Archive for the ‘Directors’ Category

Succession Planning

Why is succession planning important?

Succession planning is seen as crucial to ensuring that a successor is in place to carry on the work of key individuals in a business should they leave the company in either a planned manner (e.g. retirement, job move, generational succession, or ownership changes) or an unplanned manner (e.g. fatal accident, unplanned removal from post). Sometimes the immediate successor is seen as a safe pair of hands, ready and waiting to carry on the work pending the appointment of another individual, whilst at other times there has been more time to search for a successor.

Investors are keen to know that a succession plan is in place for key directors to help ensure the ongoing smooth running of the business, its strategy going forward, and to maintain a steady steer at the helm, thus retaining investor and market confidence. The successor may also be appointed for their new ideas on strategy, whether that is to take the business forward into new spheres or to concentrate more on a few core sectors which may be more appropriate for the company at that time.


Corporate Governance Codes

Corporate governance codes mention succession planning in different degrees of detail.  Looking at a few of these, the UK, Japan, and Italy, illustrates this.

The UK

The current UK Corporate Governance Code (2016) mentions succession planning in the context of the role of non-executive directors, they ‘have a prime role in appointing and, where necessary, removing executive directors, and in succession planning,’ (A.4, Non-executive Directors, Supporting principle, UK Corporate Governance Code 2016, Financial Reporting Council); and in the context of Appointments to the Board ‘The board should satisfy itself that plans are in place for orderly succession for appointments to  the  board  and to  senior  management,  so  as  to  maintain  an  appropriate  balance  of skills and experience within the company and on the board and to ensure progressive refreshing of the board (B2 Appointments to the Board, Supporting principle, UK Corporate Governance Code 2016, Financial Reporting Council)

However the proposed revisions to the UK Corporate Governance Code (2017) cover succession planning in more detail.  Section 3 is headed ‘Composition, succession and evaluation’, and its Principle J states ‘Appointments to the board should be subject to a  formal, rigorous and transparent  procedure, and an  effective succession  plan  should  be in  place for board and senior management. Both appointments and succession plans should be based on merit and objective criteria, and promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths.’ Provision 17 states that ‘The board should  establish a nomination committee that should lead the process for appointments, ensure plans are in place for orderly succession to both the board and senior management positions, and oversee the development of a diverse pipeline for succession.  A majority of   members of the committee should be independent non-executive directors, with a minimum membership of three. The chair of the board should not chair the committee when it is dealing with the appointment of their successor,’ (December 2017, Proposed Revisions to the UK Corporate Governance Code Appendix A – Revised UK Corporate Governance Code)


Japan’s Corporate Governance Code (2015) states that ‘Based on the company objectives (business  principles, etc.) and specific business  strategies, the board should engage in the  appropriate oversight of succession planning for the CEO and other top executives,’ (4.1.3, Japan Corporate Governance Code, Seeking Sustainable Corporate Growth and Increased Corporate Value  over the Mid- to Long-Term (2015), Tokyo Stock Exchange)


Italy’s Corporate Governance Code (2015) refers to the fact that ‘The Board of Directors shall evaluate whether to adopt a plan for the succession of executive directors. In the event of adoption of such a plan, the issuer shall disclose it in the Corporate Governance Report. The review on the preparation  of  the  above  mentioned  plan  shall  be  carried  out  by  the nomination committee or by another committee established within the Board of Directors in charge of this task.  Should the issuer adopt a succession plan, the Corporate Governance Report shall disclose whether specific  mechanisms are set forth in the succession plan  in  case  of  early  replacement, the corporate bodies and the persons in charge of the preparation of the plan as well as the manners and timing of its review.  As far  as the succession  procedures  are  concerned, the Committee believes that these procedures shall clearly define their scope, instruments and timing, providing both for the involvement of the Board of Directors and for a clear allocation of tasks, also with regard to the preliminary stage of the procedure,’ Appointment of directors, 5.C.2. Corporate Governance Code (2015)

Also in Italy in 2017, the Corporate Governance Principles for Unlisted Family-Controlled Companies were issued. Article 9 relates to Planning and Succession Plans going into some detail. On this issue, there are two Principles: 9.P.1. ‘Being  aware  of  the  differences  that  the  company  size  and  ownership  structure  involve,  it  seems appropriate for the members and the Board of Directors to ensure the continuity of corporate governance and  management  of  the  company  by  defining  precise  regulations  for  effectively  addressing  generational transitions or ownership changes.’ Also 9.P.2. ‘For  the  purposes  of  administration  of  the  company,  succession  plans  must  be  appropriately established  in  advance,  taking into  account  the  specific  conditions  of  the  company,  the  Group  and possibly the currently controlling family.’

