The inscription in Latin on the tomb of Sir Christopher Wren in St Paul’s down the road means roughly “If you want to know what he accomplished, look around you”. I would make the same observation about this occasion in relation to Jonathan Charkham’s achievements. It is a real pleasure to be occupying this platform today with Adrian, whose name will forever be associated with corporate governance, and with Anne, who now, as leader of the International Corporate Governance Network, plays such an important part in the cause of corporate governance worldwide. Above all, I want to thank most warmly the Lord Mayor, his colleagues and their staff for allowing us to use this magnificent setting. They pay a great compliment both to the FRC and to the role of corporate governance.
Jonathan Charkham’s contribution in the corporate governance field was special, immensely characterful, and highly influential. On taking over the Chair of the FRC in January last year, I don’t know what I would have done without the guidance of his book, “Keeping Better Company” – with its wide historical and international perspective, its wisdom based on deep corporate governance experience, and its wonderfully British style and “take” on things.
When Jonathan and I last met over lunch a week before he died we swapped recollections of corporate governance milestones in our respective lives. The conversation covered a lot of governance experience in pre-Code days, our joint involvement with Adrian Cadbury’s seminal committee in 1992, and genuine awe at the speed of governance developments since then. The emphasis of our whole discussion was on behaviour, not theory, and very funny much of it was in recollection, even if it hadn’t been at the time.
What you will get from me today will also be personal and reflective, though not, I fear, as amusing as the lunch was thanks to Jonathan’s spicing.
For the last forty-five years, since graduating from Harvard Business School in 1962, I have been preoccupied with how to run enterprises well. It is the crucial skill in dynamic economies.
The heart of running enterprises well is good corporate governance. The heart of the UK’s corporate governance regulation is the Combined Code. And the FRC is the regulator with responsibility for keeping the Code under review.
So corporate governance was the reason for my having taken on the Chair of the FRC. After so many years as a practitioner, it allows me to look from a different and wider perspective at why enterprises do or don’t succeed; and maybe to seize an opportunity or two to help them run better.
The part played by the Code itself in underpinning good corporate governance needs to be clearly understood. So bear with me if I comment briefly on it. The Code is at best a means to an end. It is not an end in itself. It is a powerful statement of principles which characterise good governance practice. These principles are backed up by associated rules – the Code calls them “provisions” – which companies may or may not follow. But if they don’t follow a provision, they have to explain their reasons to shareholders. This is the famous “comply or explain” feature, designed to give the Code the essential flexibility to enhance its value in practice.
The Code was pioneering when its first version was drafted in 1992 by Adrian and his Committee; and it has been much flattered by imitation elsewhere in the world ever since. Its opening paragraph 1.1 goes to the heart of the matter:
“The country’s economy depends on the drive and efficiency of its companies. Thus the effectiveness with which their boards discharge their responsibilities determines Britain’s competitive position. They must be free to drive their companies forward, but exercise that freedom within a framework of effective accountability. This is the essence of any system of good corporate governance”.
The FRC’s principal aim in corporate governance stems directly from this paragraph, as you can see in our recently published ‘Strategic Framework’ which summarises across our very extensive remit what it is that we are trying to do.
Good governance is a function of what good Boards actually do; and this is simply not accessible to precise rules covering all the endlessly different circumstances under which Boards operate. One cannot say, “If you follow this principle you will govern well.” One can say “If you don’t follow this principle, the chances on balance are that your governance will be worse as a result.” The Code, in other words, is a sort of governance health warning: Boards are well advised to take good notice of it; but they may still survive without following it 100%.
The Code’s potential flexibility through the “comply or explain” feature is in my view its most important single characteristic. Meeting the spirit of its principles, but not necessarily obeying all its provisions to the letter, is what matters. If investors insist on all the Code’s boxes being ticked rigorously, regardless of explanation, it damages the dialogue between Boards and investors and does the cause of governance a great disservice. In my book, the sin of thoughtless box-ticking ranks in deadliness alongside that of sloth.
Having said all that to put the Code in its proper perspective, I now want to put governance and the Code in the context of my own working life as a route to talking about the behaviour of Boards and, finally, to reflecting on the future course of corporate governance.
If I look back to the foothills of my managerial life in the 1960s, I can now see how narrowly preoccupied I was with the details of what made executive management effective. I regarded Board positions as status symbols for executives who had made it. In that era it was the Managing Director (now called the CEO) who dominated the corporate landscape. Boards were usually very much his appendage. The members of Boards were certainly not stupid. They were simply the prisoners of their times, as we all are.
