Stephen Haddrill, chief executive of the Financial Reporting Council, is proud of the UK’s corporate governance, but sees the recapture of public trust as a big issue to address
This article was first published in the April 2017 UK edition of Accounting and Business magazine.
If you want a benchmark for the success of UK corporate governance, then Stephen Haddrill suggests the best one is international investor confidence. The chief executive of the Financial Reporting Council (FRC), the independent regulator of corporate governance and reporting in the UK, says that the willingness to put money into UK businesses is a sound measure of the success of the 25-year-old system of codes and rules that control the behaviour of listed companies in the UK.
One of the secrets of the code’s success is that it has evolved over a quarter of a century. It has been a flexible vehicle for improving corporate governance and – especially since the global financial crisis – corporate reporting. ‘We have introduced measures through the code that have enhanced reporting,’ says Haddrill. ‘These include the concept of the report and accounts as a whole being fair, balanced and understandable; the assessment of the reporting of risk; and the introduction of the longer-term viability statement, which is an innovative change.’
While Haddrill points out the strengths of UK corporate governance, he says that there are also issues to address. The FRC has announced a ‘fundamental review’ of the code for publicly listed companies (see box on page 14), prompted in part by what Haddrill says is a ‘lack of investor confidence in high executive pay’.
The problems centre on trust. Haddrill quotes the Edelman Trust Barometer’s description of the British public’s trust in business, government, media and non-profits as plummeting – part of an ‘unprecedented crisis of trust shared across the Western world’. Business has contributed significantly to that fall. ‘Continuing success depends on the strength of a business’s reputation with the public,’ says Haddrill, adding that the quoted value of a listed company – which is far in excess of the balance sheet – is made up of many factors, including trust and reputation.
Modern corporate governance arrived on the back of a series of corporate scandals in the late 1980s and early 1990s. Initially the code focused on the board’s structure, with an emphasis on the right number and quality of non-executives. Increasingly it has taken an interest in values, behaviour and culture.
The code’s key principle is comply or explain. ‘Comply or explain allows companies to adapt the code to their circumstances,’ Haddrill says. ‘And it allows for a transition period, which makes directors comfortable with supporting corporate governance.’ Regulatory progress is accordingly faster. Independent directors on boards, independent audit committees and annual election of directors have all happened quicker in the UK than elsewhere because there is no need for legislative backing. In 2016, 90% of FTSE 350 companies were code-compliant with the exception of one or two provisions. Haddrill says that the code provides chairmen with the framework and the impetus to conduct the business of the board in the right way.
He admits, though, that he finds CFOs and CEOs less engaged in it. ‘The code is important in helping to establish the right relationship between the chairman, the non-execs and the execs. In particular it creates a separation of power and responsibilities between the chair and the chief executive. For the CEO, that brings greater clarity to their role and a basis for the support of their board. The code seeks to establish the right balance between support and challenge.’
Beyond the boardroom
Haddrill, though, wants to look beyond just what is happening in the boardroom and bring the wider world into the equation. Recently the FRC has set up a wider stakeholder group with representatives of employees, consumers, investors and non-governmental organisations. ‘The debate is broadening. The prime minister is talking about establishing the employee voice in the boardroom, although we’re not sure how that is going to pan out.’
On pay Haddrill draws an analogy between executives’ rewards and footballers’ pay: ‘On the terraces fans aren’t happy if they are not scoring goals.’ As a Crystal Palace fan, perhaps he understands only too well the outrage when pay is way out of kilter with performance. The answer, he says, is to link the deal on remuneration with strategy to simplify its terms (‘Even those who benefit sometimes don’t understand the deals’), to ensure it is reported, and that the views of investors are listened to. Companies are not currently obliged to do anything even when advisory votes on executive remuneration go against the pay proposal. Haddrill says: ‘We would like to see an escalation, with another round of consultation followed by a vote, and that vote should be binding.’
Board diversity does not generate the same anger as pay, perhaps because there is progress. The good news is there are more women on boards; less encouraging is that so few of them hold executive positions. Smaller boards with fewer executives hasn’t helped. Haddrill says that issue has to be dealt with by companies working on the pipeline and succession planning.
Ethnic diversity too remains a worry, with the 2016 Parker report concluding boards did not reflect the ethnic diversity of either the UK or their stakeholders. It recommended that FTSE 100 boards ‘should have at least one director of colour by 2021’, and that FTSE 350 companies should join them a year later.
Over the horizon
If diversity and gender are works in progress, next up is the viability statement. Haddrill distinguishes between the views of chairmen and of CFOs. ‘Chairmen have been positive, as it has led to a good conversation in the boardroom. It has caused thinking about the longer term. Also the work that goes on behind the statement about giving assurance on risk is valuable.’
He dismisses suggestions of confusion between viability and the one-year going concern view. Most companies are fixing on three years – it fits with their strategy horizon – but with defined benefits pension schemes providing assurance to trustees for way longer than three years, ‘Why not give that assurance to the shareholder?’ He adds that some CFOs think that viability has generated a level of work around stuff that they already knew.
Looking at the longer term, there are clouds on the horizon caused by both Trump and Brexit. While the new US president talks deregulation, Theresa May is talking about strengthening corporate governance, heralding divergence. Haddrill notes that the US public is broadly confident about main street business (banks may be a different story), and that the US public trust deficit is in government, summed up by the ‘drain the swamp’ cry. ‘If the largest economy in the word is heading in one direction, you can’t just ignore that,’ he says.
Brexit for the FRC so far is about restating a belief in elements such as international accounting and auditing standards and their importance in attracting international capital. ‘We want to retain our commitment to those. Even though they are underpinned by European Union law, leaving shouldn’t change that.’
The FRC will be looking for opportunities in the changed world – think easier passporting of qualifications. It will also work hard to retain its influence with bodies like the International Accounting Standards Board (IASB) while working with what Haddrill calls ‘our regulatory friends in Europe’, even if the FRC won’t always be at the table. ‘London is the largest European capital market and our role in regulating that gives us a lot of weight. Brexit will make it harder, but we won’t give up.’
Back in the UK the FRC is keen to develop a code for private companies that have a public interest impact, but Haddrill says it cannot be the same as for listed entities. ‘What is the same is that all companies have to take account of the full range of their stakeholders.’ He points out that this is already a requirement under the Companies Act. ‘That part of the act does not receive much attention; it needs to be reinvigorated.’
Clearly, the next 25 years is about helping businesses build trust in their governance, and reporting to a broader stakeholder community. ‘We are focused on helping companies, whether private or public, to recognise the broader public interest.’
Peter Williams, journalist