Tougher governance – or more board diversity?

Jul 22 2005 by Print This Article

It is all very well handing out long jail terms for corporate fraudsters, but the real need is not for tougher regulations and codes of governance, but for genuine efforts to implement best practice in the boardroom.

The 25-year jail sentence handed down to former Worldcom boss Bernard Ebbers last week for his part in the scandal that brought down the firm served as a stark reminder to all organisations about the importance of good corporate governance.

WorldCom's collapse was the biggest bankruptcy in US corporate history, with shareholders losing an estimated $180bn and around 20,000 workers ending up jobless.

Ebbers was found guilty of fraud and conspiracy following revelations of an $11bn accounting fraud at Worldcom three years earlier.

The sentence was the harshest to date in a series of corporate scandals, including that of Enron that could have been avoided with effective corporate governance.

The boards in question appeared to have little control over management actions, or the senior executives who engineered the false accounts.

The fallout from these and other corporate scandals has been instrumental in changing the corporate governance environment, and in particular has meant that the role and responsibilities of non-executive directors (NEDs) have changed over the past few years.

Their role is seen as instrumental to good governance, yet in many cases the appointment process is flawed.

Business consultancy Roffey Park is currently conducting a joint research project, with HR consultants Cedar International, examining the role of non-executive directors.

Boards fear disruption. As a result, unity is valued more than diversity
The initial findings suggest that non-executive directors tend to be selected either because they are known to the Chair or because they already have board-level experience.

Principal researcher at Roffey Park Valerie Garrow says, "Boards fear disruption. They are highly protective of who they appoint and careful to maintain their culture. As a result, unity is valued more than diversity."

The research also found that the typecast recruitment of non-executive directors can be counterproductive, and suggests that organisations should open the boardroom doors to 'non-conventional' candidates.

Stricter rules on reporting are also set to impact on businesses. On the back of the high profile scandals the US authorities enacted the Sarbanes-Oxley Act (SOX), designed to improve corporate governance within companies listed on US exchanges.

All foreign companies with a dual listing on a US exchange with 500 or more US-based shareholders will also have to become compliant.

Section 404 of the Act requires the CEO to certify the effectiveness of internal controls and procedures for financial reporting, and the external auditors to attest to and report on this assessment on an annual basis.

According to Jonathan Wyatt, a director of the London office of risk management consultancy Protiviti, it is widely accepted that there will be a European version of SOX.

"It may be less prescriptive than in the US, more open to interpretation, and therefore allowing greater flexibility for companies - but there will be a lot of pressure from the US for European businesses to meet that standard," he said.

But corporate governance in the UK may already be heading towards a SOX-type regime, with the Company Law Reform White Paper promising tougher penalties for accounting offences, and liability for breaches in legislation extending beyond directors and company secretaries.

The International Federation of Accountants (IFAC), a worldwide organisation for the accounting profession, recently issued its updated code of ethics for professional accountants with a major focus on auditor independence.

"The revised Code protects the public interest by requiring all professional accountants to be alert to situations that could potentially compromise their compliance with the Code's fundamental principles and to take action to ensure that the principles are not compromised," said IFAC ethics committee chair, Richard George

Investors too took comfort from the move earlier this year to introduce new corporate governance ratings to the FTSE ISS Corporate Governance Index (CGI) Series.

These form the foundation of an index series created by global index provider FTSE Group (FTSE), and corporate governance specialists Institutional Shareholder Services (ISS) to assist investment managers in assessing and managing portfolio risk.

The ratings are based on five themes of corporate governance; equity structure and anti-takeover devices, structure and independence of the Board, independence and integrity of the audit process, executive and non-executive director stock ownership, and compensation systems for executive and non-executive directors.

But many business experts feel that the real need is not for tougher regulations or tighter codes of governance, but for a genuine and heartfelt effort to implement best practice.

This means establishing a stronger and more probing board, an audit committee in control of key accounting issues, and ensuring that ethical behaviour and turning a profit become inextricably linked in business strategy.