The management of large quoted enterprises was then conducted in a rather different environment from today’s, both administratively and politically. Accounting standards gave great latitude. Work forces tended to be exploited, not led, and union relationships were all too frequently adversarial. The corrupting effects of corporate power were checked only in the last resort by others; or by the CEO himself exceptionally. Non-executive directors were few and far between. An imperial culture, deeply engrained but then approaching its twilight, shaped attitudes to “being in trade”. Money-making in the City was OK, perhaps because it was largely invisible. On the whole, money-making was regarded as a disreputable motive in the leaders of business. There was a marked absence of foreign participation in management and share ownership alike.
The person who had by far the greatest influence on me and my career and whose example and achievements, both positive and negative, were the crucible in which my governance experience was formed, was Frank Kearton - one of the greatest industrialists Britain produced in the second half of the 20th century. The fields on which he played were first ICI, then the bellwether of British heavy industry, and thereafter Courtaulds, founder of the world’s man-made fibres industry, which Kearton drove into being the largest textile company in Europe.
Kearton brought me into Courtaulds in 1968 to be a Director of a major subsidiary. He had then been Chairman and CEO for three years. He provided a completely unforgettable example of dynamism, energy, grasp, determination and speed of decision-making. His leadership was brilliant; but also ungoverned – only late on in his Chairmanship did two non-executive Directors join the Courtaulds Board, then consisting of fifteen executive Directors – and the price paid for the headlong expansion he drove was very high. After he left in 1975, Courtaulds endured two decades of agonising retreat under a Board of which I was ultimately chairman and CEO for 11 years which tallied almost exactly with the Thatcher era.
By 1991, the year before the Cadbury Committee gave birth to the Code, I had had a crash course in just about every aspect of corporate governance and had met Kipling’s two impostors, Triumph and Disaster, many times. The major part of my governance experience was the challenge of negotiating Courtaulds’ survival after the explosion of the Kearton years and against a background of “the melancholy long withdrawing roar” of the British economy from manufacturing to services. An additional and completely different governance task was the non-executive chairing of Reuters, which came to me unexpectedly and unsought in 1985. The Reuters problems in the 1980s of controlling growth were as formidable in their way as the problems of handling Courtaulds’ decline, but were rather more enjoyable to deal with. In both Courtaulds and Reuters I was able to pioneer major corporate moves which seemed to me to be brave at the time but which have long become totally commonplace in the handling of companies: a demerger in Courtaulds; and in Reuters the return to shareholders of substantial capital; and the first general share incentive scheme based on the Total Shareholder Return criterion.
In 1991 I made a major career decision not to take up another Chief Executive position but to specialise as a non-executive on the back of the two FTSE 100 Chairs I then held: those of Courtaulds and Reuters. Even before the Cadbury Committee, it was clear that being a non-executive Chair was going to be a far more contributory position than it had ever been.
I was adviser to the Cadbury Committee with much the same function as the canary down the coal mine used to have: to cheep and keel over if the air got too foul. At the end of that great 1992 effort which resulted in the first Code, Adrian in his thoughtful and impeccably mannered way wrote me a thank you letter in which he said “What was particularly useful was your reaction to our proposals as someone who was going to have to implement them”.
That was prophetic as well as gracious because the subsequent years of my working life have added another 25 plus years cumulatively to my experience of chairing FTSE 100 companies to the 20 or so I had already accumulated by the early 90s. They have also added another 30 plus years cumulatively to my Board experience outside FTSE 100 companies in chairing and non-chairing capacities and in different environments: central finance on the Court of the Bank of England; major philanthropy with the Ford Foundation in New York; a two tier Board of an outstanding European company, Air Liquide in France; artistic leadership with the National Theatre; and now regulation with the FRC. The missing elements in that list, by the way, are private equity, hedge funds and partnerships. I have had no first hand involvement in any of those three; but I have watched them all carefully over the years to learn lessons.
I remember that at the time of the Cadbury Committee I did wonder whether there was really a need for a Code of good practice in corporate governance. Good Boards had already learnt many lessons through surviving the major challenges of the Thatcher era: greatly increased competition, all the pressures of globalisation (enhanced by the strength of sterling on the back of North Sea Oil), rising shareholder activism and the post Big Bang transformation of the City.
So was the Code necessary? Has it really added value?
My answers now are unhesitatingly in favour of the Code, albeit with some qualifications which I will come to.
