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Iod And A Corporate Governance Index

by AppliedCG

The UK’s Institute of Directors (IOD) has recently launched a project to try to create an Index reflecting the Corporate Governance performance of the most important quoted companies in the UK.

In this article, we look at the project and give our own views on the purpose, the approach taken and its likelihood of success.

Above: Word cloud of most used words by respondents to the IOD’s Corporate Governance Index project; the bigger the text, the more times the word was used (click for the free report).

What was the background to the Corporate Governance Index project?

The IOD says that it saw how the existence of corporate governance codes failed to prevent the 2008 financial collapse and more recently the unhappy experiences of investors in relation to events at Bumi and ENRC. So they decided to set up a project to research:

  • what is good governance and
  • how do we measure it

Interestingly, this was the task we at Applied Corporate Governance set ourselves nearly twenty years ago when embarking on an assignment with a big retailer client to help the board with its corporate governance.

The IOD’s research project was overseen by an advisory panel consisting of the head of the IOD’s corporate governance function, two academics (professors from Cass Business School), an ex-fund manager, an industrialist, the head of a think tank into business governance, and chaired by an entrepreneurial investment banker. All these members would claim to have significant experience in the field of corporate governance.

The project had a public launch in June at the Pall Mall headquarters of the IOD, at which the purpose of the exercise, the methodology adopted and the preliminary conclusions were presented to an audience, which was then asked for its reactions.

The public launch – the IOD’s initial report

At the public launch, attended by the author, the IOD released its report, entitled The Great Governance Debate – Towards a Good Governance Index for Listed Companies. In his Preface to the report, Ken Olisa, the chairman of the panel, summarising the initial conclusions, says: “good governance is hard to define and hard to recognise”. He goes on to say that it can’t be reduced to code-defined items and box-driven compliance and a red-top call to action. This, perhaps, summed up the uncertainty and lack of confidence permeating the subsequent presentation.

So what did the study consist of and how was it conducted?

Definition of corporate governance:

The team took two definitions.

Firstly, the corporate governance definition from the UK Corporate Governance Code:

The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver the long term success of the company

Secondly, the definition from the UK Companies Act 2006, section 172

A director of a company must act in the way he considers, in good faith, would be most likely to promote  the success of the company for the benefit of its members (shareholders) as a whole, and in so doing have regard (amongst other matters) to:  the likely consequences of any decision in the long term; the interests of the company’s employees; the need to foster the company’s business relationships with suppliers, customers and others; the impact of the company’s operations on the community and the environment; the desirability of the company maintaining a reputation for high standards of business conduct, and the need to act fairly as between members of the company.


Professor Volpin and Professor Clare, in their Foreword to the report, clearly indicate that they felt they needed to design a new set of indicators not simply relating to compliance with the Code. Existing indicators, they believe, are vulnerable to being “gamed”. So, having accepted the two definitions of corporate governance above, they had to address the issue of measurement.

They decided on a three element approach to measurement:

  • a survey of perceptions of corporate governance in regard to the targeted companies by members of the UK business community. Average assessments for the target companies were in a range from 0 – 1000
  • assembling what they called “quantifiable instrumental factors” which they believed were associated with corporate governance. Five broad areas of governance were chosen:
    • board effectiveness
    • audit & risk
    • remuneration & reward
    • shareholder relations
    • stakeholder relations

and 53 factors, addressing corporate governance per se and the business environment. The average assessments again were in a range 0 – 1000

  • creating a predictive model by statistically combining the instrumental factors with the perceptions to analyse factor weightings and test the predictive capability of the model. The statistical analysis:
    • uses regression of relationships between perception and instrumental
    • tries to give an insight into:
      • whether objective measures matter but participants don’t recognise good governance, or
      • participants recognise good governance but objective factors don’t measure it

The project:

  • looked at corporate governance of the 100 largest UK listed companies (excluding investment trusts) which had available data for 80% of the instrumental factors measured
  • surveyed IOD members, using 407 responses (excluding members who were associated with the surveyed companies)


The results from this first exercise are summarised as follows:

  • the survey of perceptions by IOD members produced assessments which were grouped into eight tiers from <600 to >800
  • the analysis of instrumental factors produced assessments which were grouped into eight tiers from 500 to >675
  • the predictive exercise produced assessments which were grouped into eight tiers from 553 to >724

Conclusions so far:

The interim conclusions in the report are:

  • different questions give different answers
  • the predictive model gives a narrower range
  • the predictive model didn’t predict the survey results


“it seems unlikely that ever simpler measures for firm-level corporate governance are able to account for the complex and multiple interactions that exist between corporate governance mechanisms and between these and environmental factors”

Next steps:

In taking the project forward, the IOD plans:

  • to work with business to develop ideas on which factors can affect corporate governance
  • to try to understand what good corporate governance is and how the business community can deliver it

Reactions and responses at the launch meeting

The views expressed by the members of the Advisory Panel very much confirmed the tone of the report, that the exercise had been interesting and was a commendable thing to try. However, it had failed to define corporate governance or to produce satisfactory measurement tools and similarly had failed to create a useful predictive model.

