UK: Reviewing The Governance Black Box

Last Updated: 13 December 2017
Article by Brett Simnett

The many recent governance failures show the code is not enough in isolation

In the 25 years since the foundation of the UK Corporate Governance Code – the Cadbury Report – was published, its various iterations have been lauded for boosting transparency and gaining insight into the behaviour and performance of company boards.

The code states that 'corporate governance is about what the board of a company does and how it sets the values of the company'. It also states 'the responsibilities of the board include setting the company's strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship'.

The core principles of the code are leadership, effectiveness, accountability, remuneration and shareholder engagement. These principles, in their raw form, aim to encourage responsibility, ethical behaviour, measurement and communication.

As an investor there are key considerations if you are looking to invest or continue to invest in a business: considerations around whether the board is structured to fulfil its responsibilities, and how its behaviours and actions instil those same behaviours across the business.

"Corporate governance reports are not always giving us those answers or the necessary clear insight into how the business is being run"

Shareholders want to know how performance is measured and remunerated – it is important the board is communicating this effectively to them, as well as to wider stakeholders.

The answers should provide a real sense of how a board is conducting business. But the reality is corporate governance reports are not always giving us those answers or the necessary clear insight into how the business is being run.

Since the reports launch in 1992, the numerous examples of corporate governance failure must question whether we have really seen consistent good governance and true transparency, and, more importantly, why those failures were not identified and managed more effectively.

Barings Bank

In 1995, an employee of Barings Bank in Singapore, Nick Leeson, was trading futures, signing off on his own accounts and taking the bank further and further into debt, resulting in losses of £827 million.

As floor manager and department head, Leeson had free reign to settle his own trades. More importantly, there was little or no governance leadership coming from the London board. Those London directors were subsequently disqualified as being unfit to run a company.

Leeson claimed the lack of oversight and risk management from management was as much to blame as his own actions. Yet there was a lack of clarity in reporting to allow others outside the company to question the way it was operating – that questioning is essential to good governance.

MG Rover Group

MG Rover's collapse in 2005 is not a simple example of one management team's failure, but a case study of multiple owners and management teams fundamentally failing to address the core issues facing the business.

In an analysis of the company's collapse by the academic partnership Cambridge-MIT, entitled 'Who killed MG Rover?' it said: 'Its decline from the 1960s was because of a range of ignored factors: an ill-conceived product strategy, a failure to integrate various elements of the business, multiple ownership changes and a lack of capability to develop new products for key markets.'

Ultimately, the various owners of the car manufacturer – whether British Leyland Corporation, BMW, British Aerospace and finally, the Pheonix consortium – did not recognise core weaknesses in the business: weak products, poor market analysis and lack of long-term financial capital.

The owners tried to paper over the cracks rather than resolve them. The report stated: 'The main reason behind Rover's demise was an inability, which started to manifest itself 50 years ago, to manage its constituent's operations as well as its competitors were able to do so.'

After diminishing demand and a £6.5 million loan in April 2005 from the UK government, the company went into administration. This is an example of where proper checks and evaluations have systemically failed, and the question of whether the business was fit-for-purpose was never sufficiently challenged.

Financial crisis

Looking at the fundamentals of the 2007–8 financial crisis, the Financial Crisis Inquiry Commission concluded the crisis 'was avoidable and was caused by widespread failures in financial regulation and supervision, dramatic failures in corporate governance and risk management at many systemically important financial institutions'.

The heart of the issue was that the complexity of financial instruments had overtaken the ability of boards to govern their businesses effectively. While financial success was the norm, the need to tighten governance was either overlooked or, even worse, ignored.

"The results of 2008 were prime examples of how governance can slip when the going is good"

From Northern Rock, RBS, LBG and HBOS – to name a few firms – the results of 2008 were prime examples of how governance can slip when the going is good, and the results can be dramatic and destructive.

Again, board challenge and checks fell by the wayside. Those who should have been challenging their activities failed to act while business was good, although whether there was true transparency for stakeholders to challenge can be debated.

Tesco

In 2014, the revelation Britain's biggest grocer had overstated its profits came to light. With pressures on constant financial growth, Tesco looked beyond the traditional buy-and-sell to customers, and to suppliers as a source of profit.

