Conference 2017: The future of governance
Peter Swabey, FCIS, policy and research director at ICSA: The Governance Institute, spoke at the annual conference on why corporate governance is now high on the government’s agenda, and the expectations placed on it to restore public faith in business.
Governance is an increasingly high-profile term in our society. As a chartered secretary, I can’t help being pleased about that, although some of the reasons for its increasing ubiquity give me cause for disquiet.
One of the constant struggles of the company secretary or governance professional is getting people to understand what we do. For Law Society members, that is less of a problem. Tell people at a dinner party that you are a solicitor, and they get a picture in their head of what it is they think you do. That picture will probably be wrong (and will probably involve a wig), but they will have an idea nonetheless. For a chartered secretary, it will probably involve typing speed; until recently, governance would simply elicit a blank look.
That has begun to change. On 11 July 2016, Theresa May made a speech in which she emphasised the importance of corporate governance. In September, the Business, Energy and Industrial Strategy (BEIS) Select Committee launched an inquiry into corporate governance and, just in time to push it back into the headlines, BEIS launched a major green paper on the subject in November.
We expect to see some legislation in this area in the coming months, and for the Financial Reporting Council (FRC) to be asked to address some of these issues through the UK Corporate Governance Code (the Code). But is this the right approach?
In February, ICSA: The Governance Institute launched the first in a series of thought leadership papers on the future of governance, in which Chris Hodge, formerly director of corporate governance at the FRC, looked at the current UK corporate governance model and whether it achieves what is intended. His first, and perhaps key, point was that over time, we have changed what we mean by the term ‘corporate governance’.
Back in 1992, the Cadbury Committee defined corporate governance as ‘the system by which companies are directed and controlled’. In her introduction to the government’s green paper on corporate governance reform, published in November 2016, the prime minister said that ‘both the Government and big business must rise to the challenge of restoring faith in what they do, and in the power of the market economy to deliver growth, opportunity and choice for all’.
Hence, in the 25 years since the Cadbury Committee reported, our expectation of corporate governance has gone from ‘improving control and accountability’ to ‘restoring faith in capitalism’. That is clearly a much bigger job – for boards of companies, and for the regulatory framework on which we rely. The prime minister is expressing the expectation that corporate governance can prevent, or at least reduce, the sort of behaviour that led to the loss of faith in business, and can contribute to public policy objectives.
For policy makers, restoring faith in business is very difficult to deliver. Your ability to exert any direct influence on the outcome is severely limited – trust has to be earned. The most you can hope to do is take actions that will encourage companies and their directors to adopt and display the sort of behaviours that may, in time, earn back that trust.
There is also a tendency to argue that every time a company behaves in a way that impacts adversely on an interest, it represents a failure of public policy or of governance. Blaming each example on systemic weaknesses encourages the assumption that the system can be adjusted to prevent them from being repeated.
Revising the Code, or adding more reporting requirements or voting rights, may often be the right response. But sometimes it won’t. Most corporate scandals are not examples of systemic failure, but bad judgement, bad behaviour, or negligence. Their root cause is human nature, which is not something that can be remedied by regulation.
In other areas of public policy, the human factor is explicitly recognised. Nobody assumes that the rules will always be obeyed. Sanctions for disobeying them are an integral part of the policy approach, and serve as both a deterrent and a punishment. The governance framework does not include adequate sanctions for punishing bad behaviour by directors.
Delivering opportunity and choice for all
The regulatory framework for corporate governance is never, on its own, going to be sufficient to deliver ‘opportunity and choice for all’ or other public policy objectives.
The first and most obvious shortcoming is that – at present – it applies only to listed companies; the second is that the enforcement role rests with shareholders who are only responsible to their clients and beneficiaries, rather than to society at large. Their interests, and those of other stakeholders, may often coincide, but if stakeholders do not have the ability meaningfully to represent their own interests, the answer is not to ask shareholders to do so on their behalf.
Furthermore, the current governance framework relies heavily on reporting for its effectiveness. Policy-makers have too often been guilty of assuming that a requirement to report on something would be sufficient to bring about change. As a result, reporting has been overused as a policy solution.
Reporting can be a very effective way of bringing about change, but only when there are consequences associated with failure. If there are no consequences, reporting in itself achieves nothing.
There is no better example of this misdiagnosis than reporting on directors’ remuneration. It is over 20 years since the Greenbury Report first recommended that companies report to their shareholders on this issue, and since then the reporting and voting regimes have been strengthened regularly – and, it seems, may be about to be strengthened further.
But in over 20 years, it has done nothing to slow the increase of executive pay – some would argue it has contributed to it – or to reduce income inequality. There is no evidence to support the view that those objectives can now be achieved by adding more reporting requirements and voting rights.
To achieve ‘opportunity and choice for all’, we need to recognise that, while listed companies can and must contribute to this and other public policy objectives, they cannot achieve them on their own. Addressing issues such as income inequality and equal opportunities only in the listed sector limits both the ambition and the impact.
We also need to address the issue of sanctions. While good governance standards and scrutiny by shareholders and other stakeholders reduces the risk of bad behaviour or poor decisions, they cannot eliminate the human failings that cause them. Any sanctions must, of course, be proportionate and justified. But that does not reduce the need for them.