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Thoughts on Corporate Governance

The primary role of companies in a society’s economy is to produce goods and services for the benefit of society.  It is important that that is done as efficiently as possible.  It is largely accepted that this is best achieved by privately owned companies but that there needs to be a public benefit to their performance.  So it is that boards of directors, answerable to the owners (shareholders), have a responsibility for the performance of their companies.  Hence the concept of corporate governance.

In December 1992, a Committee chaired by Adrian Cadbury produced the first of many subsequent reports on the governance of companies by their boards of directors.  It had been commissioned as a consequence of a number of corporate scandals – notably those of Polly Peck and Maxwell Communications.  Since then there have been another 6 reports (Greenbury, Hampbel, Turnbull, Myners, Higgs and Smith).  As a consequence of these reports and ongoing additions from the Financial Reporting Council (“FRC”), we have today the UK Corporate Governance Code.  It is part of UK company law with a set of principles and, increasingly, legal obligations aimed at the governance of companies listed on the London Stock Exchange.

At the heart of the Code lies the practice of comply with its principles or explain why not in the company’s annual report.  By and large most companies comply – the directors being fearful of the consequences of non-compliance.  However, comply or explain has not always worked well in practice – most commonly, I would guess, in the matter of directors’ tenure.  Institutional investors (most of whom have corporate governance departments) have their own set of governance rules and take little notice of “explain”.  In an effort to force institutions to hold the boards of directors of their investee companies accountable for their governance, the FRC established the Stewardship Code, a guide for institutions to raise their level of involvement in corporate governance.

The Code has unquestionably resulted in a box ticking approach to the governance of companies – prioritising procedure and structure over other aspects of governance – including the wider interests of those involved in the welfare of companies.  Ownership of any sort (be it a house, a car etc) confers, to a greater or lesser extent, responsibilities on owners to go with the benefits of ownership.  In the case of shareholders those responsibilities stretch far and wide because corporate involvement in society, in the economy is far reaching.  Fulfilling those responsibilities is effected by shareholders appointing a board of directors to look after their interests and their responsibilities.  However, it is not the responsibility of shareholders/directors to assume political responsibilities despite political pressure to make them do so.  It would set up dangerous conflicts of interest and confusion of duties.

The Code does not address these issues – and I am not sure that it should.  The Code is not perfect by any means but it should be regarded as just a minimum set of governance practices.  The trouble is that it tends to be the limit to which directors feel their obligations extend – other than earning a growing profit stream and achieving a rising share price.  As a consequence we have today what I would describe as “share price capitalism”.  Over and above their statutory governance duties, directors should understand that they have ethical and social responsibilities.  How these are established is a matter of some importance because ethics cannot be established or enforced by law and social responsibilities will vary hugely from company to company.  One size fits all simply won’t work and will conflict with the primary purpose of companies.

Given that the governance of companies and the laws, rules, regulations and practices that determine directorial duties is British, the question arises as to whether corporate governance is a separate matter for us in Scotland.  Yes, I believe that it is.  It is an important issue because it affects the performance of Scottish companies and thence our economy and our society.  Without well managed Scottish companies, our economy and our society will become ever more dependent on England’s commerce at a time when we are achieving ever greater political self-dependence.

The fact is that the two most disgraceful corporate governance scandals of the new millennium were both Scottish, being in banking, a sector in which we have taken pride in setting the highest global standards over centuries.  The failures of both the Royal Bank of Scotland and Halifax Bank of Scotland have cost our economy and our society dearly – unquantifiably so.  And these failures occurred under the already strict corporate governance regime in existence by 2008.

So clearly there is more to corporate governance than a set of rules and best practices.  We need to establish a healthy corporate sector in Scotland – consisting of large, medium sized, small and (importantly) start-up companies.  Their successes will provide jobs, investment, then new jobs and rising salaries, tax revenues and, as a package, a rising level of prosperity that we all aspire to.  Proper and effective governance of those companies is a key to such success.

I have not attempted to address the “how” in relation to these add-on issues but rather to establish that there is more – much more – to corporate governance than the UK Corporate Governance Code.  By setting our own and highest standards of corporate governance in Scotland, we can help achieve a level of prosperity that would otherwise be unattainable.

Alex Hammond-Chambers is a non-executive director, concentrating on investment trusts and companies, and a member of Reform Scotland’s Advisory Board