The FRC includes a crucial word in the new UK Corporate Governance Code
The Financial Reporting Council (FRC) today published the new UK Corporate Governance Code to predictably mixed reviews. However, one overwhelmingly positive aspect of the new Code is that it includes the most critical word in corporate governance: behaviour.
For this reason, all companies with a board, not just those with a premium listing, would benefit from voluntarily adopting its Principles and Provisions.
“The board should assess and monitor culture. Where it is not satisfied that policy, practices or behaviour throughout the business are not aligned with the company’s purpose, values and strategy it should seek reassurance that management has taken corrective action” (Section 1, Provision 2).
The link between behaviour and the role of the board is set out explicitly in Section 1, Principles, A & B:
“A. A successful company is led by an effective and entrepreneurial board, whose role is to promote the long-term sustainable success of the company, generating value for shareholders and contributing to wider society.
B. The board should establish the company’s purpose, values and strategy, and satisfy itself that these and its culture are aligned. All directors must act with integrity, lead by example and promote the desired culture."
In this, the FRC is calling for a move away from a "tick-box approach". It includes a specific reference (Section 3, L) to individual behaviour, not just collective board effectiveness box ticking behind which many boards hide: "Annual evaluation of the board should consider its composition, diversity and how effectively members work together to achieve objectives. Individual evaluation should demonstrate whether each director continues to contribute effectively."
If the individual evaluation of board members is to be meaningful and not to create yet another set of boxes to tick, then the emphasis must be on support in behavioural change and not on a finger-pointing exercises.
To this end, there is a useful section in the accompanying guidance note Guidance on Board Effectiveness July 2018, headed: EVALUATING THE PERFORMANCE OF THE BOARD AND DIRECTORS which includes helpful suggestions. I have selected some of these below:
"...induction and board development, evaluation should be bespoke in its formulation and delivery... facilitation can add value by introducing a fresh perspective and new ways of thinking, and a critical eye to board composition, dynamics and effectiveness...
...Questionnaire-based external evaluations are unlikely to get underneath the dynamics in the boardroom. The external evaluator should also meet with the executive team to gain their views of the board...
...Whether facilitated externally or internally, evaluations should be rigorous. They should explore how effective the board is as a unit, as well as the quality of the contributions made by individual directors...
...Some areas which may be considered, although they are neither prescriptive nor exhaustive, include...how the board works together as a unit, and the tone set by the chair and the chief executive...key board relationships, particularly chair/chief executive, chair/senior independent director, chair/company secretary and executive/non-executive directors...
· ...effectiveness of individual directors...process the chair uses to ensure sufficient debate for major decisions or contentious issues...clarity of the decision-making processes and authorities, possibly drawing on key decisions made over the year processes for identifying and reviewing risks..."
Much of the commentaries in the Press and on social media focus on the most disappointing aspect of the new Code, i.e. that it is not radical enough in its attempt to shake up corporate governance in the UK.
While this disappointment is well founded, nevertheless, if every board in the UK voluntarily complies with its Principles and Provisions however short of radical they may be, particularly concerning behaviour and culture, then we will be a step closer to the essential balance between ROI and ESG factors - environment, society and governance - required for businesses to sustain over the long term.
Perhaps, even, another Carillion type disaster could be avoided.