What does good governance really look like?

The starting point to answering this question is to consider what governance actually is and its purpose. The first version of the UK Corporate Governance Code, published by the Cadbury Committee in 1992 defined corporate governance as “the system by which companies are directed and controlled”, which remains as the core definition. The modern overall objective of any organisation, and that which governance now plays a significant part in, is for long term success and sustainability.

By 1998, the Combined Code had been published following the Greenbury and Hampel Reports, the key principles and provisions of which related to the board of directors; directors’ remuneration; relations with shareholders; accountability and audit; and the responsibilities of institutional shareholders.

The five sections of the most recently published UK Corporate Governance Code (2018) relate to board leadership and company purpose; division of responsibilities; composition, succession and evaluation; audit, risk and internal control; and remuneration.

Over the last twenty-six years, we have seen the various updates to the Code evidence necessary developments in order for it to remain relevant in our changing business environment and to address ongoing governance issues and necessary reforms. For example, the Cadbury Committees’ work was carried out following the financial collapses of Coloroll and Polly Peck (1990), and during the BCCI and Mirror Group scandals. The publication of the 2018 Code followed the government’s calls for governance reform and the collapse of Carillion.

Recurring governance topics over that time of the board, its effectiveness and leadership; shareholder and stakeholder engagement; risk management and audit; and directors’ remuneration can be clearly seen. Relations with shareholders is still covered in the 2018 Code but not under its own section as previously, with the responsibilities of institutional shareholders now covered by the UK Stewardship Code in the main.

In addition to these recurrent themes, we now commonly see reference to governance both in general terms and specifically in respect of unlisted companies, larger private companies, subsidiary structures, health sector, public sector, academy trusts/schools, sports bodies, charities/not for profit, projects, environmental, and IT. So, in just over two decades, the scope and relevance of governance has widened considerably.

The use of the word ‘companies’ at the time the Cadbury Report was written referred, by default of its terms of reference, to listed companies. However, we often see reference to ‘organisations’ being quoted in this and other definitions and it is understandable why this is happening and why it feels appropriate. It makes no distinction between the size, nature or complexity of a business – it could, in fact, refer to any organisation (or subject matter as the examples above suggest).

The fact that the UK adopts the ‘comply or explain’ approach highlights that the level and type of governance that may be appropriate for one company may not be for another, even in the same listed environment, industry or sector.

In attempting to determine what good governance is, an organisation needs to consider its aims and objectives, as well as the needs of its shareholders and its stakeholders. In conjunction with this, where an agent and principal relationship exists – as with directors and shareholders – the main objective of governance is to align the interests of the managers and owners to overcome the agency conflict that exists between them (as identified by Jensen and Meckling, 1976).

However, organisations in today’s world do not fit into an agency theory framework. Nor do they often fit completely into a stakeholder theory one. The adoption of stakeholder focussed approaches to governance, as opposed to purely shareholder (agency) focussed, has been developing over the years. Organisations now have to take a much more holistic approach to each and every relationship that exists as part of its operations and locations.

In any organisation there is a need for there to be an effective, diverse board providing leadership; a division of responsibilities between the owners and managers; risk management and internal control systems; a wide remit of monitoring and evaluation with necessary actions being taken; formal and transparent remuneration policies and practices; and engagement and dialogue with investors/shareholders and all stakeholders. The overarching general principles of governance then overlay these requirements, so that the approach to be taken across them all needs to focus on:

• Fairness
• Transparency
• Responsibility
• Accountability

Company failures and scandals are often attributable to weaknesses in governance structures and, at their most basic level, will relate to some or all of these principles being disregarded. Carillion’s 2016 Annual Report stated that “the company complies fully with the UK Corporate Governance Code” and that “we remain committed to a responsible approach to executive pay”. In contrast to these statements, the behaviours that were highlighted within the parliamentary inquiry included “recklessness, hubris and greed” on the part of the board and its advisors.

In seeking good governance, it will depend on the size and type of organisation, who its stakeholders are and what their needs and expectations to identify the most appropriate governance framework to adopt. However, if an organisation does not approach governance with foundations built on the four fundamental general principles of fairness, transparency, responsibility and accountability, then its practices will not be good, nor for the good of the company, its shareholders or its stakeholders. Since the introduction of governance codes, criticisms have been that compliance (and even explaining non-compliance) is no more than a tick-boxing exercise and this is evidenced by some of boilerplate type statements still being made in annual reports.

The introduction of the new Companies Act Section 172 reporting requirements will see companies having to report on the issues, factors and stakeholders the directors consider relevant; the main methods directors have used to engage with stakeholders and understand the relevant issues; and the effect that taking these factors and methods into account had on the company’s decisions and strategies during the financial year under review.

If the result is reading more meaningful, transparent, accountable and responsibly made statements, we could be moving into the next phase of development where legal requirements have to overlay governance frameworks in order to demonstrate what good governance does really look like and how it is contributing to a company’s long term success.

This article was first published by The Chartered Governance Institute on 23 January 2020