Five application criteria are then listed which provide guidance on the process to be followed including the timeliness of establishing the process and having it ready in good time. Corporate Governance Principles for Unlisted Family-Controlled Companies 2017


Examples of succession issues in practice

For many family firms – large and small – succession planning is a real issue when either the next generation doesn’t want to take on the mantle of the founder, or there is no obvious successor.  Leo Lewis in his article ‘New prescription’ about Takeuchi Optical, a Japanese glasses manufacturer, highlights that ‘thousands of family-owned businesses in Japan face uncertain futures due to a lack of heirs,’  (Financial Times, 5th April 2018, page 9). Whilst Japan has a rapidly ageing society, similarly, other countries also face succession planning issues.

In South Korea, for example, Lee Jae-yong, vice-Chairman of Samsung Electronics and grandson of the group’s founder, was arrested in February 2017 on charges relating to bribery and corruption connected to a nationwide political scandal. Lee Jae-yong was convicted and sentenced to five years in prison on corruption charges. However in February 2018, he was freed on appeal with his original sentence being halved and suspended for four years. In April 2018, Samsung Electronics announced that it would split the roles of CEO and Chair but there will continue to be three co-CEOs with ultimate power still residing with Lee Jae-yong as vice-chairman. However Elliott Management, the activist institutional hedge fund, is seeking a change in the company’s corporate governance to limit the power of the family successor in waiting, Lee Jae-yong.

Chris Mallin

April 2018

Boards need ability not diversity

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

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

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

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

On board diversity

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

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

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

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

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

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


What is the purpose of the board of directors?

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

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

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

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

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

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

Bob Tricker, October 2017

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


British Airways loses IT – a case study

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

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

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

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

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

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

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

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


Discussion questions:

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

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, 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:

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:

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

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$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

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



Business ethics is the bedrock of corporate governance

Serious study of corporate governance is relatively new.  Early books on the work of directors and boards date back no more than forty years and the subject only acquired its title in the mid 1980s.  Throughout the 20th century, the focus of attention was not on corporate governance but on management.  Marketing, production, finance, operations research, and management information systems were at the forefront of interest.   Organizational studies forged ahead, but the board of directors seldom appeared on the organization chart.

Now corporate governance has become the focus for the 21st. century.  True, the US Securities and Exchange Commission had existed since 1934, promoting sound corporate regulation and reporting practices.  But that was before the collapse of Enron, the world-wide implosion of Arthur Andersen, and the sub-prime financial catastrophe.  Corporate scandal and collapse in the 1980s led to the first corporate governance code: the UK’s Cadbury Report.  This seminal work soon led to codes in other countries around the world.  

These codes, however, tended to concentrate on form rather than function, emphasizing the importance of independent outside directors, the need for audit, remuneration, and nomination committees of the board, and the separation of the role of the board chairman from the CEO.   More recently, enterprise risk assessment, and corporate social responsibility have been added to the lexicon.  Corporate governance reports were required confirming that public companies had complied with the code or, if not, explaining why.    With the emphasis on structure, little concern was shown for the process of corporate governance: what actual goes on inside the board room, the leadership style of the chairman, internal political manoeuvres, and directors’ inter-personal behaviour when strong personalities meet.

 Corporate governance is about the way power is exercised over corporate entities. 

It involves the behaviour of boards and their directors, the interaction between the governing body and management, the company’s links with its shareholders and other players in the stock market, and the relations between the company and its many stakeholders.  It involves strategy formulation and policy making on the one hand, and executive supervision and accountability on the other.

Corporate governance codes have been incorporated into the rules of many stock exchanges and compliance has become a requirement for listing.  They have developed and reinforced good governance structures. But have they changed corporate behaviour? 

