The financial sector meltdown has led many to question the effectiveness of corporate governance rules around the world. But we need to look more deeply into how they work, including behavioural aspects, says Gillian Lees, CIMA corporate governance specialist.
Recent woes in the financial sector have again thrown the spotlight onto corporate governance.
This is hardly surprising - the speed and magnitude of the sector’s problems have led to intense corporate soul searching and a ’never again’ sentiment.
There is widespread consensus that corporate governance failures played an important part in the financial crisis.
Three issues have come up consistently in the deluge of reports on the subject:
- the effectiveness of boards and their ability to fulfil an effective oversight role
- the adequacy of risk management
- remuneration policies that have encouraged and rewarded excessive risk-taking.
Let’s take a look at policy responses and likely developments.
The United States
A number of policy proposals are being considered in the US:
- to force firms to let shareholders have an annual advisory vote on executive pay
- to make directors who set compensation more independent
- to make it easier for shareholders to nominate and elect board directors – a right that is largely taken for granted in the UK, but the subject of intense debate in the US
- a ‘shareholder bill of rights’ has been introduced to Congress by Democrat Senators Schumer and Cantwell. This includes a number of the proposals already listed above, but adds others such as requiring directors to face re-election annually. It would also require companies to split the role of chairman and CEO and to have a risk committee separate from the audit committee.
The US may enact legislation before the end of the year. However, the Obama administration is facing stiff opposition from business leaders who are not keen on seeing the balance of power shift away from managers to owners.
Europe
Back in Europe, the European Commission’s focus has largely been on reforming financial supervision. It has also issued two recommendations on executive pay and on rewards for risk taking staff in financial institutions. As their name suggests, these are best practice proposals and do not have any force in law. Still, it’s more than likely that there will be more to come from the EU.
UK
In the UK, two reviews of corporate governance are running in parallel. First is the Walker Review, which focuses on the financial sector.
CIMA has supplied initial evidence to this enquiry. A consultation paper is expected towards the end of July - it is anticipated that it will set out three possible options for future governance practice in the financial sector. We do not know what these will look like yet, but we do have a few clues.
Sir David Walker has suggested that there needs to be better prior qualification and post appointment training for non executive directors.
There might also need to be greater time commitment for NEDs on bank boards. Look out as well for additional proposals on risk - for example, the requirement for all banks to have a risk committee separate from the audit committee, and the need for better information flows to the board.
The Financial Reporting Council (FRC) is carrying out the second review. The FRC has responsibility for the Combined Code on corporate governance which applies to listed companies.
So far, the FRC has gathered evidence on how the code is judged to be working. This will be fed into the Walker Review and any proposed changes to the code will come into effect in 2010.
Initial indications are that there is no great appetite for wholesale revision of the code – and in particular, the idea of enforcing a mandatory regime.
This is in line with CIMA’s view. We argued that the FRC could play a key role in setting out what good governance looked like, and that it was essential not to draw the wrong lessons from the financial crisis by applying inappropriate solutions across the corporate sector as a whole.
We offered 16 recommendations - including the suggestion that boards should develop an appropriate and robust process for overseeing a company’s strategy and that it should disclose this in the annual report. We also emphasised the importance of ongoing research to really understand the basis of effective governance.
We’ll continue to take an active role in the debate.
Will there be change?
Will these policy responses make much difference? - you could argue that the reforms initiated post-Enron failed to prevent the more recent crisis.
That’s a fair point. It explains why we need to give more attention to the behavioural aspects of governance. You could have the best balanced board in the world, but this counts for nothing unless the actual quality of debate and decision making is robust and challenging.
Do the directors ask the right questions – even if they appear to be ‘stupid’ questions? And can they understand the implications of the answers? Does the board have a good chairman who can facilitate debate in such a way that it brings out the best in all the participants? Is there a good constructive relationship between the board and management with everybody committed to the long term prosperity of the organisation – even if there are heated, but healthy debates?
CIMA’s submissions and comments
Read CIMA’s submissions to the FRC and the Walker Review. I would welcome your views on governance in your organisation and the direction that you think it should take in the future. I would particularly like to hear about developments in countries other than the UK and US and the specific areas under debate at the moment.
There will be further updates for Insight readers, but in the meantime, you can read CIMA Innovation and Development’s blog on CIMAsphere for current views and developments.
July 2009