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What scope for corporate governance reform?

Sarah Hillary

Could corporate governance in the UK be improved? If so, how? The Government is seeking opinions in its Green Paper on Corporate Governance Reform.

At Moore, we think there is no need for radical reform, but there is scope for improvement. In particular, improvements now need to focus on the ‘functions’ rather than the ‘features’ of governance.

In relation to chief executives’ pay, for example, a functional approach considers what compensation package is required to attract and retain the talent needed to achieve an organisation’s goals. This is likely to be of more benefit to an organisation that focusing on features – looking at the CEO’s total compensation package and how it compares to that of peers.

The presence of a feature does not necessary mean that a function is being performed properly. For example, it would be wrong to assume that, because a risk committee is in place, a company is diligent about managing risks. Therefore, when designing governance systems or considering reforms, the focus shouldn’t be on features but on the more difficult – and fundamental – issue of what can be done that really adds value by encouraging the pursuit of corporate objectives and discouraging self-interest behaviour, while at the same time respecting the spirit of corporate governance features.

NED ‘champions’

The government’s Green Paper asks how we could strengthen the way in which the interests of employees, customers and wider stakeholders are taken into account at board level in large UK companies. Of the options identified, we think the most appropriate is to designate an individual non-executive director (NED) to be a stakeholder ‘champion’, whether for employees or customers. This individual would be responsible for ensuring that the views of such stakeholders are sought and expressed as part of the ongoing Board decision-making process. This approach would not undermine one of the key underlying principles of UK company law and corporate governance – that there should be a unitary Board – and the concept that all directors have the same duties – directors and NEDs alike. The impact of such champion NEDs could be supported by enhanced reporting, for example, explanations of how they have undertaken their designated role and engaged with the stakeholders they are responsible for.

We see problems with alternative suggestions. For example, requiring firms to have advisory panels for stakeholder issues would be disproportionately costly (given that other methods for seeking views exist) and could begin a move away from the unitary board. Another suggestion, appointing new ‘stakeholder’ directors to represent specific constituencies on a board, would create a tension between loyalty to the constituency and the legal duties owed to the company. It could also result in boards becoming too large to operate effectively.

A flexible framework

If new corporate governance reforms are introduced with the aim of strengthening the stakeholder voice, they would need to apply to both listed companies and large privately-held businesses in order to be effective. However, the compliance frameworks would vary, as they do now.

In our view, it would be appropriate for listed companies to be required to meet the new requirements on a ‘comply or explain’ basis. This would be simple to put into practice and would give companies and their boards the chance to explain their rationale where they believe the requirements to be inappropriate for their particular circumstances.

However, drawing up a single code that is appropriate for privately-held businesses is far harder. These businesses differ hugely in size, complexity, stage of development and the relationships between their owners and managers. Therefore, encouraging compliance with a voluntary code is the most appropriate solution for unlisted companies: boards should determine how the business is run, based on the nature of the organisation for which they are responsible. Legislation need not be required – nor even a code – if there is a willingness to improve.

The most appropriate solution for privately-held businesses, however, would probably be a combination of legislation at a high level – requiring companies of a particular size (for example, with more than 500 employees) to report against a code – with the application of an ‘apply or explain approach’. This would need to be linked to some sort of monitoring programme, so that annual trends could be analysed and reported in order to promote best practice.

As a final thought, the UK has a rich diversity of corporate firms outside listed companies, including employee-owned business, family business, private-equity-owned businesses, mutuals, social enterprises and a variety of hybrids. Policymakers need to think about reforming corporate governance from a holistic perspective, taking account of such diversity and other initiatives under way to encourage the long-term wealth of the UK and wider engagement between businesses, communities and other stakeholders.