Introduction
In December 2018, the Financial Reporting Council published the Wates Corporate Governance Principles for Large Private Companies. This was in response to the views expressed that very large private companies had a substantial impact on the country and should not be exempt from the kinds of regulation that applied to listed companies. The requirement for such guidance was prompted by the government introducing secondary legislation in July 2018 – The Companies (Miscellaneous Reporting) Regulations 2018 – requiring companies of a certain size to report on their corporate governance arrangements.
In February 2022, the University of Essex published a survey aiming to assess the proportion of affected companies responding, and the degree of compliance with the letter and spirit of the Wates Principles. So it seemed appropriate to look at the results of the survey and consider the findings and conclusions against the Corporate Governance Code itself and the Wates Principles themselves, and, of course, the Companies Act 2006.
So, firstly, we remind ourselves of the requirements of the Companies Act in terms of directors’ duties, as augmented by the 2013 amendment, in the form of the FRC’s Guidance regarding the Strategic Report required by the Statutory Instrument “The Companies Act 2006 (Strategic Report and Directors’ Report) Regulations 2013”. Then the principles of the Corporate Governance Code and Wates’ guidance for larger private companies.
Next, we summarise the findings of the Essex University survey into the adoption of the Wates guidance for larger companies.
Finally, we set out our ACG Corporate Governance principles, and discuss how well the Corporate Governance Code in its latest release, and by extension, the Wates Principles address corporate governance needs in comparison with the ACG approach.
Regulatory Principles of Good Corporate Governance
The key sections of the Act relating to Board duties are:
- S170 Scope & general nature of duties owed by a director to a company
- S171 Duty to act within powers
- Act in accordance with the company’s constitution
- Only exercise powers for the purpose for which they were intended
- S172 Duty to promote the success of the company for the benefit of its members as a whole and have regard to
- Likely consequences of decisions in the long term
- Interests of the company’s employees
- Need to foster the company’s business relationships with suppliers, customers & others
- Impact of the company’s operations on the community & the environment
- Desirability of the company maintaining a reputation for high standards of business conduct
- Need to act fairly as between members of the company
- S173 Duty to exercise independent judgement
- S174 Duty to exercise reasonable care, skill and diligence (with)
- The general knowledge, skill & experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and
- The general knowledge, skill & experience that the director has
- S175 Duty to avoid conflicts of interest
- S176 Duty not to accept benefits from third parties
- S177 Duty to declare interest in proposed transaction or arrangement
This document runs to 104 pages, and its contents cover guidance on:
- purpose
- materiality
- communication principles
- content elements
- content elements for section 172 reporting
- supplementary material
In the context of PIEs (Public Interest Entities), it suggests that the content element can be divided into three broad categories
- Strategic management
- Business environment
- Business performance & position
There are five broad principles in this version of the Code
- Board Leadership and Company Purpose
- Entrepreneurial board/promoting long term success/generating value for shareholders/contributing to wider society
- Establishing purpose, values, strategy, promoting culture alignment
- Ensuring necessary resources, measures & controls
- Engaging with shareholders & stakeholders
- Workforce policies consistent with values & supporting long term success
- Division of responsibilities
- Chair leads the board
- Appropriate combination of executive & non-executive, clear division between board leadership & executive leadership
- Non-execs contribute fully
- Board gives itself adequate time and resources
- Composition, succession & evaluation
- Formal, rigorous appointment process, succession planning
- Appropriate combination of skills, experience & knowledge, refreshed regularly
- Annual evaluation
- Audit, risk & internal control
- Formal policies & procedures to ensure independence of internal & external audit
- Presenting fair, balanced & transparent company assessment
- Procedures to manage risk & internal controls
- Remuneration
- Policies & procedures to support strategy, & aligned to corporate values
- Formal procedures to develop remuneration policies
- Exercising independent judgement when authorising remuneration
- Purpose & leadership
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- An effective board develops and promotes the purpose of a company, and ensures that its values, strategy and culture align with that purpose
- Board composition
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- Effective board composition requires an effective chair and a balance of skills, backgrounds, experience and knowledge, with individual directors having sufficient capacity to make a valuable contribution. The size of a board should be guided by the scale and complexity of the company.
