions may be seen in the German Corporate Governance Code (2009) ‘The Supervisory Board appoints and dismisses the members of the Management Board. When appointing the Management Board, the Supervisory Board shall also respect diversity’ (5.1.2) and the Dutch Code of Corporate Governance (2008) ‘The supervisory board shall aim for a diverse composition in terms of such factors as gender and age (111.3).

The UK has not gone as far as Norway which has, since 2008, enforced a quota of 40% female directors on boards of all publicly listed companies. Similarly Spain introduced an equality law in 2007 requiring companies with 250+ employees to develop gender equality plans which clearly has implications for female appointments to the board.

Whilst it is fair to say that the number of females with experience at board level in large UK companies is relatively limited, non-executive directors can be drawn from a much wider pool including the public sector and voluntary organisations. Their experience can bring new insights to the board, maybe challenging long-accepted views and hence adding value.

Institutional shareholders

As mentioned above, the Code currently contains Schedule C ‘Engagement Principles for Institutional Shareholders’ but this will be withdrawn when the Stewardship Code becomes operational. The Stewardship Code is being developed separately by the FRC and will set out standards of good governance for institutional investors, the FRC hopes to publish it by the end of June 2010.

Andrew Hill in the FT Lombard column (FT, page 18, 28th May 2010) ‘New code sets the high-water mark for governance’ discussed the new Code. He points out that ‘Now it is up to shareholders, encouraged by their own forthcoming stewardship code, to rise to the challenge……the FRC has set a new high watermark for post-crisis governance standards. The test will be whether investors use it responsibly and maintain sensible pressure on boards, as recession turns to recovery and chief executives’ and directors’ risk aversion dissipates’.

Concluding comments

The FRC has produced a robust UK Corporate Governance Code, building on the earlier Codes and retaining the flexibility of the ‘comply or explain’ approach. Future success will be measured by companies following the substance, or spirit of the Code, and not just its form and by institutional shareholders and boards engaging more fully.

The new edition of the Code will apply to financial years beginning on or after 29 June 2010. The Code, and a report explaining the main changes, can be found at: http://www.frc.org.uk/corporate/ukcgcode.cfm

Chris Mallin 28th May 2010