This is part of my Eccentric MBA, a self-paced self-taught online programme of study.
You can tell it’s self-paced, because I’m doing two weeks in one here because of other commitments. It’s important to get back on the horse rather than letting it gallop away. This topic is corporate governance, and I’m focusing as before on large listed companies in the UK.
There is a wide variety of views on what is right and wrong in corporate governance concerning what ought to happen.
For UK listed companies, there is an official UK Corporate Governance Code [PDF] published by the Financial Reporting Council, that sets out in some detail what has to happen. In this section I’m going to call it simply ‘the code’.
The code is statutory. The Listing Rules say the company’s annual report must set out how the code has been applied, on a “comply or explain” basis: you can do what it says you should, or explain why what you’ve done is a better approach in your specific context. They even have detailed guidance on how to do “comply or explain” reporting better [PDF]. In yet more detail, there is comprehensive guidance for Boards and Board Committees.
For unlisted companies, there is a corresponding set of Wates Corporate Governance Principles for Large Private Companies. These don’t have quite the statutory force that listed companies have, but there is a recent requirement under secondary legislation for large companies (>2000 employees, turnover >£200m, balance sheet >£2bn) to report annually on corporate governance. To comply, a company must either report on how it applied a governance code, or explain why and say what it did instead. The Wates Principles were developed to be just such a governance code. They mirror the Corporate Governance Code but are much less detailed and specific.
The FRC also publish the complementary UK Stewardship Code, which sets out what investors (or rather, people who act on behalf of investors – asset owners like pension funds, asset managers, service providers) should do to be good stewards.
Worth noting here in passing just how long the chain is from someone with a pension to the company they’re investing in. We are many, many layers deep in principal-agent problems between an individual pension holder, the trustees of the pension fund, the fund management company (eliding here its workforce, management, and board), the board of the company whose shares are held, its management, and the workforce of that company. And of course any advisors or intermediaries along the way in the value chain.
Anyway. What does the code actually say? What is corporate governance?
The key distinction is between governance and management. This is a distinction about which much has been written (and a fair bit read by me) and I’m not going to get to the bottom of it here. My summary is that management is making things happen, and governance is deciding what should happen and making sure it has happened. Governance sets strategy and policy, and scrutinises management. Management is accountable to the board, the board is accountable to the shareholders, and the shareholders (if they’re institutional) are accountable to all sorts of bodies. Importantly, ‘accountable to’ in this context includes ‘can fire’, although with shareholders it’s more often about fining than firing.
The company is run on a day to day basis by the management, headed by the Chief Executive. The board sets the purpose, values, and strategy of the company, ensures the required resources are in place, and sets up appropriate monitoring and controls. The board answers to the shareholders through the annual reporting and AGM cycle (directors must be re-appointed, sometimes annually, sometimes on a rolling 3-year basis), and are also required to engage meaningfully with them at other times. There’s specific provision that any vote of more than 20% against the board’s recommendation on an AGM resolution requires consultation, action, and reporting.
In contrast to the material I was reading in previous weeks about corporate law and mergers & acquisitions, the code is at some pains to require effective and meaningful engagement with other stakeholders, including suppliers, customers, and the workforce. There are detailed provisions requiring the Board to, for instance, assess and monitor culture, explain the company’s approach to investing in and rewarding its workforce, and to provide a “means for the workforce to raise concerns in confidence and – if they wish – anonymously”. There are also many points at which diversity and inclusion are specific requirements.
The code insists on a clear distinction between the board and the executive leadership and management of the company. In practice the executives on the board will have considerable ‘sapiental authority’: they know what’s going on better than the others so will tend to take the lead. Independent non-executive directors (NEDs) must be the majority of the board, not counting the chair, who should be independent on appointment – although they can have been a NED before, but not for too long. I’m familiar with this causing difficulty and friction internally: outsiders do not understand the organisation as well as insiders. However, I can see the rationale for ensuring sufficient independence – and it is anyway a requirement. Effective briefing of NEDs can really help here, and of course NEDs have a responsibility to ensure they have as full and accurate a picture of the company as required to discharge their responsibilities. This is an ongoing requirement: NEDs who’ve been in post for >9y are no longer automatically deemed to be independent.