- Director responsibilities
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- The board and individual directors should have a clear understanding of their accountability and responsibilities. The board’s policies and procedures should support effective decision-making and independent challenge.
- Opportunity & risk
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- A board should promote the long-term sustainable success of the company by identifying opportunities to create and preserve value, and establishing oversight for the identification and mitigation of risks.
- Remuneration
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- A board should promote executive remuneration structures aligned to the long-term sustainable success of a company, taking into account pay and conditions elsewhere in the company.
- Shareholder relationships & engagement
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- Directors should foster effective stakeholder relationships aligned to the company’s purpose. The board is responsible for overseeing meaningful engagement with stakeholders, including the workforce, and having regard to their views when taking decisions.
Essex University Survey February 2022
Three years after the publication of his Recommendations, Sir James Wates introduced the report on the research carried out by a team from Essex University, assessing how companies had responded to the legislation, and of those who had chosen to follow his recommendations, the quality of their reporting. Their findings regarding the quality of disclosure rates are summarised below (the explanation of each recommendation is that of the Essex team).
Principle One (Purpose and Leadership) emphasises the purpose of the company and how this is developed and promoted by the board. It also acknowledges the role of the board in ensuring that the company’s values, strategy and culture are aligned with its purpose.
- Purpose 10%
- Values & Culture 23%
- Strategy 22%
Principle Two (Board Composition) discusses the effectiveness of the board. In particular, it outlines the role of the chair, the importance of diversity within the board in terms of skills, backgrounds, experience and knowledge, and also recognises
- Chair 37%
- Balance & diversity 34% (in table wrongly labelled 24%)
- Size & structure 31%
- Effectiveness 19%
Principle Three (Director Responsibilities) focuses on the board and individual directors’ understanding of their responsibilities and accountability. It discusses the policies and procedures in place to support effective decision-making and independent challenge.
- Accountability 28%
- Committees 36%
- Integrity of information 39%
Principle Four (Opportunity and Risk) discusses how the board should ensure the long-term sustainable success of the company by identifying opportunities and risks.
- Opportunities 44%
- Risk 40%
Principle Five (Remuneration) focuses on the executive remuneration policy and its alignment with the company’s long-term sustainable success.
- Remuneration 25%
- Delegating remuneration decisions 61%
- Subsidiary companies 40%
Principle Six (Stakeholder Relationships and Engagement) discusses the importance of stakeholder engagement and the key role of the board in fostering such relationships.
Special emphasis is placed on the relationship between the board and the workforce.
- Stakeholder engagement 35%
- Workforce 39%
The highest response rate was in relation to Principle Four (Opportunity and Risk) and in this regard, there was more disclosure about opportunity than risk.
There was least observance of Principle One (Purpose and Leadership), which had the lowest disclosure score among the six Principles. The Essex survey found companies disclosed on average less than one fifth of the disclosure elements (18%) within the Purpose and Leadership Principle. In particular, the first area of interest – ‘Purpose’ – presented the lowest score.
Purpose 10%
Values and culture 23%
Strategy 22%
Overall disclosure score 18%
When it came to more in-depth disclosures about company purpose, companies generally exhibited low scores. Less than 2% of the companies disclosed information about the link between their purpose and their behaviours, whether their purpose was aligned with the company’s business practices and business model, or the process in place for the board to understand shareholders’ views on the company’s purpose.
Applied Corporate Governance Principles 1998
In 1998, FT Pitman published our book, Real World Corporate Governance, in which we spelled out the principles of good corporate governance which we had established following several years of research in this field, and particularly work with a large client to implement a system designed to foster continuous improvement in performance in governance. We called this an “holistic” approach, and the rationale for our principles of “applied corporate governance” as we called it, were as follows.
From the history of corporate governance and related regulation outlined in our book, we drew some conclusions and, on the basis of the way successful companies conduct themselves, we formulated, and presented in our book, a set of rules regarding the practice of genuine good corporate governance. When we look at the record of successful organisations, we find they have to a great degree abided by these rules, and failed ones have to a large extent ignored them. Hence we christened the practical application of these rules Applied Corporate Governance.
