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Corporate governance codes are often inappropriate to individual organisations, and a new approach is needed, argues Adrian Berendt

This article was first published in Edition 8 (January 2014) of Accountancy Futures, ACCA's research and insight journal.

The surgeon emerged from the operating theatre and pronounced the operation a complete success: ‘Er, the patient has died.’ In reading the annual reports of many large companies, I find them equally successful in complying with corporate governance codes, with many succumbing to financial or other problems. This misses the central point of corporate governance: creating long-term value.

Modern corporate governance started under promising circumstances with the UK’s Cadbury Report of 1992. Since then it has suffered so many ‘improvements’ that reporting in most countries is little better than useless and is no longer fit for purpose. It is difficult enough for board members and other ‘insiders’ to recognise good governance; it is far worse for outsiders. The examples below are mere symptoms of a wider, global problem. Solutions seem few and far between, although we have hopes for the King III code in South Africa.

Not so co-operative

In November 2013, under questioning by the UK parliament’s Treasury select committee, Paul Flowers, the Co-operative Bank’s ex-chairman, did not know its profit, balance-sheet size or the number of loans – the major asset. When asked if he knew roughly how many loans and advances the bank had, he replied: ‘No, because it was not my function as the chair of the board to have all those details. They would be details supplied to the committees, and in particular to audit, risk and exposure committees.’

Although it is unclear to me how he could lead the board strategically without this knowledge, my concern is more with the organisation itself. The Co-operative Group’s 2012 annual report reads: ‘The Board of the Co-operative Group is committed to the highest standards of corporate governance and recognises that good governance helps the business to deliver its strategy… It believes that good governance is essential to the success of the group and should be focused not only in the boardroom but across the entire business.’

In reading the select committee’s report and knowing how the bank had suffered near-terminal financial losses and reputational damage in 2013, I wondered how these words could be justified. The answer is straightforward: like too many other companies the Co-op complies with the letter of corporate governance, but does not place enough emphasis on its spirit. The boilerplate text in its reporting conveys little of value. Particularly worrying is that the Co-op prides itself on its ethics and its responsibility to a broad group of stakeholders. 

If this represents compliance, what does non-compliance look like? Let’s look at the 2012 annual report of Panther Securities, an investment property company listed on the London Stock Exchange. The report is a model of clarity and conciseness and unashamedly states the purpose of the company: ‘Each board member has responsibility to ensure that the group’s strategies lead to increased shareholder value.’ This expresses perfectly in one sentence the purpose of the board.

The firm openly acknowledges that it does not comply with the UK Corporate Governance Code in three respects: the chairman is also chief executive; the performance of the board, its committees and individual directors are not subject to specific evaluation; and two non-executive directors have served for more than nine years. However, there is a clear and reasoned explanation of why the company has chosen not to comply. Further, chairman and CEO Andrew Stewart Perloff manages to explain, clearly and succinctly, how the organisation is governed, how it mitigates risk and the impact of its activities on local communities. What is more, he does so despite accounting and disclosure requirements, commenting: ‘Every year we are obliged to provide shareholders with more information and each year it becomes less understandable to you and slightly harder for me to explain what is happening in our accounts.’

Time to start again

These two contrasting examples show how inappropriate corporate governance code provisions are for many companies. On the one hand, we have a company that prides itself on corporate governance but has significant shortcomings; on the other, a chairman who questions the value of reporting but is transparent about what the company is doing. I think I prefer non-compliance.

What is the solution to this conundrum? Clearly not the current corporate governance codes. In a soon-to-be-published consultation, ACCA head of corporate governance and risk management Paul Moxey and I suggest that the time has come to start again. We need to remove the check-box approach and ensure that governance is appropriate for each organisation individually. This boils down to one question and one instruction:

The question: is the way in which the organisation is being governed adding value for the benefit of all stakeholders?

The instruction: the board of directors must explain how its governance adds value and where it could do better.

This approach of application and explanation contrasts sharply with the ‘comply-or-explain’ regime, which allows an organisation to use boilerplate text without actually explaining how it is governed or the risks it is running. We suggest a new accountability framework to help institutions perform by informing and by being held to account. The framework applies in three places: between board and management; between shareholders and board; and, most importantly, between individual shareholders and those who manage their investments.

Statements of compliance with a code tell us little about the quality of governance in an institution. Addressing the challenge is complicated and requires us to start by recognising the seriousness of the problem. Is the purpose of governance, as we believe, to create sustainable long-term value? If so, we need an informed debate among investors, boards, regulators and others about how better to assess whether governance is delivering on ensuring companies create sustainable value.

ACCA is seeking responses to the consultation paper with a view to producing a considered paper on the link between corporate governance and value creation in mid-2014. See link at top of page.

Adrian Berendt FCCA is chair of ACCA’s Global Forum for Governance, Risk and Performance and is former executive director of LCH Clearnet. He is an active member of ACCA’s Financial Services Network Panel and has been heavily involved in ACCA initiatives on issues relating to the credit crunch. 

 

Last updated: 13 Jun 2014