If you’re not a Finance Director or CFO, the intricacies of corporate governance isn’t the easiest thing to get people excited about. (Trade secret – even if you are a Finance Director or CFO, it’s still hard…)
Yet good corporate governance is fundamental to the effective working of the modern free enterprise system. We need to have at least a degree of trust in the people looking after our money, whether we’re customers, investors or employees waiting for our next salary payment. Without that, the whole system would collapse.
The trust that’s necessary for businesses to operate is much harder to create than it used to be. When we only bought and sold things with people in our home village, corporate governance was largely unnecessary because artisans had to be trustworthy and do least a reasonable job or they’d be thrown out of town, banished beyond the city walls.
But as the industrial revolution came along, creating multinational businesses which spawned global supply chains, we all started to depend on the honesty and trustworthiness of thousands of people we’re unlikely ever to meet in person.
Over time, structures and processes have evolved to give us all at least a modicum of trust in people in people we’ll never meet in person whether we’re buying or selling good or services, choosing which company we want to pursue our careers with and deciding which businesses have an ethos which most closely aligns to our views on specific ethical or social issues we feel strongly about.
From a Finance Director and CFO’s perspective, one of the most important structures in a world where we need to demonstrate trustworthiness is the modern system of corporate governance.
In the UK, corporate governance is generally reckoned to have started, in however modest a way, when Parliament passed the Joint Stock Companies Act of 1856. After that, anyone could invest in a business with the protection of limited liability for the actions of the company. The business was now, in the jargon, a “separate legal person” from its individual owners.
Without that level of legal protection, it’s quite unlikely the modern economy as we know it would even exist. Holding thousands of individual shareholders personally responsible for the debts of Enron, say, or WorldCom would be a mammoth administrative task.
And on a practical level, one scandal of an Enron/WorldCom magnitude which resulted in thousands of investors becoming destitute would probably end for good the access businesses currently enjoy to equity capital from thousands of individual investors.
Back in the mid-1800s, in return for this new limited liability structure, the 1856 Act required companies to hold annual meetings and present the accounts to investors on an annual basis so they could satisfy themselves the company was being run properly.
The limited liability company, in a form we’d largely recognise today, was born. And, in the same breath, the early stirrings of good corporate governance.
The concept of a business having to report on its activities to shareholders who didn’t work within the business was established, but it would be another 100 years or so before the term “corporate governance” was heard regularly, even amongst lawyers, accountants, auditors and company secretaries.
But following a number of high profile scandals, in both the UK and the US, the term “corporate governance” came into much more common usage from the mid-1980s onwards.
In the UK, the first flurry of “corporate governance”, as we’d think of it today, was sparked by the publication of the Cadbury Report in 1992.
Following the Maxwell and BCCI scandals of the late 1980s and early 1990s, Adrian Cadbury was asked to lead a group of the great and the good, formally called “The Committee on the Financial Aspects of Corporate Governance”. Their findings, colloquially called the Cadbury Report, was the starting point for what would evolve into the Combined Code, or the UK Corporate Governance Code as it’s now known.
Today, it is a condition of listing on the London Stock Exchange that the provisions of the UK Corporate Governance Code are adhered to, whether or not the company itself is based in the UK. Nowadays, a well-organised corporate governance process is seen as essential to any business which expects to trade its shares on major financial markets.
At around the same time, the Savings and Loan crisis, along with some large-scale corporate collapses, such as Enron and WorldCom, led to the US passing the Sarbanes-Oxley Act of 2002. Between the mid-1980s and the early years of the new millennium, there were few hiding places from the increasing pressure for good corporate governance.
But neither the UK Corporate Governance Code, nor Sarbanes-Oxley, were perfect solutions to a freewheeling corporate decision-making approach. The global banking collapse in the late noughties, for example, took place despite the plethora of corporate governance procedures and Sarbox compliance large businesses had spent the previous 20 years implementing.
In the meantime, the costs of compliance, audit committees, internal audits, independent directors and goodness knows what else kept climbing….and show no sign of stopping any time soon.
