Cicero Policy Briefer

Issue 21, February 2008

Corporate Governance—is it adding value?

By Daniel Godfrey, Director General, Association of Investment Companies

The philosophy behind the contention that companies should follow a “corporate governance code” is that the practice will lead both to better corporate performance and reduced risk of “something bad happening”. While these are fine objectives, it is sadly not the case that the current structure of corporate governance codes, monitoring or application is always delivering the intended benefits.

There are a number of flaws which have combined to create an edifice in which boards are encouraged to toe the line even if they believe that standard practice may not fit their circumstances, where shareholders are inclined to contract out governance monitoring and voting to third parties and where those third parties are often unwilling or unable to engage with companies to understand their governance, preferring to “score” their performance against a fairly rigid set of boxes that need ticking.

This is not the way to achieve better corporate performance or to reduce corporate risk.

The central plank around which UK corporate governance is structured is the Combined Code. The intent behind the Code is that companies should be able either to “comply” with its principles and recommendations or to “explain” why they have not done so.

Unfortunately, the Code itself is quite detailed and fussy in places, and this has enabled that intent to be undermined. The subcontracting of monitoring and, in some cases, of voting has led to a situation where third parties find that they are unable truly to engage with smaller companies and a “tick-box” approach is permitted to develop.

This can then put pressure on boards to make sure that they run the company in such a way as to ensure the boxes get ticked, rather than looking at the principles to ensure that they really think about the best ways forward for the company.

The result can be detrimental to a company. Some governance professionals take the view that any director who has served for more than nine years cannot be regarded as independent. Surely a more qualitative approach is called for? It is clearly wrong to say that all directors act independently in their first eight years and then, on passing their ninth anniversary, suddenly become creatures of executive management.

If current orthodoxy means that some companies are losing good directors just because they have passed some arbitrary length of service, then that is inconsistent with the objectives of a corporate governance regime.

The right way forward is for a simpler and even more principles-focused code; one which gets boards thinking and debating the key issues and which encourages them to communicate the outcome of their deliberations to shareholders.

And it is for shareholders to genuinely engage, either directly or through third parties, at a level which promotes understanding and confidence and not the ticking of boxes by rote.

Such a change would help the UK make governance more effective, promote better performance and improve shareholder returns.

Daniel Godfrey is the Director General of the Association of Investment Companies and can be contacted here.