FRC shares insights, not prescriptions, for boards on risk

The UK's accountancy regulator thinks it's time that boards of corporations think again about how they discuss and manage risk. In conjunction with a report on narrative reporting and audit, the Financial Reporting Council has also issued a summary of views about a discussion paper it had circulated on risk. The summary makes clear its intent to revisit the so-called Turnbull guidance on risk disclosure but also that it broadly finds those recommendations – first issued in 1999 and then updated in 2004 – still fit for purpose. But the paper acknowledges that board practice has moved on, and so the update to the guidance is really just a first step for boards. It said: "the approaches and techniques used by boards have been developing rapidly. One size very definitely does not fit all, but there were some common themes and techniques found to be useful. We therefore felt that the insights gained about the issues boards were facing, and the ways they were addressing them, should be shared more widely to reflect and contribute to best practice."

Among the conclusions are that better risk decision-making needn't and shouldn't lead to less risk-taking. The FRC doesn't want to dampen entrepreneurship spirit. That means that board committee structures may need to vary from industry to industry, so it won't be recommending, for example, that all companies establish risk committees. Board need to focus their attention, however, on "those risks capable of undermining the strategy or long-term viability of the company or damaging its reputation".

The FRC noted that the velocity of risk has increased, and with it the global transmission of risk. Companies needed "robust crisis management plans", with a clear distinction between the roles of the chairman and the CEO in dealing with them.

Source document: The FRC discussion summary "Boards and Risk" is a 17-page pdf file.

Boards still don't do much on strategy – McKinsey

It's not quite a case of "Crisis, what crisis?" But three years after the shock of the collapse of Lehman Brothers and the ensuing steep recession in major economies around the world, boards of directors seem to be doing the same old thing. According to a survey on governance from McKinsey Quarterly, directors at companies around the world say their boards have not increased the time spent on company strategy. The previous survey by the consultancy's house journal, conducted in February 2008, seven months before the collapse of Lehman, boards spend 24 per cent of their time on strategic issues. In 2011 it was 23 per cent. On "talent" issues in 2008, it was 11 per cent; now it's 10 per cent. "Moreover, 44 percent of respondents say their boards simply review and approve management's proposed strategies," the report states. "Just one-quarter characterize their boards' overall performance as excellent or very good; even so, the share of boards that formally evaluate their directors has dropped over the past three years." Underperforming boards see a greater need to do better: 78 per cent want to spend more time on strategy, compared with 65 per cent of directors who rate their boards' performance as excellent or very good.

These highlights of the study – what McKinsey itself chose to highlight – mask another finding: that 70 per cent expect their boards to do more strategy work in the future. Most also expect to spend more time on risk management and talent issues. Even more operational areas like performance management and execution, more directors expected to spend more time than those who expected to spend less. In fact, there was only one category of work where more directors expected to spend less time – that was on governance and compliance!

Source document: The highlights from the McKinsey board survey, "Governance since the economic crisis," is a nine-page pdf file.

Separation of chair and CEO is one way to skin a cat

But there are others. Twenty years ago, a weak government in the UK, faced with a string of corporate collapses, gratefully welcomed an industry-based panel to devise a new model for corporate governance. The Cadbury Committee was formed and after 18 months of consultation came up with the code of conduct that set a standard for corporate governance around the world. Its central recommendation was surprisingly simple: separate the roles of chairman and CEO so that no one person would have "unfettered powers" of decision-making. Over protests in the UK, it quickly became the norm, and many other countries soon adopted similar recommendations.

Twenty years and two major crises in corporate governance later, and it's still a live topic, in part because the empirical evidence of success – measured by financial performance or avoidance of collapse – is ambiguous, and in part because theoretical perspectives to explain what should happen diverge. Take one contemporary example: What's the most valuable company in the United States, and what's the fastest growing large company there? There's one answer: Apple. Who the chairman of Apple? Who's the CEO? Until recently there was one answer: Steve Jobs. What led to a separation of the roles in August was probably cancer – but certainly not some code of conduct.

A pragmatic, contingency approach would suggest that you work out what's best for your company, now. But that's hardly a solution unless you can work out a basis for deciding which aspect of the contingency counts, now, and when that changes. In Apple's case it was easy. The illness told Steve Jobs he couldn't work all the time, but could still work enough to organise the board meeting and add a little bit of his special juice to product design and selection. But not every joint chairman-and-CEO gets that sort of message saying when it's time to go. So, how do you decide?

A couple of academics-cum-consultants, from Canada and California, have been musing on this 20-year-old chestnut for The Conference Board, a New York-based think tank. With US legislation now requiring disclosure about board leadership structure, they reckon the decision of whether or not to separate the chairman and chief executive roles is a hot governance topic again – still – for public companies, boards and shareholders. Their report proposes that board effectiveness is affected by the chairman's industry knowledge, leadership skills, and influence on board process rather than by the particular leadership structure chosen.

Source document: The analysis "Separation of Chair and CEO Roles: Importance of Industry Knowledge, Leadership Skills, and Attention to Board Process", by Richard Leblanc and Katharina Pick, is a 12-page pdf file.

Say-on-pay proxy outcomes – less than meets the eye?