In the first place, the Code has greatly increased the chances of CEOs remaining relatively free from the corruption of power. By “corruption” I do not mean criminal activity so much as the excessive self-belief and loss of objectivity which can stem from concentrated power in the centre of companies.
The Code insists on a degree of transparency and accountability which make it much more difficult, though not impossible, for one individual to damage a company materially. I know that a possible cost of the Code’s restraining influence is an increase in risk aversion – or, which is not quite the same thing, a decline in venturesomeness. However, if a Board is well led and cohesive, it should not fall victim to the malaise of risk aversion. For there are great pressures on Boards these days to both raise their game and face up to risks. Private equity, albeit under different governance conditions, is showing what can be achieved. The best private equity conduct is both driving and risk conscious.
So the Code adds important value by making Boards and managements accountable and reducing the risks arising from corporate folly or villainy. However, it does more, much more, than that and to see why one must consider the basic characteristics of Boards.
Boards in my experience are fascinating, almost addictive. They are like grapefruit: full of individual segments with a lot of pith and pips which defy getting to the fruit without a mess.
Think about it. Directors are all characterful individuals who have proved themselves in one way or another. They come together at quite long intervals. All are busy and pressed for time. At least half of them, whose major concerns are with other enterprises, have to be substantially and continuously educated about the matters on which the Board has to form a view. If the CEO isn’t really interested in the Board being effective, it’s a killer. If the Chair and the CEO don’t see eye to eye, that too is a killer. Events come at the Board, many of which are random and unforeseen. In the background there is a sort of Greek chorus of professional service people who are guardians of process, paid by the hour and consequently not too bothered about the clients’ time, and forever wailing about omissions and risks and depositing boilerplate fungus. Circling overhead are hedge funds and media birds of prey. Activist shareholders or would-be bidders may be parked in their tanks on the lawn.
This picture of a Board may be overdrawn, but anyone who has served on the Board of a large publicly-quoted company would recognise it. There are three permanent and major problems to be faced. The first is that the Board never has enough time. The second is mining the information the Board must have to do its job. The third is getting the necessary performance from everyone round the table. My object as a regulator is to try to ensure that regulation is not a fourth major problem that public company Boards have to face.
The Code can be seen by Board Chairs subject to it as a glass half empty or a glass half full. On the one hand it stipulates a lot of things Boards must cover: strategy, risk, remuneration, audit and succession. On the other it establishes the conditions for doing them: a unitary Board, a Chair solely focussed on running the Board, adequate experience and calibre round the table, proper information, Board cohesion, and regular evaluation by the Board of how it and its members are doing. The catalyst of good Board performance is the Chair, whose leadership is critical. Without the Chair’s courage, skill, prioritisation and effective handling of Directors, above all the CEO, the Board gets nowhere. This is where the Code can be such a help owing to its very intransigence about the principles of good governance. It is, as I have said, a governance health warning. Its existence can prevent a whole lot of the argument and counter-productive behaviour which used to exist in the pre-Code days. Directors then could far more easily get away with grandstanding, idling, politicising, doing their own thing regardless, and then getting re-elected. I know because I have been there myself.
I would now judge the effectiveness of a Board by three things, all three being assisted by the Code if the Board is in the hands of a good Chair.
The first test is where the Board places the focus of its efforts on the spectrum which has strategy endorsement at one end and watch dogging at the other. In other words, does the Board as a whole, particularly the non-executives, want to reach understanding and agreement on the strategy the company should follow, having regard to the market concerned, the competition and the company’s own strengths and weaknesses? The Board cannot do this without the CEO’s active co-operation in supplying the non-executives with first class, permanently refreshed information; in discussing strategic alternatives; and in exposing himself (or herself) to challenge and disagreement. I think the spirit of the Code demands this from the executive component of a Board. But the letter of the Code, without firm Board leadership, can get in the way of achieving it by interposing a whole lot of other priorities, many of which can frustrate openness and co-operation between the executive and the non-executive Directors.
Secondly, in judging a Board, I would look to the performance of the Remuneration Committee because it sits at the crossroads of much of what a Board should do. The work of the RemCo requires knowledgeable judgements about the performance of the executive and these in turn must be based on real understanding of the drivers of the company’s performance and how the executive have contributed. Furthermore, the RemCo is also a clear indicator of the quality and robustness of the relationship between the executive and the non-executive Directors, especially that between the Chair and the CEO. Finally, the RemCo is an acid test of the relationship between a company and its major shareholders simply because the shareholders have chosen to focus on remuneration in a major way. The RemCo must satisfy them. But in a way which puts first what is right for the company. The investors’ remuneration guidelines must be a guide, not a straitjacket.