Have the codes worked? 

The corporate governance codes have certainly been a force for improving governance structures, procedures, and reporting.  But the codes have not changed perceptions of corporate behaviour.  Consider a few cases. 

  • BP, the oil company, published policies on corporate social responsibility and sustainability, yet lost over half its share value following the Deepwater Horizon oil-rig debacle in the Gulf of Mexico. 
  • Companies claiming to be good corporate citizens have been criticized for ‘aggressive’ tax avoidance by moving their profits, legally but questionably, through offshore tax havens. 

Despite companies’ declared commitment to corporate social responsibility, publishing ethics codes and compliance reports, concerns about business ethics are widespread and serious.  Around the world, the behaviour of companies, the attitudes of their directors and the actions of key executives have come under the public spotlight.  Fraudulent management in Australia’s HIH Insurance, the world-wide collapse of auditors Arthur Andersen, corruption in Italy’s Parmalat, allegations of bribery against BAE Systems in Europe, the rigging of Libor interest rates by British banks and, of course, excessive risk taking by financial institutions around the world that sparked the global economic crisis, provide just a few examples.

Critics of business behaviour point to fraud, bribery and corruption.  They allege price-rigging, pollution, and counterfeiting.  They see arrogance, greed, and abuse of power by those at the top of companies.  Some are cynical about business behaviour. How can you trust these people, they ask?  Protestors challenge the basis of capitalism. For them, business ethics has become an oxymoron, citing corporate avarice, disparity of wealth, and excessive director remuneration that does not reflect corporate performance.

Yet business exists by satisfying customers, creating employment, and generating wealth.  Business provides the taxes that society needs to function.  Many companies accept a social responsibility to be sound corporate citizens.  They recognize that they have a duty to respect the interest of all the stakeholders who might be affected by their actions. Many also seek a sustainable, environmentally friendly approach to their operations. To those who doubt whether modern business can be trusted, they point out that business dealings and the very concept of the limited-liability company are based on trust.  Not everyone is convinced.

Since the 19th century, the underpinning of corporate governance has been company law, with ownership as the basis of power.  Shareholder members of the company appoint directors, approve the directors’ reports and financial accounts, receive the report of the auditors, and approve dividends.  The fiduciary duty of the directors is to be stewards for their shareholders’ interests.  The reality, as we all know, is very different, particularly in large, international, listed companies.  It is the directors, not the shareholders, who wield the power over the corporate entity, despite valiant attempts by institutional investors to regain the initiative.

Meanwhile, interest in business ethics seems to be at an all time high. The subject of business ethics has grown significantly, with interest focusing on corporate citizenship, companies’ social responsibilities, and their relations with stakeholders.  More recently, green credentials and sustainability have been added to the agenda.  But business ethics is not just about corporate citizenship: business ethics are basic to running successful business. 

Ethics and the corporate governance codes

Ethics are hardly mentioned in the corporate governance codes, yet the examples just cited all raise ethical issues.  They concern the way those companies were governed, how power was exercised over them, and the way business risks were taken.  In other words, business ethics are inherently part of corporate governance. They are not an optional exercise in corporate citizenship. 

Ethics involve behaviour.  Business ethics concern behaviour in business and the behaviour of business.  Decisions at every level in a company have ethical implications – strategically in the board room, managerially throughout the organization, and operationally in each of its activities.  Ethical risks abound, whether decisions are at the strategic, managerial, or operational level.

Corporate entities, though granted many of the legal powers of human beings, have no moral sense. The board has to provide the corporate conscience.  Directors set the standards for their organization, provide its moral compass. British-based Barclays bank was fined £290 million by US and UK regulators for colluding with other banks to rig the interest rates set for loans between them.  Misstating the rate improved the financial standing of the bank and increased traders’ bonuses.  The British regulator said that “the misconduct was serious, widespread and extended over a number of years…There was a cultural tendency to always be pushing the limits… a culture of gaming, and gaming us.  The problem came from the tone at the top.”  Every organization’s culture is fashioned by its board and top management.  