As we view it, there are three groups of players:
- Group 1 Stakeholders
- the owners, employees, customers, suppliers and sources of funding
- the wider group of stakeholders, including local communities, the general public and the state
- the board of directors which controls the company in its aim of fulfilling the expectations of the various stakeholders
- Group 2 Company
- The Company itself, which is, of course, an independent entity, in relation to which the shareholders own certain rights
- Group 3 External monitors
- Regulators, including those controlling corporate performance and those regulating particular industries
- Auditors
Good corporate governance requires:
- holistically excellent performance by the Board and key Stakeholders
- excellent execution by the Company
- holistically excellent performance by the regulators and auditors.
We need only state these requirements for it to be obvious why bad corporate governance happens fairly regularly, as these high and holistic standards are not always met. Therefore, each of these three groups must:
- have the right set of compatible objectives
- monitor the key elements of the company’s performance and their own and that of the other key participants
- be provided with an information system to keep them up-to-date on the total performance so they are able to take any necessary action in a timely fashion
We can picture these relationships in the diagram in Figure 1.
Considering first the Boards. There is an enormous literature and many courses on good boardroom practice, and we will therefore limit ourselves here to saying that the requirements of good practice demand an information system designed to help directors do an excellent job in ensuring that good corporate governance prevails.
In turn, Regulators and Auditors need to take a holistic approach and similarly require an appropriate information system to enable them to do their job properly and not get behind the curve on spotting things going wrong.
Central to good governance is the operation of the company according to good corporate governance practice, and the company must therefore have in place a monitoring and reporting mechanism which permits accurate observation of corporate governance performance and encourages continual improvement. This monitoring mechanism must be based on measuring the company’s performance in regard to the principles constituting the Five Golden Rules of good governance.
As we spell out in our book, and have restated in this website many times over the years, these are:
- an ethical approach which is in tune with the societies and cultures in which a company operates
- balanced objectives which fulfil the goals of all the key stakeholders
- a policy and decision-making process approach based on strategic management rather than opportunism or clientelism
- an organisation structured and resourced to deliver the strategic plan
- a culture of accountability and transparency to all stakeholders.
Note that compliance with rules and regulations is simply one small part of this.
And the principles behind the monitoring mechanism are:
- the company’s performance in regard to the five Golden Rules must be measured regularly, and this can now be done continuously and economically
- performance is determined by taking the views of the key stakeholders
- these views must be gathered by independent survey, thereby avoiding “capture” by the company’s internal systems and vested interests
- the results of the survey should be reported to the office of the chairman for consideration by the board and communicated with the key stakeholders in an open and transparent way
- finally, the directors in preparing for their board meetings, must properly brief themselves in order to carry out their legal and fiduciary duties, and the company must have systems in place to facilitate this.
We can now set out these key relationships in a new diagram, Figure 2, showing how the corporate governance information system can provide the essential feeds to the Board and the key stakeholders, to enable them to fulfil their obligations regarding corporate governance.
Holistic Corporate Governance Board Management System
Determining good corporate governance holistically is key to assessing the company’s true performance, but we need to consider the system to gather the required information and to deliver it to the board and other involved parties.
Drawing on the requirements summarised above, we need to create a system which enables the three groups to fulfil their goals and obligations.
Needs addressed:
Bigger companies, particularly, are under public scrutiny and need to demonstrate that they are behaving properly. Compliance with Corporate Governance regulation is not preventing bad things happening but is required anyway. Worldwide, public and investing institutions, responding to the public’s perceptions, are addressing the wider interests of employees and society through measures such as sustainability, environmental protection and employee protection. Something more is needed beyond compliance with current Corporate Governance regulation to meet the public’s expectation of a wider accountability to a broader group of interests, or stakeholders. Similar attention is now being addressed to investing institutions through Stewardship Codes and to auditors and regulators following well-publicised corporate scandals.
