The term corporate governance means many things to many people. I’m often asked to explain what it means and whether anyone other than those associated with a listed company needs to worry about it. My response is that every business owner, every director and every manager should be clear about what corporate governance means in the context of their own business.
In his report on corporate governance published in 1982 in the wake of some spectacular corporate failures including BCCI, Polly Peck and the Robert Maxwell affair, Sir Adrian Cadbury defined corporate governance as the “the system by which companies are directed and controlled…”. Although there have been many alternative, and more sophisticated, definitions of corporate governance since then, these few simple words provide the key to an understanding of the fundamental principles which underpin corporate governance and its importance for your business.
A company is a separate legal entity. It is separate from its shareholders (who own and ultimately control it) and its directors and managers (who are responsible for the day-to-day direction of the business). It has a life of its own; it continues notwithstanding that shareholders and directors can come and go. Contracts for the goods and services provided by the business are made in the name of the company.
Shareholders invest in a company because they expect to see a return on their investment. Save in small family businesses, the shareholders are generally not the people who are making the day-to-day decisions on how their investment will be utilised by the company.
Directors and managers will often be employees of the business but may not have a significant equity stake. The managers will want as much freedom as they can get to use the resources of the business in the ways that they see fit. Sadly, whether for good reasons or bad, some managers may be prepared to take risks with the company’s assets which perhaps they would not do if it was their own money.
There’s an obvious conflict of interest. Developing a system by which companies are directed and controlled requires that the interests of management are aligned with the interests of the shareholders (and relevant stakeholders). This responsibility falls to the board of directors irrespective of whether there’s a two-tier board comprising an executive board and a supervisory board, as is usual in continental Europe, or a unitary board, which is the standard in the UK.
The board (or in the two-tier system, the supervisory board) is central to the governance system. There are times when the board must step up and provide leadership. There are times when the board can satisfy itself by monitoring activity within the business and intervene by exception. Where the board perceives that management may be engaged in potentially risky activity, the board may have to actively oversee the work of management. Corporate governance includes making sure that the board is fit for purpose and that the relationships between the shareholders, the board and the management are clearly defined.
Corporate governance also includes adopting processes which lead to agreement on the vision, the values and the strategy for the business. The objectives of the shareholders and management must be identified, articulated and aligned.
Adopting efficient and effective systems for the identification and management of risk is essential to the sustainability of your business. Many of the businesses I have worked with are very good at managing low level operational risk; they are less good at identifying and managing risk at the strategic level. Decisions such as a bad acquisition; the failure to get the mix of products and/or services right; the failure to recognise and keep up with change in a chosen market; over-reliance on inadequate information systems, can lead to catastrophic business failure. An effective corporate governance system will help to ensure that key decisions are made collectively, with sufficient care and attention, and on the basis that the decision will promote the success of the business.
No one individual can do all of this on their own; appointing one person (even at board level) to head up a corporate governance function is not enough. The corporate governance model developed in the UK requires that the board should take collective responsibility for the key decisions which affect the long-term sustainability of the business whilst leaving the day to day operational activity in the hands of the CEO and the management team.
There are often deficiencies in the mix of skills and competencies necessary for the board to conduct its three roles of leadership, monitoring and oversight. Many governance failures have been accidents waiting to happen because the board did not have the skills and competencies necessary to provide the checks and balances which are key to effective corporate governance.
Lack of succession planning can also lead to unnecessary difficulties. The corporate governance system should provide for emergency succession where a key member of staff, particularly at board or management level, suddenly becomes unavailable. It should also address the need for planned succession as key people, including owners, look to retire. Smooth transition requires planning and can take at least 12 months; failure to plan can put the business at risk.
Once upon a time, an investor would make an investment decision based on a rudimentary business plan and a good lunch.
No more! Using sophisticated search and information systems, investors can identify a huge range of investment opportunities. Once the investment opportunities have been shortlisted, the investor will want to be confident that their investment is going to be safe and that the business can deliver what it says it can deliver. Investor decisions will be influenced by the effectiveness of the governance structures and systems. A company which adopts best practice in corporate governance is far more likely to secure investment that one that does not.
Many businesses in the UK have had to learn the hard way. As a result, there are plenty of examples to learn from and a great deal of time and effort has been invested in developing governance systems which can be tailored to meet every type of business whether in the private, public or not-for-profit sectors as well as businesses large and small.
If you consider that there are any weaknesses in your governance structure and systems – or you want to satisfy yourself that your governance systems are as good as you think they are, especially in the cross border context, contact us in the BPCC.
Corporate governance is not a box-ticking exercise. It’s a complex exercise that requires real commitment to make it work. We can help to put you in touch with the expert assistance you need whether that expertise is in law, finance, economics, people management, risk assessments, strategy development, market research or regulatory and compliance work.
David Buckle is a director of BPCC, a practising international lawyer and specialist in corporate governance. David has worked with more than 50 boards of directors in the last 20 years.