Ultimately, the board of directors and top management are responsible for the ethical behaviour of their enterprise.  The board of directors with top management are responsible for establishing their company’s risk profile, determining the acceptable level of risk.  Some companies accept higher levels of risk than others.  Determining the acceptable exposure to ethical risk needs to be part of every organization’s strategy formulation, policy making, and enterprise risk management.

With moral dilemmas in business it is often not a matter of right or wrong, but what’s best for all concerned, both in the company and among all those affected by its actions.  Boards have to recognize issues and make choices.  This is a function of corporate governance, which needs to be built on the bedrock of business ethics.  It seems likely that future codes of corporate governance will find their foundations in ethics.

Bob Tricker


Executive Pay – the Days of the Golden Packages Are Numbered?

The disquiet over excessive executive remuneration packages and a lack of appropriate links with relevant performance measures has been a matter of concern in recent years.  After the financial crisis, there is even more of a focus on this aspect with shareholders becoming increasingly frustrated with both the amount and the design of executive remuneration packages.


Recent trends

The latest Manifest and MM&K Total Remuneration Survey 2011 finds little link between remuneration, performance and shareholder value, reporting that the median FTSE100 CEO remuneration increased by 32% to £3.5million in 2010 compared to 2009, whilst the FTSE100 index only rose 9% over the same period.  Moreover over a 12 year time horizon, CEO remuneration has quadrupled whilst share prices have been flat.

In the US, the BDO 600: 2011 Survey of Board Compensation Practices of 600 Mid-Market Public Companies reported that ‘director pay in the middle market is up seven percent, reflecting the increased responsibilities, time commitment, and regulatory issues – such as the Dodd-Frank Act – that boards face today’. The report states that these factors, coupled with a rebounding stock market, have allowed companies to increase director pay to $110,155, up from $102,809 in 2009, and that much of this increase can be attributed to a greater use of full-value equity vehicles, which are up 22% from last year, indicating that the recovering stock market is adding to compensation growth overall.


Issues of concern

Concern has been expressed at a number of companies where shareholders have thought that executive directors would receive remuneration in excess of what they deserved in relation to their performance or in relation to the company’s performance.  For example, Andrew Parker in his articles (FT, Page 17, 29th June 2011 ‘Strategy and pay fuel anger at C&WW’ and FT, Page 15, 5th July 2011 ‘Amber-top alert over C&W pay’) highlighted that the Association of British Insurers (ABI) issued an ‘amber top’ to alert shareholders about a number of issues at C&W including aspects of the planned new pay scheme at C&W Worldwide.  The ABI was concerned that ‘given C&W Worldwide’s depressed stock price, the chief executive and finance director could be awarded too many performance shares’.

Robert Wright in his article (FT, Page 4, 24th June 2011) ‘Ex-rail chief defends £1m payoff’ stated that that Mr Coucher, the former CEO of Network Rail, had defended the £1.07m payout that he received on leaving the company saying that it represented a payment in lieu of his notice period and the bonuses he would have received if he had been allowed to work his notice period after resigning. 

In some companies chief executives have forfeited their bonus if the company has not performed to expected standards.  In his article (FT, Page 16, 28th June 2011) ‘TalkTalk struggles see chief’s bonus cut’, Andrew Parker pointed out that Dido Harding, chief executive of TalkTalk, had secured only 20% of her maximum potential bonus in 2010/11 as there were ‘acute customer service problems’.  Justin King, the CEO of J. Sainsbury, saw his salary and bonus fall significantly because the company did not achieve key profit targets, reported Andrea Felsted (FT, Page 19, 8th June 2011) ‘Sainsbury chief’s pay drops sharply after missed targets’.

Elsewhere Vodafone has decided to place more emphasis on profit improvement in its executive pay plan.  Andrew Parker in his article (FT, page 20, 2nd June 2011) ‘Vodafone refocuses executive pay plan’, reported that greater account would be taken in future of profit-based targets by reducing the relative importance of revenue-based targets.


