FRC to ARGA – the word ‘Governance’ is critical to this evolution

Sir Jan du Plessis’ appointment as Chair of the Financial Reporting Council (FRC) is welcome news for corporate Britain after a long period of apparent government apathy alongside adverse press comment concerning the state of the FRC’s own governance. The ‘when’ and the ‘how’ behind the plan for the FRC to morph into the Audit, Reporting and Governance Authority (ARGA) is yet to be announced but one thing is clear – institutional investors and individual shareholders expect better governance to be embedded into corporates and better oversight of board reporting through audit so that scandalous failures such as BHS, Carillion, Conviviality and Patisserie Valerie are consigned to history or business school case studies.

I share Sir Jan’s view that audit firms, especially the Big Four, must take their share of responsibility for implementing the reforms envisaged and restoring public confidence in audit and governance. However, ultimately the watchdogs and scrutineers (on behalf of shareholders and all stakeholders) expect that the boards of directors are doing their utmost to demonstrate that faith in their organisations’ robust management, systems and financial controls is not misplaced. Leadership, as I have said previously, is an organisation’s central risk. If board composition isn’t optimal, or if commitment to good governance doesn’t go beyond lip service to excellence, and if ethics are not firmly embedded in a company’s corporate culture and values, ARGA will not be enough to prevent further business failures.?

My work latterly as an external board evaluator after a long career as a headhunter has thrown up many interesting insights into the collective behaviour of boards and the wide range of attitudes in the boardroom towards current corporate governance directives.?

It is now almost 20 years since the UK Combined Code of Corporate Governance stipulated that large (FTSE 100) public company boards should undertake formal and rigorous evaluation of their performance annually. And it is more than 10 years since the guidance was extended to the FTSE 250 and two years ago that the revised UK Code widened to include the FTSE 350, with external board reviews expected at 3 year intervals.?

The quest for universal good governance in corporate life has come a long way but there is much scope for improvement. A 2018 APPCGG (All Party Parliamentary Corporate Governance Group) commissioned survey quoted one FTSE 100 Non-Exec Director favouring internal board evaluations over external ones because they are “faster, cheaper and tick the box”. The temptation for some unenlightened Chairs to run boards as small fiefdoms no longer exists but complacency is still rife. The appetite for investing time and money in comprehensive, externally facilitated board reviews varies enormously, not least in the still surprisingly ‘pale, male and stale’ world of investment trusts and the asset management industry. None should be oblivious to the huge pressures being exerted on boards not just by the regulators but also by increasingly vocal institutional investors and shareholders. No boards can now afford to ignore implementing good governance practices. Naturally, external board evaluations bring cost factors into consideration. “You get what you pay for – and we chose not to pay very much!”??said one survey respondent. But be aware that ‘external’ does not necessarily equate to ‘added value’ unless the board review includes one-on-one interviews with directors in addition to a well-structured questionnaire.??The worth of an external review is not just measured by cost – it is determined by the quality of the external facilitator.

Board evaluation is an art as well as a science. External board reviews inevitably lead to an examination of behaviour and chemistry in the boardroom. “Behavioural aspects require skills (in an evaluator) that are not always present” stated one FTSE 250 Chair. Modern governance is about more than meeting the basic structural requirements of a board. Harder to measure governance issues include how a board deals with a crisis, how a board effectively oversees culture, how it responds to all manner of risks and not least how it manages its composition and leadership succession. To add value, external evaluators need to be expert observers and interpreters of board dynamics and know how to ask palatably all the tricky questions to avoid ‘whitewash’. The aim of an external board review must be to exceed, not just meet, the expectations of regulators and stakeholders about how the board is structured and performs, transparently and honestly, in achieving the company’s stated strategic objectives – year in, year out, whilst protecting necessary confidentiality.?

In a world where companies face digital disruption, complexities in the geopolitical landscape, and the risk of reputational damage at the speed of a tweet, boards need to assure themselves they know what ‘Good’ looks like and one of the best ways of doing that is to ask themselves, “What do we look like from the outside?” Cue – bring in the external evaluator, who is truly independent, who can bring to bear perspectives gained from working with many different boards over time and above all is not conflicted by being part of an executive search firm, NED recruitment organisation or management development consultancy business.?

As the graveyard of globally reported recent corporate failures testifies, the cost of poor attention to good governance is potentially catastrophic.?