Comments during the meeting included the following:

  • regulators are far from the practice of running businesses and impose rules regardless
  • regulation needs to be more rounded
  • a company like ENRC ticked all the compliance boxes but was a corporate governance disaster
  • the original Greek meaning of governance was about steering a ship in the right direction; that can be deemed to correspond to ensuring that a company can fulfil its purpose
  • Goodhart’s Law states that when a measure becomes a target it ceases to be a useful measure. That was a danger in the idea of setting up a corporate governance index
  • the two approaches to measurement adopted in the project could be described as people versus machine, and whereas the rating system could be said to capture the architecture of corporate governance, the survey perception seems to give a better impression of corporate governance than the architecture model
  • the best rated companies might have come out better because they were smaller and less well-known
  • corporate governance is about helping companies make better business decisions; how do you measure this aspect?
  • there must be doubts about how the statistics are presented and about the confidence limits – an impression of spurious accuracy
  • despite thousands of papers written by academics, very little is really known about practical corporate governance
  • five lessons can be drawn from the academic research
    • corporate governance is complex
    • no one size fits all
    • executive compensation is a sideshow
    • boards are not enough
    • shareholder power is what regulators are driving
  • companies which have endured over a long period exhibit three characteristics:
    • a clear purpose
    • a focus beyond shareholder value
    • being connected closely with society – which enables them to change and adapt
  • in regard to the issue of stewardship, stability of ownership is very important and, in that context, dispersed ownership can look like a bad thing
  • it isn’t possible to create an Investable Index out of the corporate governance project
  • the project needs to produce a set of indices relating to stakeholder groups and looking for emerging trends; it needs to produce hard evidence based on such elements as stock price, employee relations and customer views
  • the aim is to balance the views of the stakeholder groups and reflect the wider views of society as a whole
  • producing an Index will help guide shareholders’ views of companies’ corporate governance performance in a wider frame of reference and the existence of peer pressure will lead to an improvement in standards generally.

Our assessment:

As mentioned above, we addressed these issues ourselves some years ago, working with a large client. The answers we produced to the questions the IOD project posed were:

What is good corporate governance?

Good corporate governance is the means by which an organisation fulfils the balanced aims of its key stakeholders, the most important of which are customers, owners and employees 

How do we measure corporate governance?

There are five golden rules to good corporate governance:

  • an ethical approach
  • a clear goal, synthesising the aims of the key stakeholders
  • a strategic approach to management
  • an organisation structured and resourced to deliver the strategy and achieve the goal
  • a system of transparent reporting and accountability to the stakeholders

Measurement consists in periodically conducting independent surveys of the key stakeholders to get their views on the organisation’s performance in relation to the five golden rules. These results are fed back to the stakeholders who can then expect action to improve areas indicating deficiencies.

Our comments on the IOD’s efforts can therefore be summed up as follows:

  • by their own admission, the project has failed to define corporate governance and has (understandably) therefore failed to come up with a satisfactory way to measure it
  • they have, rightly, identified getting perceptions via a survey as an important tool, but the questions posed in the survey were not based on a holistic approach of the kind adopted by us
  • the survey was apparently restricted to IOD members and only a little over 400 responses were used. It asked respondents to indicate whether they knew the targeted companies as customers or through some other relationship, but the sample isn’t large enough to really qualify as a statistically valid exercise, and moreover, it excluded employees. We would therefore question the value of the results while encouraging the principle.
  • the architectural approach seems like an attempt to produce a more academically thorough assessment of corporate governance than the kinds of comparisons produced by various agencies based on analysis of compliance in published company reports. However, it isn’t clear what lessons can be learned from the results and the difficulties encountered in using it to create a predictive model speak for themselves.

All in all, while wishing the IOD luck with its next steps, and applauding its adoption of a perceptions survey approach, we are not convinced that the philosophical framework is sound. And we therefore think it is unlikely that it will be able to create the Corporate Governance Index that is the ultimate goal.

We would be very happy to see them adopt the Applied Corporate Governance approach, but to achieve a successful index, they would have to sign up to one of our training programmes! 


IOD’s Corporate Governance Index project (free report).

Surveys: The Sure Way To Good Governance. ACG White Papers

Corporate Governance and Research

The Stakeholder Survey

Best Corporate Governance Practice

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