Banking and insurance sector

In the banking and insurance sector, some banks have slashed cash bonuses, for example, Michiyo Nakamoto reported in his article (FT, Page 15, 4-5 June 2011) ‘Nomura slashes cash bonuses’  that Japan’s largest investment bank, Nomura, had slashed the cash bonuses paid to its top executives and directors by 95% after suffering a decline in profits and its share price.  As a result only 6 out of 23 directors/executives received a cash bonus in the year to March 2011.  Patrick Jenkins reported in his article (FT, page 19, 1st July 2011) ‘Europe’s banks and insurers lead in withholding bonuses’, that nearly three-quarters of banks and insurers in Europe have introduced a system to withhold bonuses from staff if their performance does not match up to expectations.  One of the contributors to the financial crisis was thought to be overly generous short-term bonuses, and many banks have decided to put in place a system of deferred payments. There are also malus or clawback arrangements which may be used, for example, for a breach of code of conduct.


Increased use of ‘say on pay’

The use of ‘say on pay’, whereby shareholders have an advisory vote on executive pay proposals (remuneration committee report), has been utilised much more in recent months.  Tim Bradshaw and Kate Burgess (FT, page 20, 3rd June 2011) in their article ‘WPP suffers shareholder revolt over pay’ highlighted that WPP had a large shareholder revolt when over 40% of shareholders voted against the WPP pay policies. They report that one large fund manager stated ‘Investors are increasingly concerned by salary creep.  It is a topical issue at the moment.  Some companies seem to think after a couple of years of restraint that they can claw back the pay rises they would have got’.  Roger Blitz (FT, Page 19, 14th June 2011) ‘William Hill expects fallout over chief’s pay deal’ points out that some 38% of votes cast either opposed or did not endorse the group’s remuneration report, with Ralph Topping, the Chief Executive, receiving a salary increase of 11% and shares worth £1.2m by way of a ‘golden handcuffs’ retention payment. 

In the US, the say on pay has also been used frequently in recent weeks, as Dan McCrum finds in his article (FT, Page 17, 6th July 2011) ‘Shareholders quick to put ‘say on pay’ powers to work’. He reports that Hewlett-Packard and Jacobs Engineering saw their pay packages rejected outright whilst Monsanto and Northern Trust faced stiff shareholder protest votes, during this, the first year that large public companies have been required to have an advisory vote on executive compensation as part of the Dodd Frank legislation.

It may be that, with the advent of a more widespread use of say on pay in a number of markets, the days of golden executive remuneration packages are numbered.


Chris Mallin 13th July 2011

Tokyo Electric Power and the disaster at Fukushima Daiichi

A great deal has been written about the cause and effect of the nuclear power station disaster at Fukushima Daiichi, which followed the Japanese tsunami and earthquake. No doubt more will be said in the future. But relatively little attention has been paid to the governance of the company behind the Fukushima plant. This case and commentary look at some aspects of the governance of the Tokyo Electric Power Company (TEPCO). The material comes from the second edition of Corporate Governance – principles, policies and practices due in 2012.

The TEPCO case study
In an unlikely outburst, Naoto Kan, the Japanese prime minister, shouted “What the hell is going on?” to executives of the Tokyo Electric Power Company (TEPCO) following Japan’s worst nuclear crisis at the Fukushima Daiichi nuclear power plant, after the tsunami and earthquake on 11 March 2011. Were the directors or the corporate governance systems and procedures at fault?

The company appeared to have a commitment to sound corporate governance. As it stated on its web site:
“At TEPCO, we have developed corporate governance policies and practices as one of the primary management issues for ensuring sustainable growth in our business and long-term shareholder value. We believe in strengthening mutual trust through interactive communication with our valued stakeholders, including shareholders and investors, customers, local communities, suppliers, employees and the public, so we can move forward toward solid future growth and development. Therefore, TEPCO considers enhancing corporate governance a critical task for management and is working to develop organizational structures and policies for legal and ethical compliance, appropriate and prompt decision making, effective and efficient business practices, and auditing and supervisory functions.”

The TEPCO web site explains the company’s corporate governance processes:
“The Board of Directors currently comprises 20 directors, including 2 outside directors. Also, TEPCO has seven auditors, including four outside auditors. The Board of Directors generally meets once a month and holds additional special meetings as necessary. Based on interactive discussion with objective outside directors, the Board establishes and promotes TEPCO’s business and oversees its directors’ performance. TEPCO has also established the Board of Managing Directors, which meets once a week in principle, and other formal bodies to implement efficient corporate management through appropriate and rapid decision making on key management issues, including those deliberated by the Board of Directors. In particular, we have established internal committees to deliberate, adjust and plan the direction of the whole Company across a range of key management concerns, including internal control, CSR and system security, as well as stable electricity supply.”

