Governance: performance, not probity, must be the top priority

Corporate governance has only recently been seen as a social responsibility issue at all. In fact, the debate about recent scandals raises fundamental questions about how companies are run and what they are for.

Higgs delivers the goods

Significant revisions of the UK’s combined code on corporate governance are set to follow the recent publication of the much-heralded Higgs Review on non-executive directors. Included in the reform package, published by the government on January 29 and due for implementation in early summer 2003, are the following provisions:

• that at least half the board, as well as the chairman, should be independent, as should all members of the audit and remuneration committees and a majority of the nomination committee;
• that the definition of an independent director should be strengthened and clarified;
• that the separation of the roles of chairman and chief executive should be reinforced;
• that new descriptions should be given of the respective roles of the board, the chairman and non-executives.

The government is appointing a working group, led by Laura Tyson, dean of London Business School, to encourage companies to recruit a more diverse group of non-executive directors.

Derek Higgs, the author of the review, is chairman of Partnerships UK and a non-executive director of Egg, The British Land Company, Allied Irish Banks and Jones Lang La Salle. Contact Jonathan Prior, DTI, on 020 7215 5969 (http://www.dti.gov.uk)

Audit report

A government-commissioned inquiry into strengthening audit and accountancy rules in the UK was published on January 20 by Sir Robert Smith, chairman of the Weir Group. The Smith report parallels the Higgs review, and includes the following recommendations:

• a bigger role for company audit committees, which should consist entirely of independent members, with a key role in protecting the interests of shareholders;
• the creation of a new accountancy regulator, which will undertake joint investigations with the Financial Services Authority of accounting abuses;
• the transfer of responsibility for setting ethical standards on independence, objectivity and integrity from professional accountancy bodies to an independent body.

Contact Jonathan Prior, DTI, on 020 7215 5969 (http://www.dti.gov.uk)

Out of step

After four years of operation, only a third (34%) of UK companies fully comply with the combined code on corporate governance, according to the annual review of corporate governance, published by Pensions Investment Research Consultants on December 12. More than three quarters of UK company boards are dominated by executives and non-executives who are not independent, and nearly three out of ten (28%) companies have one or more directors with a contractural notice period longer than one year.

Meanwhile a MORI survey of company directors, published on January 20, finds that nearly half (48%) of the non-executive directors of UK listed companies are appointed through personal contact with a board member. Only one in twenty-five non-executives is appointed through a formal interview, and only one in a hundred answers an advertisement. Once in the role, three quarters (76%) of non-execs have never had a formal personal performance review, and fewer than two in five (38%) have been given objectives for their role. Contact Stuart Bell, PIRC, on 020 247 2323 (http://www.pirc.co.uk); Neil Wholey, MORI, on 020 7347 3000 (http://www.mori.com)

Fat cats pay

Archie Norman MP, former chairman of ASDA, failed in his push for new laws to give non-executives the power to sack under-performing executives, and to deny them large pay-offs. Norman launched a private members bill on severance pay on December 9, which proposed amending the Companies Act 1985 to oblige directors to demonstrate they have taken into account the performance of the departing director in setting the amount of any payment for loss of office or employment.

The government responded with a pledge to review the severance pay issue. Contact Archie Norman, House of Commons, on 020 7219 3000 (http://www.parliament.uk)

Reporting’s next steps

Representatives from PricewaterhouseCoopers, KPMG, Henderson Global Investors and HBOS are joining the Department of Trade and Industry’s corporate reporting group, set up to advise the government on plans to require companies to publish an ‘operating and financial review’, as announced in last year’s company law review. The group met for the first time on December 11, and plans to report in September 2003. A formal consultation is also planned for May 2003. Contact Jonathan Prior, DTI, on 020 7215 6405 (http://www.dti.gov.uk)

Sarbanes-Oxley rules

The US Securities and Exchange Commission voted on January 15 to adopt rules implementing the Sarbanes-Oxley Act of 2002, which requires US-based companies to disclose in their annual reports whether they operate a code of ethics for their chief executive, chief financial officers or senior accountants. The SEC also adopted new rules on January 23 that require mutual funds and other registered management investment companies to disclose their proxy voting policies and procedures. Contact John Heine, SEC, on 00 1 202 942 0020 (http://www.sec.gov)

US mirrors UK changes

US companies should separate the chairman and chief executive functions, argues a report on improving corporate governance, audit and accounting practices, published by The Conference Board on January 9. The report mirrors parallel UK studies in recommending improved scrutiny of directors’ qualifications, corporate policies and procedures that define ethical conduct, and a stronger role for audit committees. Contact Frank Tortorici, Conference Board, on 00 1 212 339 0231 (http://www.conference-board.org)

COMMENT:

Corporate governance has only recently been seen as a social responsibility issue at all. In fact, the debate about recent scandals raises fundamental questions about how companies are run and what they are for.

Before Enron, Tyco and WorldCom, too few managers responsible for community and external relations saw corporate governance as an issue they should concern themselves with. Too dry and technical. Equally too many at board level saw issues such as the competence of directors, their appointment and remuneration as matters of internal concern, not wider social responsibility. Even now, some don’t grasp the connection. One FTSE100 company secretary was recently heard to ponder what CSR had to do with his job – an understandable attitude, perhaps, if CSR is all that soft do-gooding stuff, nice when you can afford it, but essentially an irrelevance to the people really running the business.

Certainly, some governance issues do seem dry and technical: what constitutes independence; should the chairman come from outside; which board sub-committees must be majority independent; and so forth. But they raise profoundly important questions about how a company is best managed, and to what ultimate end. There is a real danger that changes on both sides of the Atlantic – driven by loss of public confidence – will result in more systems of control, risk avoidance and undue power given to independents who don’t really understand what’s going on in the business.

In that sense, those – like the Institute of Directors – who wrongly resist the call for greater accountability, nonetheless make a valid point. This whole debate should at heart be about performance, not probity. Governance mechanisms need to be tightened up and made more transparent, not to stop more Enron-style crookedness but to ensure companies are well managed and more successful at their primary social role – putting goods and services into the marketplace in the most efficient and effective way possible, complying with laws and behaving in ways that meet stakeholders’ expectations.

Opting for the US-style, ‘tick box’ mentality would be a mistake. The better alternative is to set out the standards expected, leave maximum flexibility on how to achieve them, and then require full reporting. There’s a parallel here with the debate about the future of CSR – government regulation and compliance, to stop wrong-doing, or a voluntarist approach based on encouraging high standards. In both debates, loss of public confidence and the breakdown of trust may mean it’s too late to avoid the prescriptive approach.