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Reconfiguring governance

22 August 2016 by Anthony Hilton

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How does business get out of this mess? asks Anthony Hilton

Theresa May is surely the first Prime Minister in our history to decide that their first address to the nation should, in large part, be devoted to the failures of corporate governance and the way modern businesses are run. What she said would be damning coming from any politician, but it is astonishing coming from the mouth of a Conservative Prime Minister.

From Labour’s Jeremy Corbyn it would have been understandable. When Theresa May makes it her battleground, then something seismic has happened.

She said: ‘The people who run big business are supposed to be accountable to outsiders, to non-executive directors who are supposed to ask the difficult questions, think about the long term and defend the interests of shareholders. In practice, they are drawn from the same narrow social and professional circles as the executive team and – as we have seen time and time again – the scrutiny they provide is just not good enough.’

Theresa May was interpreting signals from the Brexit vote. Many people opted for leave because they felt the system was not working for them. Their vote was an expression of disgust at the way business and financial elites behave. They saw business leaders line up to support membership of the EU, so voting against this became the way to kick back.

It does make you wonder what the last 25 years of corporate governance have been for. Sir Adrian Cadbury’s original report was designed to rebuild the trust in business when it had been rocked by the collapse of Robert Maxwell and Polly Peck. Today, in spite of the governance efforts by a cast of thousands, big business is tainted in the public eye and among politicians. So, can governance adjust to meet this new challenge? Can it be reconfigured to give confidence to all stakeholders? If not, what is governance for and how does business get out of this mess?

A lot of the problem seems to come from the interaction between the mantra of shareholder value and a code that drives things forwards from the shareholder’s perspective. Together they leave little space for the board to fulfil its responsibilities, as laid out in company law, to consider the impacts on the other stakeholders. Boards do consider these other interests but they get treated as second order issues. They rarely trump the pursuit of shareholder value or deflect a board from its chosen course.

Would it help if these other interests were elevated? There is a danger that a company trying to serve several masters will end up satisfying none, because it will no longer have a clear objective. However, talk of sustainability and long termism is, in essence, a pursuit of the same issue. Thus, if such a shift could be achieved, and corporate culture aligned so it is properly embedded, that might make a difference. It would involve tough decisions however, not least in the area of executive pay because evidence suggests that incentive-driven rewards systems have an inherent short-term bias, which undermines long-term thinking.

Shareholders do not seem to be the right people to drive this change because they have their own conflicts of interest between short and long term, as well as being disunited and often uninterested. Although some, like Hermes, are travelling down this path, which leads to a string of policy options. One is to have a public interest or worker representative on boards; a second is to take the scoping of board effectiveness reviews out of the hands of chairmen and have the results published so they become like a statutory audit.

A suggestion made by Tom Bonham Carter, is that board strategy should be presented every year at the AGM and require a shareholder vote to approve it. Could the government help by tinkering with the tax system to favour equity over debt finance and build in a bias in favour of long-term gains?

Perhaps most relevant however is the thinking of Guy Jubb, recently retired from Standard Life, who highlighted the need for a two-tier system. He thinks there is a need for a split between ‘significant public interest companies’ and the others, which should be classed as ‘shareholder interest companies’

This is akin to the split in finance where some organisations are designated as systemically important and regulated differently. In Jubb’s case ‘significant public interest companies’ would be expected to show a duty of care to society and the wider public interest. This, Jubb says, ‘should inject a new authoritative and legally minded dimension to decision taking – particularly long-term decision taking in Europe’s boardrooms.’ Others may question whether that would be enough – but business is going to have to come up with something.

Anthony Hilton is Financial Editor of the London Evening Standard

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