“For more appropriate and quicker decision making, TEPCO also has the Managing Directors Meeting generally held once a week and other formal bodies to efficiently implement key corporate management issues, including those to be discussed by the Board of Directors. In particular, the Board has inter-organizational committees such as the Internal Control Committee, CSR Committee, System Security Measures Committee and Supply and Demand Measures Conference to intensively discuss directions of key management issues across the entire company.”

But behind the reassuring corporate governance explanations on the TEPCO web site lay a different reality. The company’s opaque handling of the situation at the stricken plant was widely criticized. The extent of the danger was minimized and the full extent of the damage only gradually became apparent, as the risk severity level was gradually increased to rank alongside Chernobyl as a most severe nuclear accident.

The effects in Japan included damaged to fishing and agriculture through radio-activity in sea and soil, disruption in manufacturing as power supplies were rationed, and longer-term strategic concerns about the future of nuclear power generation. Around the world, the effects included slow-downs in production as supplies of parts from Japan dried up, concerns about the safety of Japanese produce, and serious questioning about the safety and strategic future of nuclear power.

TEPCO’s handling of the incident exposed failings in its risk management systems. The company had a history of safety violations: in 2002, it falsified safety test records and in 2007, following an earthquake, its Niigata nuclear plant had a fire and a leak of radioactive water, which were concealed.

In fact the board was dominated by inside directors, qualified by their seniority within the company. Out of the 20 directors, 18 were insiders, whilst of the two nominally outside directors one of them, Tomijirou Morita, was chairman of Dai-Ichi Life Insurance, which was connected financially with TEPCO. In 2008, Tsunehisa Katsumata, the company president at the time of the 2007 problem, was elevated to chairman, being replaced by Masataka Shimizu, another career-long TEPCO employee. TEPCO had never appointed a head from outside the company.

TEPCO commentary
At first glance, the web site seems to reflect a company strongly committed to sound corporate governance: ‘corporate governance policies and practices a primary issue’, ‘interactive communication with our valued stakeholders’, ‘corporate governance a critical task’. So how to account for the discrepancies between the company’s alleged concern for corporate governance and the catastrophic failure of its Fukushima reactors?

Some clues can be found in the web site explanation of the company’s corporate governance. Notice the emphasis on ‘management’: ‘corporate governance is a primary management issue,’ ‘corporate governance (is) a critical task for management.’ The directors seem to make no distinction between management and governance. Nor is that surprising, because they are the same people. 18 of the directors are executives at the top of the management hierarchy, and one of the two alleged outside directors is not independent.

The classical model of Japanese corporations and their keiretsu groups reflects the social cohesion within Japanese society, emphasising unity throughout the organization, non-adversarial relationships, lifetime employment, enterprise unions, personnel policies encouraging 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.

In the classical Japanese model, boards of directors tend to be large and are, in effect, the top layers of the management pyramid. People speak of being ‘promoted to the board’. The tendency for managers to progress through an organization on tenure rather than performance means that the mediocre can reach board level. A few of the directors might have served with associated companies, others might have been appointed to the company’s ranks on retirement, or even from amongst the industry’s government regulators (known as a amakaduri or “descent from heaven”).

But independent non-executive directors, in the Western sense, would be unusual, although the proportion is increasing. Many Japanese do not see the need for such intervention “from the outside.” Indeed, they have difficulty in understanding how outside directors operate. “How can outsiders possibly know enough about the company to make a contribution,” they question, “when the other directors have spent their lives working for the company? How can an outsider be sensitive to the corporate culture? They might even damage the harmony of the group.” A study by the Japanese Independent Directors Network, in November 2010, showed that of all the companies on the Nikkei 500 index, outside directors made up 13.5% of the board, women 0.9% and non- Japanese 0.17%.

TEPCO fits this model perfectly.