The board appoints a senior independent NED. They advise the chair, act as intermediary, and lead meeting at least annually of the independent NEDs to review the performance of the chair. The NEDs have “a prime role” in appointing and scrutinising the executive directors, and the chair of the board must hold meetings without the executive directors.
The company secretary (a senior manager) advises the board on its responsibilities. I remember a friend quipping that a company had many hundreds of secretaries who were extremely junior and female, plus one who was extremely senior and male. You can tell this was many decades ago because there are very few secretaries these days and – although there is a long way still to go to reach gender parity – there are at least some female company secretaries.
The board sets up whatever committees it sees fit to delegate its authority to, but this must include:
- Nomination committee (majority independent NEDs, chair of the board not to chair for the appointment of successor, can include chief executive) responsible for: appointments and succession planning for board and senior management, annual board evaluation (often external). Obviously, there has to be a proper process and procedure for these. Annual appraisals of individual board members appear to be more of a thing.
- Audit committee (all independent NEDs, chair of the board not a member) responsible for: financial statements, annual report and accounts, financial controls, monitoring internal audit, external auditor.
- Remuneration committee (all independent NEDs, chair of the board may only be a member if independent on appointment and anyway may not chair this committee) responsible for: remuneration for executive directors, chair, and senior management, review workforce remuneration and reward policies, external remuneration consultant (if used). NED remuneration is set by Articles of Association or by the whole board and can’t be shares. “remuneration arrangements should ensure reputational and other risks from excessive rewards, and behavioural risks that can arise from target-based incentive plans, are identified and mitigated”
Given my interest in data and metrics, it’s interesting that there’s no explicit mention of data governance. (I might do a whole topic on that, although it’s much closer to my previous home turf than most of this.) The board has the responsibility to ensure that effective controls are in place, which includes metrics and reports and so on, and of course are responsible for ensuring that legal requirements are complied with. All of which I would argue are tantamount to a requirement to ensure effective data governance, but I suppose one could argue that the board can discharge this by ensuring the management were doing a good job in that regard. There is a question in the guidance that asks the board “Are we securing the benefits of ‘big data’ to give us a competitive edge?”
The code, and even more so the guidance, is vocal on the need to consider the creation of value in the long term and consider value in broad terms, not just financial statements. There is much about the tension between short-term investor concerns and the long-term health of the company, and to ask “Are shareholders driving the company to act in a way that is out of line with its purpose, values and wider responsibilities?”. I’m not sure I see what they can (or should?) do in extremis if shareholders are set on that course of action and vote out the board – but that almost never happens. Although the fact that it can will influence matters long before it comes to that.
Things can be quite different in practice for smaller, private companies, especially where there is overlap between significant shareholders, directors, and employees, and there is not an immediate, liquid market mechanism for selling shares. Full exploration is beyond this topic: I might later come back to the model articles of association for limited companies.
They can also be very different in other organisations, such as charities and pensions. I might come back to that later too.
While I’m talking about things I’m skating over and might return to in future, the biggy here is financial reporting and statements. This has a lot to it and I have been deliberately not getting in to the details for this topic. But it is critical stuff.
One final thing that’s struck me throughout the first month of this Eccentric MBA is that this view of organisations is quite distinct from the internal, management perspective, with which I’m much more familiar. Obviously they overlap and intersect, particularly around strategy, but I am increasingly appreciating the way in which this level of operation is a distinct one. Some individuals live in both worlds and translate between them – executive directors and the company secretary in particular, since they are both senior management and members of the board. And I know many chairs and NEDs cultivate informal contacts with company insiders to help inform their decision-making. There is a big gulf in perspective here that takes work to bridge.