26 January 2018 by Anthony Hilton
The FRC is proposing a fundamentally different approach for boards
The announcement of the Financial Reporting Council last year that it will consult on the next stages of corporate governance provoked a fair degree of weary cynicism.
But this time the cynicism is misdirected. The FRC has duly proposed its revisions to the UK Corporate Governance Code, but rather than simply look for new fields to conquer, the paper instead delivers a blueprint for a fundamentally different approach to the topic.
Just as our politicians increasingly talk about an economy that works for everyone, so the FRC has been bitten by a similar bug, with an approach to governance which also seeks to work for everyone.
The difference is that whereas the politicians have embraced the idea without having much clue about how to deliver it, the FRC seems to have a clear vision.
It is a vision that is likely to prove controversial. For the last 20 years, British corporate thinking has been dominated by the view that the paramount responsibility of a board is to shareholders, albeit tempered by an appreciation of the interests of other stakeholders.
For example, the preface to the current version of the code says: ‘While in law the company is primarily accountable to its shareholders, and the relationship between the company and its shareholders is also the main focus of the code, companies are encouraged to recognise the contribution made by other providers of capital.’
The new version shows a significant broadening of emphasis. It says that the function of the board is ‘to promote the long-term sustainable success of the company, generate value for shareholders and contribute to wider society.’
In pursuit of these goals, it recommends boards ‘consider input from the workforce and other stakeholders and be able to explain how this was considered and the impact it had on the decision.’ Combine these two strands and they amount to a significant modification of the view that all the board must worry about is pleasing shareholders.
“It is generally accepted that the FRC’s Stewardship code has been much less effective than hoped in bringing a widespread change of behaviour”
Nor is this simply loose wording.
The FRC is clear it appreciates this new iteration may not find favour with shareholders. Having stated that boards are responsible for the company’s health and need to take a longer-term view, it observes with wry understatement that ‘this can be in contrast with some investors or potential investors who may focus on short-term returns’.
In an analysis of the FRC proposals, Anthony Fitzsimmons, head of the consultancy Reputability, suspects that there is unfinished business here.
Investment managers are frequently chastised for their short-term approach and a lack of interest in serious engagement with company boards.
It is also generally accepted that the FRC’s Stewardship code, which was intended to make fund managers more willing to embrace their wider responsibilities, has been much less effective than hoped in bringing a widespread change of behaviour.
Thus, Fitzsimmons predicts the FRC will be forced, in time, to develop robust rules to force investment managers to bring their incentives and behaviours into alignment with the interests of their ultimate clients, the retail investors and members of the public with pension and insurance savings.
That promises to be an interesting struggle when it comes.
But the prospect of battles to come should not overshadow today’s reality: that the revised code as drafted will require a significant shift in boardroom behaviour.
At one point, for example, there is a list of questions that boards should be able to answer in the context of corporate culture and how effectively embedded it is. These include whether the company’s tax policy is consistent with its stated values and how the board ensures that suppliers meet acceptable standards of ethical behaviour.
Other questions put significant emphasis on recruitment, reward and performance management schemes, not just at the top but throughout the company. It makes it clear that the board’s job is to ensure that there is no misalignment between the company’s stated values and the behaviours encouraged by internal systems and processes.
Boards will need to get much more deeply involved in their organisations, engaging ‘different parts of the business, for example HR, internal audit, risk and compliance in its assessment of culture’.
The spectrum of corporate thought ranges from short-term financial pragmatism to long-term sustainability, with many managements trying to finesse their way between the two as circumstances dictate. Whether this will be possible in the context of the new guidance is a moot point.