Dave Lewis, the newly appointed chief executive, said: 'Since 2014 we have made extensive changes across our leadership, our structures, our financial controls inside the business, and we've changed the way Tesco buys and sells'. But the damage made to supplier relationships was felt across the business and the spotlight on its behaviours is still as strong today as it was in 2014.

The question here is how did a major force in its sector lose sight of the importance of its supply chain relationships over profit, and why was the demand for short-term financial gain seen as more important than long-term, sustainable viability?

Recent history

More recent history does not fill the heart with optimism. 2016 saw Rolls-Royce's £671 million corruption case and, in 2017, we had governance issues such as Barclays' whistleblowing saga and the strategic errors at Provident Financial Group.

The code is viewed by many as a global standard, yet it failed to ensure good governance in these cases.

Insight, challenge, change, reward

The key to the success of the code is to ensure the board, shareholders and stakeholders have clear insight, and the ability to challenge and change direction. Rewards should recognise ethical and sustainable behaviour as well as financial success.

All of the examples demonstrate fundamental faults in the approach to governance and its reporting.

Insight

Firstly, there is the question of insight. This falls into two categories: the insights for the board and insights for shareholders and stakeholders.

Examples such as Barings and Tesco show that without clear channels of information from operations to the board it is impossible to drive behaviour from the top. Good governance requires clear channels of communication on how various parts of the business are performing.

This is not just financial. Viewing performance through one lens obscures the true picture. Boards need to be supported by clear communication with their operations to successfully drive culture and behaviour.

Without honest insight from across the value chain, boards cannot be effective. They must be responsible to seek and demand that information.

Secondly, if shareholders and wider stakeholders are not given clear insight into how the board is operating, communicating with the business and making decisions, how can they effectively challenge things?

"I believe better communication between management and the financial floor would have saved Barings Bank"

Governance reports that proudly tell us the board has discussed strategic, financial and risk over the year, without any clear insight into what was actually discussed and what actions came from those discussions, are deliberately being obtuse and avoiding communication with the true owners of the business.

Again, this is the responsibility of the board, but shareholders need to demand more transparent insight and actively interrogate whether financial success is driven by proper business practices.

Challenge

With clear insight comes the ability to truly challenge the status quo. Boards that are communicating effectively with their businesses at operational level can look to encourage and enhance behaviours.

The recent discussions, driven by the government green paper, to encourage better employee representation at board level is an interesting concept in helping solve the problem. However, it is actually better lines of two-way communication with staff, supply chain and customers that will drive collective behavioural change.

How many of the examples covered in this article could have been avoided by better-governed communication with the people at the coal face of the business, allowing them to question and challenge?

Not only does this help a business feel as one, it creates a collective responsibility for how the business is governed and helps a board in its responsibilities.

Change

Insight drives challenge; challenge drives change. It is a simple concept, but difficult to achieve.

Change is a word used far too flippantly in the corporate world. Change is always viewed as 'big', whereas effective change is constant development and tweaking of small elements that can have a 'big' effect.

Would better communication between management and the financial floor – and the ability for all involved to question processes – have saved Barings Bank? I believe so.

Would more effective customer and market insight have changed MG Rovers product strategy for the better? In my view, we would still see MG Rover on our roads today if there had been better collaboration across the business to drive change.

Collaboration and communication is the key to a business' ability to manage changing circumstances, avoiding 'big' issues through adaptive rather than radical change.

Reward

How a board and, just as importantly, its staff are rewarded needs to go beyond financial performance. A business' ability to adapt and change to market, economic and political forces dictates how it will continue to create value.

Key performance indicators and performance measures should look at operations and communication as well as economic indicators.

Yes, these are difficult to measure in real terms, but a successful business is one that avoids negative 'big' change. Reliability is a positive for investors and this comes from effective management and communication, so they have be a key element of remuneration measurement.

Back to the code

As a collective, we must ensure the principles of the code are lived by companies. Boards and those they are responsible for and communicate to should ask four simple questions.

  1. Does the leadership of the business have the insight, tools and communication channels to do their jobs?
  2. Is the board making effective decisions that are supported by clear insight that is transparent to its stakeholders?
  3. Do stakeholders have enough information and access to two-way dialogue to assess the performance and accountability of the board?
  4. Are remuneration targets based on long-term operations and financial viability?

When boards and stakeholders can comfortably answer these questions with an affirmative, I believe we will see the code achieve its goals.

Brett Simnett is director of investor engagement at Radley Yeldar

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions