DISCUSSION Beware of further governance prescription

by Laurie Fitzjohn-Sykes _______5th April 2017

The BEIS Select Committee has published its report on corporate governance. While these are only recommendations, they are an important input as the Government decides what reforms to introduce, which we expect to be announced before the summer. We agree with many recommendations, but are concerned that more regulatory enforcement and assessment will reinforce an overly prescriptive and tick-box approach to corporate governance. Instead, we advocate aligning the investment chain to support stewardship and to provide individuals with a voice on how the companies they own are run.

What we agree with

What we disagree with

There is a flawed assumption contained in many of the proposals, especially those that push for more powers for the FRC and even more those that suggest it is possible to arrive at a traffic light system. The flawed assumption is that good governance can be reduced to a list of processes and procedures. It can’t, and directors are telling us that the attempt to do so is distracting them more and more from a focus on the really important things such as decisions about investment in talent, R&D and innovation.

As Martin Sorrel wrote in the WPP Annual Report in 2015. “If political leaders are wary of risk-taking, the appetite for it in the corporate world is smaller still. Since the collapse of Lehman Brothers in 2008 and the economic crisis and recession that followed, boardrooms have become ultra-conservative in their decision making. In a world of zero-based budgeting, activist investors and ubiquitous disruption by tech start-ups, there is little encouragement to be bold. This is a regrettable, if understandable, fact of contemporary corporate life…..Calculated risks are necessary for the long-term health of a business, because without them innovation, development and renewal are impossible.”

The key focus of reforms should not be on reducing the number of scandals, but instead on how to encourage risk taking and investment in pursuit of a societal purpose. Every year UK companies save or distribute to shareholders over £130bn, larger than the budget of the NHS. Encouraging more purposeful investment would do more to restore public trust and improve productivity, than trying to prevent the next scandal.

An alternative to regulatory enforcement would be to align the investment chain to support stewardship and provide individuals with a voice on how the companies they own are run. This should lead to increased resources and focus on stewardship within asset managers and funding for research on how companies are meeting Section 172. In essence, the assessment of whether a company is fulfilling its duties under Section 172 would be best achieved with the diversity of voices between fund managers and research analysts, rather than a singular view expressed by the regulator. Policies to create this alignment are set out in our recent report Promoting long-term wealth.

Overall, while we agree with many recommendations, too often the focus is on tackling the symptoms and failures of poor governance, rather than how to align corporate structures to support entrepreneurism in pursuit of purpose that benefits shareholders and society. Creating this alignment through the investment chain would help create the resources for a more nuanced and thoughtful assessment of boardrooms, instead of compliance with a list.