The Definition of Corporate Governance

With this in mind, I felt a review of the Cadbury Report and the relevance of corporate governance codes would be a timely submission.

It was in 1991 that the Committee on the Financial Aspects of Corporate Governance was set up by the Financial Reporting Council, the London Stock Exchange and the accountancy profession. The concern was around the reliability of the reports and accounts of UK companies. The development of a Code of Best Practice in this country that the Committee produced helped to stimulate similar approaches worldwide and across the public, private and voluntary sectors. The concept, of course, was that adherence to corporate governance should be principle-based and not rules based. This has clearly made a significant impact on governance reporting and compliance. The 2014 ‘Corporate Governance Review’ by Grant Thornton outlines that; “For the first time, there is no provision with which 10% of the FTSE 350 does not comply. 93.5 % of the FTSE 350 comply with all but one or two of the provisions.” Such an approach has its risks and indeed there are those who would argue that if there are still issues with non-compliance, then a principle-based approach is not as successful as intended. The same report further highlights that; “Where full compliance has been reached by 61.2% of the FTSE 350 companies, only sixty percent of these companies provide informative disclosures, setting out their reasons for non-compliance and explaining alternative arrangements for maintaining good governance. The two most common areas of non-compliance remain the proportion of the board made up of independent non-executive directors (NEDs) and the composition of the remuneration committee.”

Others ask after we hear about yet another corporate failure or scandal; “Where was the governance best practice and how was this allowed to happen?” Notwithstanding these views, how many can argue with the fact that the definition that came out of the Cadbury report is still regarded as the classic definition of corporate governance.

“Corporate governance is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place.” (Cadbury 1992) (Please note that sometimes I’ll use stakeholders throughout the blog rather than shareholders to take into account the public and voluntary sectors and also to recognise the more recent focus of companies in relation to corporate social responsibility).

I mention the definition here because a closer look at the definition provides us with an opportunity to explore concepts which are fundamental to good governance everywhere. Over the next two months, we’ll take a look at the four main clauses of the definition:

1. Corporate governance is the system – the first point to emphasise in this definition is that corporate governance is indeed a system. One of the definitions of a system is; “An organised, purposeful structure that consists of interrelated and interdependent elements (components, entities, factors, members, parts etc.). These elements continually influence one another (directly or indirectly) to maintain their activity and the existence of the system, in order to achieve the goal of the system.” (http://www.businessdictionary.com/definition/system.html#ixzz3qKSBLmRd)

Therefore, if corporate governance is a system, it must have input, output and feedback mechanisms. Further to this, I would suggest that it should be an integrated and not a standalone system. Corporate governance is more than compliance to best practice. It has a purpose and depending on the inputs, it should help to provide solutions to bad practice. A thermometer style system which just measures how well you are doing would not be effective enough. The system has to do much more than just measure the results. What should be in place is a system that is more in the style of a thermostat which monitors performance within predetermined guidelines and brings them back into line when they breach agreed parameters. Sir Adrian emphasises that both the Cadbury Committee and Demb and Naubauer’s (1992) definitions of corporate governance make the point:  “…that companies and boards work within boundaries.” He further states that; “The key issue to keep in mind is that the nature of boundaries within which companies operate is continually changing.” The thermostat style approach is crucial to being able to remain compliant within the context of continual change and the changing nature of the world we live in.

2. Corporate governance directs – Another part of the definition points out the fact that corporate governance actually directs what happens. Corporate governance is established in the leadership quadrant of an organisational hierarchy. In other words, it is in strategic development and not in the execution of objectives that it works. The term for a governance leader is a director and although executive directors carry out operational tasks, their role at the board meeting should be clearly distinguished from their day-to-day role. Bob Garratt, a leading author in the area of governance has argued that executive directors should have two contracts – an executive one and a non-executive one. More explicitly in his book, ‘Thin On Top’ (p 16-17), he states that: “… they [directors] should all be paid the same director’s fees, with any misnamed executive directors being paid a separate fee quite apart from their executive salary. This helps all of them focus on understanding that directing is a very different job from managing, for which they are paid separately.” Sir Adrian highlights the importance of the appointment of executives as directors stating of that: “While at times executive directors are in an invidious position… a mix of executive and outside directors can be made to work well…”

I will cover the next two fundamental parts of the definition in next month’s blog and reflect further on the thoughts of Sir Adrian Cadbury and the report of the committee that he chaired.

Until next time….