On 29 November 2016, the UK government published its long awaited Green Paper on Corporate Governance Reform with significant publicity.

Corporate Governance is back on the UK political agenda. The Crown realise that potentially poor corporate behaviour costs the innocent bystander real money. Consequently, the UK government acts as it feels the rising tide of public discontent; with governance failures at the banks and the collapse of BHS as examples setting the public mood.

The Innocent Bystander

“For as long as the innocent bystander can suffer real losses resulting from weak or ineffective governance, it is not equitable that governance codes should be totally voluntary. The sensible Green Paper proposals must be put on a statutory footing with real appetite for enforcement.”

The Green Paper is well intentioned,  however a considerable body of long standing Corporate Codes already exist that address a number of the principles raised in it.  Therefore, the method of implementation of its sensible principles must be imaginatively different if change is to occur.

The existing Corporate Governance Code is an application of principles and therein the problem occurs; “Comply or Explain”, not an enforceable document with real sanction. Per Grant Thornton annual review, only 57% of FTSE 350 companies fully complied with the Code in 2015; a decrease of 4% compared to the previous year. In the same analysis, 24% of FTSE 350 companies gave the same risk disclosures as the previous year, despite evident volatility. 55% of those FTSE 350 companies had quality shareholder engagement in 2015, a decrease of 9% over the previous year. In their 2016 review, 62% of FTSE 350’s complied with the Code in full; although the amount of FTSE 350’s who do not comply and provide limited explanation as to why had increased by 1% to 13% and 1% did not discuss compliance at all.

As far back as 2009, the OECD noted that there was nothing substantially wrong with corporate governance frameworks; the issue relates to insufficient implementation of the same. While it is hard to argue that practices have not improved generally since the 1970s, the core weaknesses of operational governance continue to remain; executive remuneration, board practices, risk management and the exercise of shareholder rights.

The Culture of Governance

At the root of the issue is culture. We operate in the Anglo-American world in which there is a fundamental belief in the free market. A reward for good risk taking is as it should be. If organisations could fail without impacting on the innocent bystander, perhaps we can afford to allow corporates to voluntarily abide by codes. However, this is not the case, irrespective of the theory of the free market. While it is challenging if not impossible to legislate for good behaviour and ethics, it is difficult to see how good corporate behaviour can be promoted without the threat of significant sanction and a regime that is truly willing to enforce it. If the UK government is truly serious about improving governance, then the Green Paper ought to have contained for consideration a proposed legal framework of enforcement measures to the maximum extent permitted by common sense.

Similarly, corporate culture must change generally.  Too many boards sit far too remotely from the businesses they steward. They do not regard the wider stakeholders unless there is a regulatory threat of sanction. As a Board Evaluation practitioner, I note a number of boards with an alarming tendency to avoid accountability. It’s time for boards to wake up and smell the coffee; the buck stops with you and you must be fully accountable for the companies you manage and act accordingly; otherwise, the public may impose on the corporate world a stricter regime than is desirable for genuine business risk taking.

Investors should change their outlook

Corporate culture needs to change in another respect; investors need a mentality change in terms of the level of returns they expect over a given timeframe. Often driven by the mantra of risk and uncertainty, a lot of investors pine for high returns for fear of sudden investment loss. Simple greed drives others. Short term gratifying is not long term satisfying. In this context, lead executives are often judged in the short term, often quarter to quarter, against a narrow and shallow profit (or even sales) growth metric. Their remuneration is set by constantly exceeding the analyst expectation. The Executive will be well remunerated while this is the case, knowing that sudden disappointment means the gig is over. Corporate behaviour can only be improved if remuneration is based on deeper and more meaningful results measured over the duration of a 5 year appointment.

The audience should not be able to boo the artist off after just 3 songs; the discerning will judge the performance over the concert as whole. Investors and the markets need to do the same if they don’t want to end up with significant losses on a regular, recurring basis.

Corporates should learn lessons or they risk poor law

Perhaps as a starting point, corporates should do the right thing and more fully implement the Governance Codes that exist at both Top Co and subsidiary levels. They should have diversity of view at the top table with Board appointments made on merit. They should have genuine regard for all stakeholders.  Unfortunately, our business culture does not naturally promote this. Putting core elements of governance codes on a statutory footing with real appetite for enforcement will more than probably be necessary if we are serious about addressing the weaknesses that exist – the risk to business is that the legislation goes too far to our competitive detriment.

Responses to the Green Paper are due by 17 February 2017; it will be interesting to see how it develops. A meaningful exercise or a missed opportunity? Time will tell.