Thirdly, in judging a Board, I would look at what it does about succession. The pressures on a Board are substantially short term. But companies can’t afford to ignore the long term, especially in the matter of renewing their leadership. Many, however, do ignore it under pressure of time and shorter term considerations easier to tackle. The point about succession planning is that it forces a focus not only on people but also on job specification in relation to longer term needs and this can concentrate minds wonderfully on strategy and performance.
If a Board does well by my three measures of Board effectiveness, it will be the result of high class leadership by the Chair and the CEO together. It is, however, all too easy for Boards to finesse the challenges involved and to excuse themselves on the grounds of impracticability, inadequate time, unripe time, and the other placebos with which we can all justify sins of omission.
This is why the role of investors, acting as owners, is so important. Do investors, charged under Section E of the Code with the responsibility for keeping companies and their Boards up to the mark, do this job on a steadily improving basis? The good news is that the dialogue between companies and investors is judged by both sides from their respective points of view to be improving. That is encouraging. But it doesn’t answer key questions: Will the improvement continue? Where is the dialogue deficient? Could it be better, perhaps much better? Is it having an impact on the quality of Boards and their behaviour?
Remember: there is a big difference between investors and companies: investors buy and sell shares; companies manage the operations underlying the shares.
It has taken me most of my career to grasp the import of these two fundamentally different activities. As a CEO, I was wholly concerned with improving the financial performance of the company over the long term. It seemed to me that if I could do this, the share price would go up because investors would want more shares. I could never really accept that from an investor point of view what mattered was the relative value of my particular company’s shares to those of other companies. So even though I was confident about improving my company’s financial performance, an investor might actually decide to be underweight in its shares on the basis that other companies’ shares provided better value.
Fund managers naturally have a strong interest in companies’ short term performance. This drives a process of regular communication between corporates and investors which has been growing in intensity for many years since well before the Code.
Focus by investors on longer term corporate governance issues is a different matter. Their impact on a share price requires expertise to assess and in any case is usually overshadowed by the impact of the short term results. So notwithstanding the Code’s emphasis on investors taking seriously the full responsibilities of share ownership, fund managers have not taken easily to the monitoring of corporate governance, many regarding it as a costly, distracting and irrelevant chore. If this attitude is changing, it is only changing slowly despite leadership from long-termfocussed investors, such as insurance companies and pension funds, and the activities of event-driven investors who bet on the destinies of whole companies and for whom the long term view is correspondingly relevant.
Does poor investor engagement matter? Yes, it certainly does.
In the first place, active, experienced, good monitoring by shareholders of corporate governance is a benefit to the economy as a whole, even though the effort it entails may seem to a fund manager to be unjustifiable from the standpoint of an individual retail investor.
Secondly, shareholders are the natural regulators of companies owing to their investments in them and the constant contact with companies these investments require. The more effective and constructive the dialogue between investors and companies, the better the UK’s corporate governance regime will be. Not only will “comply or explain” work better. Trust will be increased, potential problems will be more readily identified, and the need for regulation will be better assessed – an important consideration in a world where there is a permanent tendency to add to regulation. A material advantage which the world of private equity has is the fact that owners and managers sit together on Boards and have the same time horizons and financial motivation. Communication between them gains not only from the directness of contact, but also because it is free from the regulatory burdens of having to satisfy distant owners and from the media attention the public company gets.
The quality of the dialogue between companies and investors will critically influence the Code’s future as a force for good or ill in the running of enterprises. I emphasised at the outset that following the Code could not guarantee good governance, which is all about the behaviour of Boards under endlessly varying circumstances. However, by putting forward basic principles for good governance practice, the Code provides a valuable framework for Boards to develop. But this framework has already expanded from two pages to twenty-five in fourteen years. If its growth goes on like this, it could become deadly. The only thing that will curb regulation inflation is understanding, and good sense and mutual trust on the part of corporates and investors as to what is really needed to safeguard good governance without killing it.
I want to conclude this lecture where I began it: in paying tribute to Jonathan Charkham. For he perfectly summarises the whole matter of corporate governance at the very end of “Keeping Better Company”:
“Corporate governance must not become a religion or cult, complete with high priests and competing sects, nor must it become a honey-pot for consultants. When the last principle has been pronounced, when the last code promulgated, when the last sanction has been sanctified, it will be seen for what it is – the proposition that the business of the world will be better run if:
I rest my – and Jonathan’s – case.