Holistic solution
So our holistic approach to a board management system builds a system which picks up the current Corporate Governance focus on the board, augments it by monitoring the performance of the company and business, and validates it by stakeholder engagement. Finally, and critically, it underpins it with metrics and a monitoring system. The totality of these elements – board, company and stakeholder perception – represent holistic corporate governance. We will simply summarise these here. Taking these in turn:
Board performance
Each country which has an official corporate governance code will have its own particulars, though most cover broadly the same areas, and most address the Board’s role in some detail. Taking the 2018 UK Corporate Governance Code as an example, the Holistic Board Management System (HBMS) would record the degree of compliance with:
- Board Leadership and Company Purpose principles A – E
- Division of Responsibilities principles F – I
- Composition, Succession and Evaluation principles J – L
- Audit, Risk and Internal Control principles M – O
- Remuneration principles P – R
Company trading performance
The four main areas by which the Company’s trading performance should be judged, and which the directors should be very familiar with are:
- Trading revenue, profitability, capital structure and cash flow
- Market and competitor information
- Industry regulations
- Constitution and legal background
Stakeholder perception of Holistic Corporate Governance
Here we pick up the views of the key stakeholder groups:
- Owners
- Customers
- Employees
- Suppliers
- Financiers
- Social/environment
And take their views on the main elements of corporate governance:
- An ethical culture
- Congruence of goal or purpose
- Effective strategic management
- Organisation and resources fit for purpose
- Accountability and transparency
And input them into the Stakeholder Engagement system which measures the corporate governance performance against agreed criteria and feeds the iterative improvement process.
Conclusions: how well does the Wates Guidance measure up?
What does Essex say about compliance?
In relation to its target audience, the compliance rate is relatively modest, though its proponents would regard it as work in progress, and relatively encouraging. It is difficult to be optimistic about the low marks given to the Principle One, dealing with Purpose, with the implication that Boards either weren’t clear what they were meant to be reporting on, or didn’t want to disclose very much.
What does it say about the effectiveness of the guidance?
There doesn’t seem to be any attempt to judge, let alone to measure, whether all this Guidance has had any effect on the quality of governance of the larger private companies. The survey simply assesses the rate of response and how well the responders have set out their responses.
What does all this say about Wates and the general trend since Cadbury’s original rules?
The Report of Sir Adrian Cadbury’s Committee in December 1992 addressed the Financial Aspects of Corporate Governance, as an attempt to solve the mistrust between City investing institutions and corporate boards following recent scandals. His Code of Best Practice comprises four sections:
- The Board of Directors
- Non-executive directors
- Executive directors
- Reporting & controls
And the totality, with nineteen subsections, all fitted on two pages of an A5 size publication.
Just compare this with the 104 pages of the FRC guidance on the Strategy section of the Directors report alone.
The proliferation of rules, guidance and regulation since 1992 doesn’t bear thinking about, and still we get scandals, whether it be Carillion going bust or P & O shamelessly admitting to breaking employee severance rules on the basis that it would be cheaper than following the legal requirements. Good governance? I don’t think so.
How would our approach be better?
So much of the proliferation of rules and guidance amounts to little more than a handbook of good management practice – surely not the role of regulation?
There is still an obsessive focus on the way boards are constituted and how they conduct themselves, rather than whether they deliver the results. Above all, there is still no attempt to measure corporate governance performance, let alone in an holistic way. And still companies are assessed by the performance reports that are produced internally. The audit role has been reduced to assessing compliance with a set of rules and carefully staying within the “safe harbour” of the auditor’s strictly defined role. What happened to “true and fair view”?
Cadbury has unquestionably led to better boardroom practice overall, but as made clear by its title, it never attempted to address corporate governance holistically.
Our holistic approach, as outlined above, meets the key objectives of good corporate governance:
- Is the company being run ethically, robustly and transparently in accordance with a sound set of objectives?
- Is the assessment of this conducted by an independent engagement with key stakeholders?
- Is the assessment part of an on-going performance-improvement programme against governance measurement targets?
Sadly, after thirty years, there are no generally accepted measures of good corporate governance other than checking boxes ticked, and no recognition of the need to take an independent view from key stakeholders on a regular basis.
The latter element, particularly, is inexplicable, as, for instance, few of the big scandals were not anticipated by some people in the company or market concerned, whether it be Enron, Madoff or Wirecard.
Long overdue time for change!