It probably is fair to say the penalties for being caught evading the principles of good corporate governance are getting tougher, especially if a corporate collapse triggers the attention of bodies like the UK’s Serious Fraud Office. But still companies collapse and investors, employees and customers find themselves out of pocket, despite all the corporate governance rules and regulations which are supposed to stop that happening.
As I write this article, the situation at Patisserie Valerie isn’t looking too pretty, the Carillion collapse remains fresh in the memory and another public service outsourcer, Interserve, seems to have just managed to squeak out of a similar fate by diluting their existing shareholders’ interests down to a mere 2.5% of the restructured business.
Yet all these operations had proper corporate governance in place, as did UK bank HBOS which recently saw a group of their former staff sentenced to a combined 50 years in jail for developing, in the words of the presiding judge, an “utterly corrupt scheme” to fleece borrowers and line their own pockets.
All these corporate collapses, or near-death experiences, have taken place under the noses of internal and external auditors, internal procedure manuals, independent non-executive directors and a panoply of other corporate governance structures, frameworks and processes.
The emergence of scandal after scandal, despite all the correct corporate governance structures being put in place, means the concept of corporate governance might have its credibility dented…perhaps even holed below the waterline.
But corporate governance is, I believe a valuable one. It provides reassurance and trust in a world where those qualities are sadly lacking, and which are essential to the proper functioning of a modern economy.
Here’s what most people miss, though…
Corporate governance isn’t about procedure manuals kept on a shelf somewhere. It’s about whether anyone follows them.
Corporate governance isn’t about having an audit committee. It’s about whether or not the audit committee asks searching questions about company finances, rather than just accepting vague reassurances from the CEO or CFO, ticking a box and moving on.
And corporate governance isn’t about being able to point to a rule book and saying “we did everything we were supposed to” after the balloon goes up. It’s about hiring trustworthy people and making sure they behave honestly towards customers, investors and colleagues.
Ultimately, corporate governance is about what you do, not what you say.
Earlier in my career I had the misfortune to work, very briefly, for a business whose supposedly independent directors appeared to think it was their job to sanction the Chief Executive’s kleptocracy, rather than stepping in to stop the Chief Executive’s unacceptable behaviour while running a business under severe financial strain.
All the independent directors were smart, intelligent people with jobs outside the business of considerable trust and responsibility. So I have to assume that they were also smart enough to realise the importance of good corporate governance. They certainly all attended the directors’ training courses on the subject.
But they took no action to put a stop to the Chief Executive’s behaviour. Ultimately this led to a major financial crisis which, in turn, resulted in the abrupt departure of the Chief Executive. (Either that or they were all in on a scam of some sort, which would be even worse corporate governance than merely being incompetent in discharging their duties as independent directors.)
Following the near-collapse of this business, an independent investigation personally censured the Chief Executive, the Chairman of the Board and the Deputy Chair for presiding over a serious business failure, caused by their poor oversight and inadequate governance.
Ultimately, the failing of this board, and the entire corporate governance structure of the business, came about because the noblest of aspirations, and all the procedure manuals in the world, counted for nothing without action.
The people with the responsibility to exercise independent control over the business were, even on the most positive interpretation of their behaviour, asleep at the wheel.
In concept it wasn’t much different to the situations at every major bank during the global banking crisis, or investors in Carillion, RBS, Patisserie Valerie and countless other large companies which have hit the buffers in a spectacular fashion over the past few years.
Every one of those businesses had in place all the rules, procedures, structures, committees, internal audit, independent directors, external oversight and other corporate governance structures and processes in place.
But they still collapsed in disgrace because their auditors, independent directors, the in-house company secretarial team and many, many others passed up the opportunity to action, hold the business to a higher standard and get things back on track again.
Without action, no amount of corporate governance procedures are going to save your business….as shareholders, employees and suppliers working in, and for, the large businesses which have collapsed in recent years can testify to.
Don’t make the same mistake those businesses did.
Corporate governance…when applied properly…is an important safeguard for your business in an uncertain world. Don’t just think the corporate governance procedures manuals will look after themselves, because they won’t.
Take action before it’s too late. Your business, your employees, your customers and your suppliers will all thank you.
(Photo by Jakob Owens on Unsplash )