A Code review is not enough. Companies must take ownership of best practice
Simon Lowe, partner and chair of the Governance Institute at Grant Thornton UK LLP writes:
It seems that corporate governance has been in the spotlight more in the past two years than at any time since the Cadbury report 1992. The spotlight is on what happens in the boardroom, and boards’ wider societal responsibility. We are at the beginning of a new phase of governance, with the Government undergoing reform, the FRC taking a long look at the Code, and all asking vital questions. Who or what is the Code for? Is governance fit for purpose? And how can we encourage better practice?
The Code is the distillation of best practice. It is the result of an evolutionary process built on the lessons and experiences of the UK’s largest companies over the last 25 years. But it is most effective when companies embrace the principles, use guidance where relevant, and are brave with their practices and their reporting.
At the Grant Thornton Governance Institute, we have spent the last sixteen years analysing annual reports, looking at Code compliance, the quality of reporting, and identifying governance trends. Over that time, we have seen immense change. Governance practices that were radical 25 years ago have become an accepted part of good governance: the separation of CEO and chair, the need for independent directors, establishing remuneration, audit and nomination committees. These are all areas that our early reviews found were adopted by only a minority of the FTSE 350, but which are now common practice.
While compliance with the Code and the quality of explanations has increased almost every year, there are still many companies, who judging by the quality of their disclosures haven’t truly embraced the principles of good governance, even when they do comply. It is these in particular who are likely to find it near impossible to adapt to the growing expectations for business to engage not only with shareholders but also with the wider stakeholder community.
In some cases there is clear cause for concern. This year for instance, 19 companies in the FTSE 350 made no update to their principal risks, 30% did not fully disclose the gender split of their workforce (either failing to disclose or disclosing partial information), 25 companies did not outline any actions arising from their board evaluation, and 78% gave minimal disclosure around how they review the effectiveness of their internal controls.
One of the biggest problems we see each year is the widespread use of ‘boilerplating’ and generic disclosure.
Taking a charitable view, it could be an indication that the company is merely poor at communicating all its good practices. Alternatively it demonstrates that key issues are not being addressed. Either way leads to uncertainty and potentially a loss of confidence by stakeholders.
When it comes to the quality of reporting and encouraging transparency, informative, practical guidance can have a significant impact. When new reporting requirements are introduced, it typically takes three to four years for all companies to take them on board and move beyond basic disclosure. But the fastest improvements we have seen are where changes to the Code or regulation are accompanied by helpful guidance, giving companies confidence and encouraging transparency.
This year for example we saw a significant increase in the number of companies using their annual report to articulate their company culture, and the role of the board, the chair and the CEO in setting the tone from the top - a clear reflection of the FRC’s work on corporate culture and the role of boards over the last few years.
Similarly, we have seen the quality of business model reporting increase this year; again a clear response to the FRC Lab’s guidance. On the other hand, viability statements – an area that has had little guidance as to good practice until very recently – are still mostly generic.
Of course pressure from investors and wider interest groups are important but for Code changes to really take root they need to be supported by helpful, good quality guidance. Given that the FRC have used their consultation on the Code as an opportunity to also refresh the Guidance for Board Effectiveness, we would hope to see this encourage better practice in the boardroom.
Effective governance is a keystone for building a vibrant economy and rebuilding trust in business. With an updated Code, now is the time for governance to fulfil its potential. If governance continued to be seen as a compliance, ‘tick-the-box’ exercise, an opportunity will have been lost. As we look to the future of governance and the next 25 years, we hope that these changes to the Code will lead to the continued evolution of best practice, providing greater transparency and accountability. It will take a concerted effort by boards, investors and wider stakeholders to embrace the principles and hold each other to account if the potential is to be realised.