We're coming to the end of the proxy season in the US, the first since the Dodd-Frank Act gave shareholders a right to vote on pay policy at listed companies. According to the governance consultants at Pay Governance, it proved something less than a revolution. Votes at several thousand annual meetings showed that shareholders voted in favour of the boards' plans for pay fully 98 per cent of the time. "Given the abundance of politically driven criticism, rhetoric and attendant media coverage that preceded SOP's debut, many believed that most shareholders would deliver a negative message," said managing partner Ira Kay in a blog entry at Harvard Law School. "Yet the opposite occurred." Using figures from the proxy voting service ISS, Kay said that when ISS recommended in favour of the company's own proposal, the plan passed every time. When ISS recommended against it, however, the acceptance rate fell, but nonetheless 87 per cent of the policies still won shareholder backing. Pay Governance drew several conclusions, one of which was the companies had done their homework in preparing for the annual meeting. While some critics argued that say-on-pay was a damp squib, Pay Governance isn't so sure. "Our view is that SOP has been a resounding success, and that the high passage record reflects shareholders’ general endorsement of the executive pay model," Kay wrote.

Source document: The Harvard Law School blog post gives further analysis.

Dubai code for SME governance

Corporate governance codes have tended to focus on larger organisations, ones listed on stock exchanges with distant shareholders likely to suffer from what academics like to call "agency costs" – the danger that managers will exploit the company's resources for personal gain. The problem is rather different for smaller companies, especially when the biggest shareholder works in the business, but where any outside interests could be ignored. But such businesses often aspire to be larger, too, so a cross-over point arises where the board needs to evolve, changing the focus of its concern and contribution. Add to that cultural differences in the home countries and you're on course for rather complex iterations of whatever might be deemed best practice. In Dubai, where the Arab and Muslim practices mix with an orientation towards more western approaches to finance, the Hawkamah Institute has been at work developing what it calls the first-ever code with key principles and practices for small to medium-sized enterprises. It will be launched at a conference for corporate governance for SMEs to be held in September 26 and is aimed to be a guide for SMEs in various stages of growth to embrace best practices in corporate governance. "The aim is to create awareness amongst SMEs on the importance of adopting a basic level of corporate governance that will make them more robust, better manage risks, be more bankable and investable," the institute said. It wants SMEs to appreciate that corporate governance is "not just something good to follow but is a must-have to grow and progress sustainably". How it squares the circle of prescription and flexibility remains to be seen.

Source document: The Hawkamah news release describes the code.

Court closes door on proxy access in US …

… though not completely. Two lobbying organisations for corporations won a partial victory in the US Court of Appeals, striking down the proxy access rule from the Securities and Exchange Commission. The Business Roundtable and the US Chamber of Commerce wanted to block the rule from coming into effect next year. They argued the rule – which gives shareholders meeting certain conditions the ability to nominate directors and have the companies pay to send out voting materials to shareholders – was unconstitutional. The Court of Appeals justices didn't get that far into the case, however. They overturned the proxy access rule on a technicality. They agreed with the plaintiffs that the SEC "failed adequately to consider the rule's effect upon efficiency, competition, and capital formation". That means the SEC could come back with a new rule after what would be, in effect, an economic impact statement.

Dodd-Frank unhappy anniversary: The ruling came almost exactly on the anniversary of the Dodd-Frank "Corporate Responsibility" Act, which had mandated the SEC to do something along these lines. That "something" involved reheating that rule that been thrown out before – also after a lawsuit by corporate lobbyists – in the aftermath of the collapse of Enron. While some shareholder activists might be disappointed to lose this way to prise open the corporate boardroom, others aren't so sure. Adam Emmerich, a partner in the corporate department at Wachtell, Lipton, Rosen & Katz, a law firm that has taken strong stances on corporate governance, wrote: "we believe this is a positive development for American corporations and their shareholders." Proxy access wasn't necessary or even beneficial, he contended, adding: "we do not expect this ruling to decrease the frequency of proxy contests."

Source documents: The court ruling is a 21-page pdf file. The Emmerich statement in on the Harvard Law School blog.

Should small company governance be different?

The question is part of the green paper that the European Commission issues a few months back as part of its general review of corporate governance arrangements in the European Union. The EU has previously shied away from going into the governance business, after member states asserted the priority of national law. But after the financial crisis, the status quo no longer sufficed, so the green paper was a first step towards some sort of new regulatory drive. Its wide-ranging questions started, though, with that particularly problematic one. Does size matter? Although its question concerned only companies with equity trading on public markets, the commission's question raises the spectre that corporate governance regimes and perhaps even law might extend obligations currently faced by large listed enterprises to private companies and even micro-businesses. Yes, size matters and there an end to it! Perhaps.

The green paper consultation was drawing to a close when a group of Canadian academics and practitioners weighed in. Writing to the commission on all the points raised, they started with this one. It's worth reading at some length:

Inevitably, good governance will look somewhat different depending on a company’s scale and dimensions. But, a diminutive corporate size, we maintain, is not a suitable reason to relax or diminish the principles of good governance. There is a compelling business case to be made for smaller companies to adopt good governance principles and to adhere to – or aspire to – lofty governance standards as a goal. The need to create standards and behaviours that add value by adopting good governance principles is as important for small and medium-sized enterprises (SMEs), we argue, as for larger enterprises.

… although overshadowed in the business press and in the public consciousness by larger market-cap companies, are in many ways the lifeblood of most economies and markets in Europe, in North America and elsewhere. To state the obvious, SMEs are, in many cases, the next generation of large market-cap enterprises. As larger enterprises, these companies and their governance practices will increasingly come under the microscope and be subjected to the heightened scrutiny by shareholder activists. If SMEs had not begun with a proper corporate governance culture, it becomes more difficult to overcome this as they grow.

So, size matters not as much as culture, and you need to get the culture right from the outset. Perhaps. The emphasis in this submission is on culture, not architecture, not the superstructure of committee and board balance and measurements of independence and all the trapping of best practice. Culture is a state of mind, in directing an enterprise of whatever size.

Source document: The submission by Canadian academics and practitioners to the EU consultation is a 53-page pdf file.