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Make That Change

08 April 2020 by Ibi Eso

With responsibility for defining the organisation’s vision and directing its behaviour, the board sets the tone. This means that each director has a moral duty to be the change they want to see in the world.

Self-reflection is the very necessary process of exploring and examining ourselves, our perspectives, attributes, experiences, actions and, just as importantly, our inaction. It helps us gain insight and see how to move forward. Yet self-reflection is often something that is overlooked, or avoided, by leaders in organisations of all types and sizes. Driven by their determination to get results, directors are typically ‘doers’ and, consequently, few allow themselves what they see as the luxury of pausing to reflect on the board’s effectiveness and, particularly, their own performance and contribution. But creating a time and space in which your board can collectively reflect on their work is essential to ensure that directors are carrying out their duties properly.

Additionally, in my opinion, I feel self-reflection is vital to good governance, but is often missing in the behaviours manifested by the majority of directors.

High Profile Failures

We do not need to look far, or have particularly long memories, to recall some of the spectacular business collapses in which poor governance played a large part.

Take the example of Carillion – once Britain’s second largest construction and outsourcing business – which has been described as a lesson in how not to do corporate governance. Following its shock demise in 2018, ten red flags have been identified in the way the former £4.4bn FTSE 250 company was run. These include the performance of Carillion’s board directors whose conduct is now the subject of a fast track investigation by the Insolvency Service. The board’s performance is questionable in at least four areas, namely:

1. Strategic risk management – the board’s inability to manage Carillion’s principal risks - it had high debts and traded on low margins – led to the company running out of cash, making its continued operation impossible.

2. No margin for error - the collective lack of understanding of the inherent dangers in Carillion’s risk-reward approach. Bids were priced aggressively low to win contracts, leading to all-too-predictable problems with delivery and late payment.

3. Financial misrepresentation - failure to properly question Carillion’s accounts to ensure they gave a true and fair view, compounded by misleading statements made to the market. Presumably motivated by the desire to protect the share price, the board’s communications to shareholders remained upbeat right up until the first profit warning.

4. No Plan B – the board wasn’t prepared for its January 2018 debt rescheduling package to be rejected by its bankers. Whether through arrogance – thinking that Carillion was too big to be allowed to fail – or over-optimism, the directors had no contingency plan in place.

Can these directors look at themselves in the mirror and honestly say that they fulfilled their duty to “exercise reasonable care, skill and diligence”?

And, sadly, Carillion is far from being an isolated example of catastrophic leadership failings. In other recent corporate scandals, we have seen the once profitable BHS business bled dry, forced to pay “abnormally high” dividends to its owners, leading to its collapse and the loss of 11,000 jobs.

Meanwhile, at Patisserie Valerie the revelation of a £20m black hole between the chain’s reported financial position and the reality led to the closure of a quarter of its stores and loss of around 900 jobs.

Sharing the Blame

Individual directors may not have been actively responsible for Carillion’s risky bid strategy, the excessive dividends paid by BHS or the apparent fraud at Patisserie Valerie but, through their silence or inaction, created the conditions in which it was possible for these events to occur. While there is a tendency to point the finger of blame at others in the wake of financial failure, all the directors concerned should be engaging in some serious self-reflection.

In the cases mentioned the directors appear to have turned a blind eye to one or more warning signs of a possible culture problem, flagged by the Financial Reporting Council (FRC) in its Guidance on Board Effectiveness, namely:

• silo thinking
• a dominant chief executive
• leadership arrogance
• pressure to meet the numbers/over ambitious targets
• lack of access to information
• low levels of meaningful engagement between leadership and employees
• lack of openness to challenge
• tolerance of regulatory or code of ethics breaches
• short-term focus
• misaligned incentives.

Undoubtedly, each corporate scandal I’ve mentioned was facilitated by inadequate auditing – both internally and externally – with Patisserie Valerie especially demonstrating a clear lack of internal controls. Yet the reasons for failure go far deeper than that. According to INSEAD Business School’s Professor Bens, passive and weak board management undeniably helped to seal the fate of both BHS and Carillion.

The Code stipulates that: “The board should establish the company’s purpose, values and strategy, and satisfy itself that these and its culture are aligned. All directors must act with integrity, lead by example and promote the desired culture”.

However, when a crisis occurs, in my experience, I sometimes feel directors are always ready to point the finger and look for culprits outside the board room, rather than looking internally to identify what the board and/or individual directors, could have done to prevent the crisis. It is at this point, I feel some self-reflection should be carried out by the board, to determine what the board could have done better to prevent the crisis. This could be as simple as not seeing the warning signs, not taking board evaluations seriously, or something more serious such as not having an effective strategic outlook. I have also noticed that in some organisations, where the role of the company secretary is often overlooked and maligned, the company secretary is normally the first person in the ‘cross hairs’ when there is a crisis. Suddenly, those minutes you prepared on time, which no one bothered to comment or review, have now become ultra important!

Additionally, all too often organisations take a tick-box attitude towards corporate governance. It shouldn’t be about a series of bolt-on initiatives, coldly calculated to assure shareholders and other stakeholders that the organisation is well-run. Or, worse still, a defensive measure wheeled out to deflect blame in a crisis, as is so often the case.

Indeed, earlier this year, some of the UK’s biggest businesses received a rap on the knuckles when the FRC published its annual review of how well (or not) companies lived up to the UK Corporate Governance Code. Some FTSE firms, the report found, were “simply paying lip service to the spirit of the Code”. Although the FRC is primarily concerned with principles and best practice for boards of directors of listed companies, the report’s findings are equally relevant to boards of all types of organisation.

A Prerequisite

Strong governance should be embedded in the very culture of the organisation, an integral part of its day-to-day activities.

But how can organisations assure themselves that they are fulfilling this instruction effectively? What checks must directors perform to satisfy themselves that the organisation’s culture is one of openness, respect, adaptability, honesty, reliability, recognition, an acceptance of challenge, accountable and with a sense of shared purpose.

In my experience, most organisations grudgingly implement a governance framework because they must, rather than because they can appreciate the numerous business benefits of doing so.
If we are to change attitudes around governance so that organisations shift from having a box-ticking mentality, we need to have more and deeper conversations about governance at senior level. As governance experts, we should treat the Code not as a checklist for compliance but as a starting point. Instead of merely obeying the letter of the law, directors should strive to reflect its spirit, asking themselves what the Code is intending to achieve and ensuring that this intent guides their decision-making.

This necessarily involves having a deep understanding of the Code itself, ensuring the company secretary has the respect and authority he/she needs to spearhead cultural change and ensure governance permeates every aspect of the organisation’s activities. Then the organisation needs to put measurement mechanisms in place to monitor its governance health on an ongoing basis.

Strong governance is not just about doing the right thing. There is a proven correlation between a culture of good governance and profits. Studies show that implementation of corporate governance standards improves the financial performance and internal efficiency of businesses in developed economies.

It’s a sobering thought that more effective corporate governance could possibly have saved BHS, Carillion and Patisserie Valerie from collapse. It is only by directors looking at themselves in the mirror and questioning their actions – and, in many cases, their failure to act – that we will raise standards of corporate governance in Britain’s businesses and the not-for-profit sector. 

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