Making Boards Better

Major business failures and, by association, those of their boards, over the past decade have brought about a plethora of new corporate governance codes such as the Combined Code in the UK and the Sarbanes-Oxley Act in the United States.  These codes are intended to be the parameters in which boards and their directors operate.

However, Professor Bob Garratt, Criticaleye Associate and author of the bestselling book on effective corporate governance, ‘The Fish Rots from the Head’, believes that corporate governance in its current form is a sham. “It does not deliver what it says on the tin for most organisations because they are not covered by the Corporate Governance Code,” he says, adding that the government needs to understand governance more thoroughly, a lack of knowledge illustrated by its failure to apply the Companies Act and Corporate Governance Code to all registered organisations – private, public and not-for-profit (as the King 3 code has done in South Africa).

Jim Wilkinson, Chief Financial Officer of SportingBET plc, agrees, “Assuming that the corporate governance rules that apply to listed companies are the most effective way of managing an entity, it makes perfect sense that these rules are invoked across all sectors, including governmental and non-profit organisations. However, there does seem to be a long way yet to go to prove that the corporate governance rules in existence have been successful in reducing the number of corporate ‘failures’.”

Worse yet, Bob suggests that civil servants, politicians and, sometimes, business leaders themselves, tend to look at corporate governance as a silver bullet to solve “any lack of organisational direction or management”.

Bernard Cragg, Senior Independent Director, Mothercare plc and Criticaleye Associate, agrees: “Corporate governance is certainly no silver bullet and, if misdirected, can have all the wrong consequences. The failures of banks are a good example. These were regulated organisations with more supervision than an industrial corporate. Having been on the board of a financial institution, they took the governance very seriously but, in practice, this resulted in not enough time spent on commercial realities and on risk.”

Sadly, most corporate governance tends to be looked upon as a box ticking exercise to be completed once a year to placate regulators. Yet, this attitude has not protected against failures. Indeed, at the time of its infamous demise in late 2001, Enron was 100 per cent compliant.

Bob continues: “Whilst this rather negative ‘tick-box’ attitude is still strong, there are some forces pushing for corporate governance to be taken more seriously. The seven non-exhaustive duties of a director (see below) codify 300 years of common law in the Companies Act 2006. Will the government and the courts have the courage to apply them?”

The Seven Duties of Directors

Each director must bear these seven duties in mind in all their activities and obtain professional advice if unsure of what is required in any given situation:

  1. To act within the powers of the company and to exercise powers only for the purpose for which they were conferred
  2. To promote the success of the company and, in doing so, have regard to the likely consequences in the long-term and to the interests of the employees
  3. To exercise independent judgement
  4. To exercise the care, skill and diligence expected of a director with knowledge, skill and experience
  5. To avoid conflicts of interest
  6. Not to accept benefits from third parties
  7. To declare any interest in a proposed transaction or arrangement

Sir Peter Mason, Chairman of Thames Water and Senior Independent Director at BAE Systems believes the following about UK corporate governance: “Personally I like the UK approach to board structure – a unified board rather than the continental approach of the supervisory board and an executive board or the American approach, where they’re essentially all non-executives. I think the UK has it about right.

“As to the importance of corporate governance codes in the UK, I certainly can’t see that codes and regulations would inhibit boards and individual directors from performing their responsibilities properly. I like to think that boards and directors do what is right at any moment in time anyway.”

However, while a legal framework for boards is essential, it is possible that corporate governance regulations can become overbearing and thus inhibit performance. “I am worried that we will again over-react to the experiences of the last two years and forget that, in many respects, there were no failures of significance in the non-banking sector and I would worry we will burden industry with more law and process when the system has actually worked well,” says Bernard.

Directors

Although guidelines, regulations and laws exist, and boards must comply, the onus of success and failure really falls to the Directors themselves: their relationships, their diversity of experiences, their skills and their passion for the role. Mike Turner, Chairman of Babcock International Group plc says, “Whilst the UK Corporate Governance Code is a helpful guide, the real key to good corporate governance is having the right people, and the right mix of individuals, on the board – people who are keen to understand the business and its markets, and who are prepared to give their views in a challenging but collegial manner.”

So what does a ‘good and compliant’ board look like? Anthony Fry, the Chairman of Dairy Crest Group plc, says that “a well performing board is a bit like a camel: you know it when you see it, but it’s very hard to describe to anyone who doesn’t know what a camel looks like! A great board is made up of a lot of different elements… fundamentally, though, it is about relationships, so it’s not just about selecting the best people and putting them around a table and assuming it’s going to work brilliantly. Boards work well because of the relationships that are established around that table.”

He continues: “I also don’t think that the performance of a board is about regulation or corporate governance – although that plays into it, based on what is officially expected of a NED. I think it is more down to whether the board directors in question want to do their role. At the most extreme level, given all the regulatory requirements on a non-executive, you come to the ludicrous conclusion that someone in that role is effectively a quasi-executive and the only difference is that they are not paid in an equivalent way. Some people simply can’t believe that I’m prepared to be a NED on a plc. They say ‘you’re carrying massive legal responsibility, you’re paid absolutely nothing and you’re treated like dog meat by executives.’ People can be very negative about it.”

In contrast to the role of executive, a director’s role is bounded by law. As many directors are former executives, they come into the role with their ‘executive’ mindset with no regard for the tight boundaries and long-term legal duties of a director.  In his book, ‘The Fish Rots from the Head’, Bob writes that, at present, “we know very little about directors and their effectiveness. A deeper issue in getting any code to improve the quality of the board linked with the quality of business output, concerns the lack of rigorous selection, induction, development, appraisal and deselection of board members.” To his point, as there rarely is an induction programme for directors, many simply do not know the difference between the role of Executive and Director.

To combat this Bob argues that directors should be given a formal induction process to explain the different knowledge, skills and attitude required for the role. There should also be rigorous development for directors and a performance evaluation process. “Much more external help is required in the rigorous and regular appraisal of the board, its committees and each individual director.”

It is important for directors to develop a broader mindset with more diversity seen around the boardroom table. Professor Sir Andrew Likierman, board performance expert and the Dean of London Business School, considers the following to be a well-performing board: “You’ve got to get the basics right. You’ve got to get the right people on the board and then structure it properly. Secondly, you’ve got to get the way the board operates right – that’s to say, in terms of the way meetings function, the way in which people interact with each other, the way the committees work, and so on. Thirdly, you’ve got to have the right kind of coverage. Are you dealing with the right issues? You must be dealing with strategy and the big issues of the organisation. We all know of organisations that spend their time fiddling around with the things that don’t matter, and should be aware of the province of operational management –that is a poorly performing board. Finally, you’ve got to keep up with good practice to make sure that you don’t sink into complacency and just assume you’re doing a great job tomorrow, just because you’re doing a great job today.”

Boards need to address the necessary balances, competencies, evaluations and learning needed to ensure more healthy organisations in the future.

Sir Peter identifies communication as the vital factor in a properly functioning board. “In my view, the key ingredient to a good board is simply that is has a good chairman to lead, but not dominate it. I don’t like to see politics or tension between board members – the shareholders’ interests should come first. It may sound like I’m stating the obvious but, to make a board coherent, communication between executives and board members and chairman and board members is critical.”

Please get in touch if you have any comments about the issues raised here.

I hope to see you soon

Matthew

www.twitter.com/criticaleyeuk

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