Governance Is Stifling Our Quoted Companies
Tom Brown, Author, Tragedy and Challenge, An Inside View of UK Engineering’s Decline and the Challenge of the Brexit Economy writes:
During my 45 year career I was a director of 22 independent companies, ranging from 7 quoted on the London stock market (FTSE250 to AIM) to private ones. I am now retired, which allows me to say what I really believe – and corporate governance is an area where this is particularly relevant. While increased governance has brought some benefits, it has also done much harm by submerging quoted companies in ever increasing amounts of futile and sometimes directly counter-productive red tape, has greatly compromised the nature of leadership, and diverts boards from what really matters in the business – but no director of a quoted company would dare to say this.
It would be very naive to think people-problems are eliminated, while the price that has been paid is a major weakening in our international competitive position both in terms of the cost burden and more importantly the speed and flexibility of decision taking, in particular in comparison to Asian companies. And excessive governance has taken much of the fun and dynamism out of business, which is actually quite important.
Modern governance analyses anything that has gone wrong in the management of a company, and then tries to prevent its recurrence in all companies. In engineering it makes sense to identify the root cause of every problem and implement measures to prevent repetition, but when this approach is applied to human relations it does not work well since what may be the cause of a problem in one company might actually be an asset in another. For example, some companies have suffered from an overbearing executive chairman, so governance insists that the chair must be non-executive – but executive chairmanship often works extremely well, for example at JCB, Dyson, and John Lewis, all in the private sector where these rules do not apply. There are also a multitude of examples where separate chair and CEO roles have worked extremely counterproductively. And this is but one example of the folly of applying engineering to human relations.
Governance rules mean that the boards of quoted companies are increasingly supervisory in nature, and divided into two camps, the ‘executives’, and to police them the ‘independent non-executives’, who have limited knowledge of the business – as by definition they’ve never worked there. UK boards now include few directors who are deeply experienced in their company’s activities, instead favouring accountants and investment bankers. This reflects a key issue; is the board’s main function governance or running a thriving business?
The root cause of many governance problems in quoted companies is the lack of a responsible custodial interest from the ‘owners’, predominantly institutional fund managers, in sharp contrast to privately owned businesses of my experience. Institutions are generally organised into the ‘front of the house’, the fund managers who buy and sell shares, and the ‘back’ where low-ranking administrators handle governance. Frequently the front is buying shares while the back is voting against resolutions! Many institutions now do not even read the companies’ annual reports, but outsource this to specialist agencies, which have gained disproportionate power because the institutions simply vote according to their recommendations. Splitting governance from fund management is fundamentally flawed; the people who know most about the company and its directors are the ones who should be voting.
Executive pay has exploded over recent years, and the biggest driver has been the greed that has overtaken UK society, but the establishment of Remuneration Committees has undoubtedly facilitated this explosion – through their desperately procedural box ticking, and adhering to the norm to avoid grief, not through cronyism. Specialist advisors provide graphs of rewards in comparable companies, and it is very difficult to justify paying any executive less than the median; if they are not very good they should not be there, and if they are good they should get at least the median – and so up goes next year’s median.
Institutional governance departments check the boxes with scant regard to specific circumstances. In one group we promoted an accountant to CFO and paid him the very bottom rung of the pay scale. He performed well, so next year he received a 15% rise to a level still well below the median – which produced significant shareholder dissent because the award was more than ‘the going rate’. Other companies avoid this by cynically putting unproven new appointees straight onto the top pay scale! Governance has created a crazy world where doing what is right only gets one into trouble.
To address these problems the Combined Code should be vastly trimmed. For example, remove the rule preventing executive chairmen, and give companies the freedom to appoint a flexible number of non-executives based on their particular skills and knowledge, reverting to the original concept of ‘eminence grises’ who can really contribute to the business through their knowledge and mature judgement. This is just the tip of the iceberg, many more such rules should be struck through. There are risks in this and it will sometimes be detrimental, but failure cannot be designed out of human relations – unlike engineering – and the problems would be greatly outweighed by the benefits.
Since companies need an intelligent interchange with their owners, fund managers should be obliged to report how they have voted at AGMs and briefly why, whether governance is handled by them or by ‘back of the house’ administrators, and whether they outsource the study of annual reports and the formulation of voting recommendations – a practice which should be banned. If measures to reduce short-termist investing were also implemented, this would really encourage constructive dialogue as fund managers would at last have reason to take a responsible interest.