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A series of governance eruptions

07 September 2016 by Ken Olisa

A series of governance eruptions - read more

Corporate governance is not mechanical, it is organic, says Ken Olisa

Thanks to The Godfather, Sicily is probably best known for being the home of the Mafia – but it is also the site of Europe’s largest volcano. Although the Mafia has been quiet of late, the same cannot be said of Mount Etna which, as recently as last December, blew lava one kilometre into the sky.

The Sicilians usually take Etna’s activity in their stride, but this time the authorities were sufficiently alarmed to take precautions, including closing the local airport until things calmed down.

The present state of UK corporate governance is comparable to that of Etna. There are long periods of quiet, during which everyone goes about their business as usual, until suddenly there is an explosion. Sometimes the authorities are sufficiently concerned that they feel the need to take action.

The UK corporate governance ‘big one’ occurred about 25 years ago when the fraudulent accounting of Maxwell, BCCI and Polly Peck led to the Cadbury Committee and the world’s first investigation into what makes good governance. The result was the Combined Code (now the UK Corporate Governance Code) which, perhaps not surprisingly, focused primarily on the accurate and honest reporting of a company’s financial results.

All was relatively quiet on the governance front until the banking crisis. That was of such seismic proportions – the equivalent of all of the planet’s volcanoes erupting simultaneously – that its impact on the non-financial world’s governance was relatively minor.

However, 2016 has witnessed the first major eruption in a long time. There were rumblings leading up to it: Starbucks’ and Amazon’s tax rows, Volkswagen’s emission saga and Toshiba’s accounting fiasco all warned that something was afoot in corporate governance. But they are all foreign companies and therefore easily dismissed as irrelevant to British practices. Even my own close encounter with corporate governance at its worst [the ENRC allegations] was easily dismissed as ‘foreigners behaving badly’. In fact, my oft-quoted soundbite summary of what happened – ‘More Soviet than City’ – seems to sum up the general mood.

And then BHS and Sports Direct blew up. Public trust in business took a dive as our TVs showed British oligarchs squirming in the crosshairs of MPs as they drilled into the pension and working practices of these household names. This was an unprecedented eruption. No lies about numbers, no robbing innocent investors. This time the victims had the misfortune to work (or have worked) for a venerable business or been compelled to wait, unpaid, to be searched.

The reaction of the authorities was also unprecedented. In the old days, business ministers merely grumbled about the unacceptable state of affairs, but this time MPs published excoriating reports about values and behaviours and the PM stepped in. Theresa May’s Conservative Party leadership campaign speech could not have been clearer: ‘I want to see changes in the way that big business is governed’, she said.

It is undeniable; corporate governance has erupted and we, the practitioners, have no choice but to heed the signs and to work hard to ensure that the tectonic consequences are not destructive.

The IoD’s Royal Charter commands it to ‘promote the study, research and development of the law and practice of corporate governance, and to publish, disseminate or otherwise make available the useful results of such study or research.’ Last year it published ‘The Great Governance Debate’ – an attempt to define corporate governance and what makes it good. The methodology had three elements:

  • A sample of company directors and other leaders active in the field of governance were asked to judge the governance effectiveness of FTSE 100 companies with which they were familiar
  • Aided by Cass Business School, a list of objectives were developed which contributed to the quality of governance
  • Those factors were weighted by their degree of correlation to the sample’s assessments and then the FTSE 100 was ranked.

The result was an analysis followed by an energetic debate about the validity of the methodology and the veracity of the conclusions. I was hauled before representatives of several FTSE 100 companies to explain how the IoD had dared to question the effectiveness of their boards. Although it is for them to judge, I believe that the IoD gave a good account and I have no doubt that the assessments sparked a considerable amount of reflection on the true nature of 21st century governance.

The IoD recently published the ‘2016 Good Governance Report’. This second edition learns from the first – not least the need to give a clearer explanation of the methodology. This is an ironic learning from the inaugural report. The IoD’s position is that good governance is not a matter of getting away with the minimum possible and then reporting it via an adviser-drafted boilerplate. It holds that corporate governance is about transparency, values and behaviours, which combine to deliver long-term value for the stakeholders as defined in the Companies Act.

Unfortunately basing the arguments using an apparently black-box methodology rather flew in the face of those lofty ideals. That is fixed in the 2016 edition and, with Cass’ help, the reader will be able to see the fact pattern and logic flow in all their glory. The message is that corporate governance is not mechanical – it is organic.

Many factors need to be taken into account when managing the human interactions of directors and those for whom they are responsible. The 2016 Good Governance Report identifies nearly three dozen, and I am confident that many more will emerge. Not all of them are important all of the time, but they are all relevant to the overall governance health of a company.

Health is the best analogy for what has been discovered. Visit your doctor for a comprehensive blood test and you will receive a report showing your scores against a wide set of physiological attributes. No one knows how they all work together, but those outside the normal range raise questions. If everything is ‘normal’ it does not mean that you are 100% healthy, but it does mean that there are probably other things in your life on which you should focus. Even if a factor is out of kilter, it is the patient’s decision whether or not to act.

Similarly with corporate governance, boards should review the list of factors, assess their performance against the ‘normal’ range and then decide whether or not they care about the outliers. The report adds to the general understanding by basing its hypothesis and recommendations on the expertise of business practitioners and not legislators or regulators.

Hopefully, the recent corporate governance eruptions will not turn into full-scale disasters for business and the British public can be persuaded that we have absolutely nothing in common with the Mafia.

The ‘The Great Governance Debate’ analysis and ‘The 2016 Good Governance Report’ are available on the IoD website.

Ken Olisa OBE is Deputy Chairman at the Institute of Directors and Chairman of the Good Governance Advisory Panel

ICSA: The Governance Institute comment

Peter Swabey, Policy and Research Director at ICSA: The Governance Institute, was a member of the advisory panel for this report. He commented: ‘It is very difficult to ‘measure’ governance, but that does not mean that we should not try to do so. The correlations and non-correlations between various factors in this report are very interesting and helpful, and the central issue that will need to be addressed in future years is the degree to which it is possible to assess culture within an organisation and the impact that has on its governance.’

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