Cleaning up Britain's boardrooms

Mar 23 2010 by Bob Berry Print This Article

The Financial Reporting Committee's Combined Code on Corporate Governance aims to improve the operation of UK companies' Boards of Directors. It is currently under review. But the proposed changes look like falling far short of what is needed for boardroom reform because the extent of the reform that is needed has been misunderstood.

There is a strong case for saying that the 2008 economic crisis was a crisis created by boardroom failures, but the reviewers of the Combined Code clearly don't agree. They see the recent problems of the financial sector as financial sector specific, not as a local manifestation of much more widespread problems in boardrooms. That is a misreading of recent history. The problem is that boards have forgotten, and need to be reminded of, their real role; they are the caretakers, not the owners of a company's assets.

A revised Combined Code needs to bite the bullet and deal explicitly with the key question, "In whose interests should companies be run?" These days the de facto answer looks to be, not the shareholders, not even an amorphous, broader group of stakeholders, but rather the occupants of the boardroom themselves.

There are very strong arguments in favour of control by shareholders. There are strong, though different, arguments for taking into account the interests of a broader group of stakeholders in setting a company's direction. It is very, very hard to make a case that companies should be run in the interests of the board members!

Discussions of boardroom performance are only sensible when the right to set the direction of the company has been correctly assigned, to the company's owners. Only then can a board's effectiveness, far more important than its efficiency, be examined.

Crucially, revisions to the Code need to deal with the massive accumulation of power by boards and kickstart the process of returning power to owners.

The Code has been designed to help boards to operate efficiently, not to make boards operate effectively. The Code places too much emphasis on the distribution of power between board members and too little on the fact that the board is able to ignore the interests of the shareholders on most issues of importance.

Disagreements these days are resolved by shareholders selling their shares rather than by removal and replacement of Directors. The Combined Code is much stronger on the need to inform owners than on the need to consult owners, and the idea that boards must obey when owners say "No" is completely absent.

The Code needs to be reconstructed so that much greater emphasis is placed on the representativeness of the board. The issue isn't simply ensuring that there are enough, empowered, non executive directors. Far more important is ensuring representation of owners.

Appointing representatives of major institutional shareholders as non-executive directors isn't going to be enough. Shares aren't owned by pension funds, in essence they are owned by contributors! That, but not only that, makes a strong case for effective workforce representation in boardrooms.

Almost as significant as the need for representativeness is the need to import different mindsets. Non-executive directors who are themselves executive directors elsewhere aren't going to challenge consensus management. At the moment boardrooms are prisoners of groupthink. Members come from too narrow a range of backgrounds and can't open up boardroom discussions to alternative views.

The Code asks for the establishment of independent audit and remuneration committees, and annual evaluation by the board of its own performance. The key question is how to ensure independence. Evaluation by the board of its own performance is more likely to be self congratulation than self criticism. Wouldn't giving annual general meetings greater power to elect, remove and replace board members have more impact?

The Code does nothing to ensure that boardrooms reflect on and respond to poor performance. After all, it does not even require boards to accept its own, limited, prescriptions for improvement. Boards must either comply with the Code or simply explain why they haven't complied. What is lacking is the identification of a group empowered to reject an explanation as inadequate and demand compliance. Again, a strengthened role for an annual general meeting seems an obvious place to start.

The unwillingness of the Code to deal with the ease with which boards can ignore the legitimate concerns of owners is its major flaw. It fudges the issue and on the basis of currently proposed revisions will continue to fudge the issue. Revision needs to be based on a wide ranging discussion of where ownership of companies should reside and what rights and responsibilities go together with ownership.

At the moment shareholders are seen as owners in law, but only in a limited sense. A re-investigation of the responsibilities which accompany an ownership claim should be part of the debate about underpinning a revised Code. Would companies be better served if ownership of shares was limited to certain groups rather than anyone, as is the case with say John Lewis? Would companies be better served if limited liability was rather less limited?

The legitimacy of the direction setting role of shareholders can only be strengthened as they re-acquire more of the responsibilities of ownership.

The acquisition of power by boards and the resulting gap between ownership of shares and influence on corporate decision making is long standing. Berle and Means in their 1932 classic book "The Modern Corporation & Private Property" highlighted the phenomenon. But what was a worry in the 1930s, potentially dealt with by performance and reward systems and shareholder vigilance, has become the major weakness of today's companies.

Boardroom reform is essential, but leaving the task of reform to board members, and concentrating on mechanics, which is what the Code does, won't be effective. The events of 2008 forced governments to address issues of industry structure, boardroom responsibilities, executive remuneration, and much more besides.

The problem is that the focus is on the financial sector boardrooms only. Widespread boardroom reform is essential and is too important an issue to be left exclusively to members of the board.

About The Author

Bob Berry
Bob Berry

Bob Berry is Director of MBA Programmes at Nottingham University Business School. His particular areas of include the implications of shareholder value management for decision and control processes.