Private Sector Commission Column

 Is corporate governance is dead?

Corporate Governance turned up a blind alley some 15 years ago. It lost its initial focus on directors delivering the long-term health of their business and degenerated into a series of compliance-fixated, and short-sighted box-ticking exercises. This irritates even more an already angry and disenchanted public who see the consequent erosion of the credibility of their organizations in the private, public and not-for-profit sectors because of the lack of  directoral professionalism.

The many international arguments tend to centre on the poor ethical behaviour of directors.  And people can become very irrational when focused on ethics.   However, I argue from my experience of Boards  and Directors in some 40 countries that the presenting problems are not ethical alone but more based on ignorance of the legal roles of directors coupled with a lack of induction into these roles, and the non-development of Directors’ critical thinking abilities in formulating Policy and developing Strategy.    Put another way – Directors do not see their roles as professional or even important.

It was not meant to be thus.  Sir Adrian Cadbury published his seminal report On the Financial Aspects of Corporate Governance in the UK in 1992.  It was a game-changer and was copied quickly over 400 times in   many countries  to form  the   framework for  many  Corporate  Governance Codes.   But it   had    structural flaws, particularly by being so closely associated with accountancy and financial services, its   sponsor.  This has led to an internationally skewed view of ‘corporate governance’.  The Report did not consider seriously the rest of the private sector, let alone the public sector or the not-for-profits.   The slavish copying of the initial Code by so many, including the NHS, has made it easier to see corporate governance as a mere box-ticking exercise leading to risk averse ‘compliance’ through non-decision-making.

I worked with Sir Adrian Cadbury before 1992 and talked and corresponded with him on the development of corporate governance effectiveness until his death in 2015. He encouraged me to write ‘Stop The  Rot:  Reframing Governance for Directors and Politicians’ and in his last letter to me urged that I ‘ensure strongly that you focus on the entrepreneurial, risk-taking aspects of good corporate governance and not on  the  Codes and  compliance’. These he saw as continuing to  harm  the  development  of  effective corporate governance.

So I stress that the key role for any Director and Board is to ensure the future of their organization by taking thoughtful risk.  This is characterized by the ‘Directors’ Dilemma’ – how do we drive our business forward whilst keeping it under prudent control? This is the fundamental question for any Board.  It  reflects more than 3,000 years of continuous meaning of the word governance in our society.  It derives from   the Greek kubernetes, the steersman of  a  ship. This   direction-giving role   is   complemented nowadays   by   the   term cybernetics (from the same root)   concerning   the   feedback   and   learning    mechanisms showing whether the direction is effective.  The careful balancing of this dilemma is what an effective Board does.  And this is why I bat on about ‘the Learning Organisation’ and ‘the Learning Board’ in my work.

 Back to Basics

Beyond the Directors’ Dilemma we both agreed that the current basis of good governance is found in sections 171 to 177 of the UK’s Companies Act 2006.  It covers all registered organizations in the UK –  private, public and not-for-profits. Few people realize this and few directors know their legal duties.

 They are:

1. To act within the powers of their constitution;

2. To promote the success of their company;

3. To exercise independent judgement;

4. To exercise reasonable care, skill and diligence in their decision making;

5. To avoid conflicts of interest;

6. Not to accept benefits from third parties;

7. To declare interests in proposed transactions;

Duties 1, 5, 6 and 7 set the legal limits in which directors deliver their duties.  Duties 2, 3 and 4 are the active verbs that deliver day-to-day competence for any director.  Yet so few directors know these that the notion of competence and professionalism are seldom achieved.   Most directors are ‘accidental Directors’.

So why do these Seven General Duties not form the basis of any enforceable Corporate Governance Code?

A clue is that so many government enquiries into corporate disasters (Carillion, Oxfam, and BHS are just    current   examples)   end   with   a   bland   statement   that   whatever   the   immediate   cause   ‘the   underlying    problem was the weak corporate governance and consequent culture in the organization’. Then nothing    happens.   An   increasingly   angry   public   demands   legislative   action   and   the   consequences   seem    inevitable – new legislation is agreed, the politicians feel that their work is done and hand the learning and enforcement to new regulators. But regulators are bureaucrats not practitioners and so begin to design Codes that they can enforce regardless of their validity in practice.  Directors and managers then game these rules   and the inevitable happens with decreased risk-taking, more compliance and less organizational effectiveness by thoughtful risk-taking. Effective corporate governance has gone missing.

What do Parents, Politicians and Directors have in Common?

A   rational   member   of the public   would   assume that the legislated Seven General  Duties   must   be    fundamental to the selection, induction, assessment, and developmental process of any director.  They would be wrong.  Like parenthood or becoming a politician or Director there is a deep and paradoxical public assumption that one needs no special preparation and training for these crucial societal roles and    that, miraculously, on being given the title the person acquires automatically the necessary knowledge,

Skills and attitudes to be instantly   competent.   This is nonsense.   Yet for   directors such continuing directorial incompetence ensures that our organisations, the cement of our society, underperform to the detriment of that society.

Often new Directors have a quick talk by the Chairman and Company Secretary, given a huge pile of previous board papers with little explanation, and are expected to turn up to four or five board meetings a    year   with  little  hope   of  their   adding  value   to   an  already  underperforming  board.   Yet the Directors’ Dilemma  is  always  irresolvable   in   a dynamic  world   –   which is   why directors have to take  their role professionally.

Otherwise they will assume that Code compliance is sufficient and then under-perform.

‘Directing’ is an active verb not a passive job title. It is insufficient just to remember the seven general Duties.  A true Director must live them 24 hours a day.  Directing is the crux of organizational learning – both of what is occurring in the political, physical,    social, economic, technological and trade environments and what is occurring internally to ensure both the effectiveness   and the operational efficiency of the organization.  Yet a Board cannot do all this,    especially in a limited time budget so their interface with the executives is crucial. Most boards over- manage their executive team rather than supervise them from the boardroom table. Few accidental    directors recognize this.

The Future Reframing of Corporate Governance – bringing four new players into the definition of Corporate Governance

Too much of the current emphasis and blame is laid on directors.  For any national system to work we need  to  bring  four new  players,  and  responsibilities, into the  learning system so that  they  too  have    acknowledged Duties:

• Owners

• Legislators

• Regulators

• Public Oversight

None of these have any prescribed corporate governance duties under current legislation yet all are gaining increasing legal rights.  So Directors are cracking under such pressures.  What is needed now is a new national system of continuous learning within each of the five parties, and between them with the emphasis on the public oversight of the whole.

This is the challenge if we are to have effective private, public and not-for-profit organisations and so restore the public’s trust.

 Authors:

Professor Bob Garratt is an affiliate of the Caribbean Corporate Governance Institute.

Professor Bob Garratt is an international Corporate Governance & Board Development Consultant.

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