However, the classical model of Japanese corporate governance is coming under pressure. With the Japanese economy facing stagnation in the 1990s, traditional approaches to corporate governance were questioned. A corporate governance debate developed and the stakeholder, rather than shareholder, orientated corporate governance model came under scrutiny. Globalisation of markets and finance put further pressure on some companies. The paternalistic relationship between company and lifetime ‘salary-man’ slowly began to crumble.

Some companies came under pressure from institutional investors abroad. Company laws were redrafted to permit a more US style of corporate governance. But few firms have yet embraced them. Signs of movement included calls in 2008 by eight international investment funds for greater shareholder democracy, and a report from the Japanese Council for Economic and Fiscal Policy to the prime minister proposing that anti-take over defences be discouraged and the take-over of Japanese firms be made easier.

Perhaps the TEPCO experience will encourage further moves towards enhanced corporate governance.

Bob Tricker 20 April 2011

Diversity – Rejection of Quotas

In late February, Lord Davies’ report on ‘Women on Boards’ was published

 The report was awaited with much speculation especially as to whether he would recommend quotas whereby listed companies would have to have a certain proportion of female  board members (see the blog post below ‘Diversity in the Boardroom’ which highlighted some of the issues).  Brian Groom (FT, page 4, 21st February 2011) ‘Drive for 20% women on boards’ reported that Lord Davies, had rejected quotas and that ‘only 11 per cent of submissions were in favour of quotas and the vast majority of women were vehemently opposed’ to quotas.  The report stated that ‘we have chosen not to recommend quotas because we believe that board appointments should be made on the basis of business needs, skills and ability’.

 From their consultation, the report identified that ‘the informal networks influential in board appointments, the lack of transparency around selection criteria and the way in which executive search firms operate, were together considered to make up a significant barrier to women reaching boards.’ Aiming to improve the situation and increase the number of women on boards, the report has made ten recommendations including, inter alia, that FTSE 100 companies should aim for a minimum of 25% female representation by 2015 and that all Chairman of FTSE 350 companies should set out the percentage of women they aim to have on their boards in 2013 and 2015; quoted companies should be required to disclose each year the proportion of women on the board, women in senior executive positions and female employees in the whole organisation; the Financial Reporting Council (FRC) should amend the UK Corporate Governance Code to require listed companies to establish a policy concerning boardroom diversity, including measurable objectives for implementing the policy, and disclose annually a summary of the policy and the progress made in achieving the objectives; investors to pay attention to the report’s recommendations as part of their central role in engaging with companies; and executive search firms should draw up a Voluntary Code of Conduct addressing gender diversity and best practice which covers the relevant search criteria and processes relating to FTSE 350 board level appointments. Moreover this steering board led by Lord Davies will meet every six months to consider progress against these measures and will report annually with an assessment of whether sufficient progress is being made. 

Companies themselves can provide support and encouragement through mentoring schemes.  Executive recruiters (or ‘headhunters’) also have a role to play as Gill Plimmer and Alison Smith (FT, page 4, 19th/20th February 2011) report in their article ‘Agencies to help break glass ceiling’.  The pressure is on for headhunters to put forward more women candidates to companies for consideration for board positions.  

Internationally, some countries have quotas, others do not.  As Joe Leahy (FT, page 10, 16th February 2011) ‘Gender gap narrows in Brazil’ reports, women executives may find it easier to climb up the corporate promotions ladder in Brazil but getting to the top rung can still be very difficult. For example, in Brazil the percentage of women board directors is only 8%, and to be appointed to the CEO position is even more difficult. In the European context, Daniel Schäfer and Peggy Hollinger (FT, page 21, 21st February 2011) ‘German groups brush off quota threat’ point out that in 2010 only 2.2 per cent of executive board members at Germany’s 30 blue-chip DAX companies were women. They also highlight that in Germany ‘until 1977 a husband was legally allowed to terminate his wife’s labour contract’! 

It remains to be seen whether the European Commission will impose quotas for the proportion of women on the boards of large listed companies in Europe.  For now there is no Europe wide quota system in place although this may change in future.  However there is much to be said for the view expressed in the Davies report ‘we believe that board appointments should be made on the basis of business needs, skills and ability’.

 Chris Mallin 1st March 2011