The new UK Corporate Governance Code – time for boards to get their heads out of the sand

The New UK Corporate Governance Code looks very different from previous versions. It is shorter, places greater emphasis on applying governance principles and for the first time explicitly requires boards to consider stakeholders other than shareholders and to assess and monitor culture. Will it make any difference?

A test of its efficacy is whether it would have helped prevent the failure of Carillion. It can only be a theoretical test because the failure was in the past and, arguably, it is hard to spot such a failure before it happens – ask the Carillion directors and its auditor KPMG. Hard to spot? – perhaps but not impossible. It is relevant to consider whether the new Code would have made failure less likely. Previous codes were, it would seem, ineffective.

The governance statement in the Carillion’s 2016 Annual Report (reported against the 2014 Code) gave the impression of a well governed company. Amongst other things its statement on its reviews of board and individual director effectiveness claimed they were all highly effective. It also reported the audit committee had concluded the board could have ‘a reasonable expectation that the Company will be able to continue in operation and meet its liabilities as they fall due over the three-year period of their assessment’.

A key factor to emerge from the collapse was whether the financial statements overstated the value of work in progress on its various contracts. Reassuringly the governance statement said ‘a significant proportion of the (audit) Committee’s time is spent reviewing contract judgements given the Group’s extensive portfolio of contracts. The Committee reviewed, through discussions with management and the external auditor, the positions and judgements taken by management…. the Committee concluded that the positions and judgements taken in relation to the contracts reviewed and the licence income recognised were reasonable’.

With the benefit of hindsight, and the findings of the Parliamentary Investigation, it seems clear that the directors and the board were not effective, that contracts were significantly overvalued and that the viability review was flawed. We may never know whether the directors knew in early 2017 that Carillion was close to insolvency and allowed misleading statements to be made in the 2016 annual report or whether they were ignorant of the gravity of the situation. In spite of years of refinement since the first (Cadbury) governance code in 1992, and the lessons from numerous subsequent corporate failures, it would seem we have not yet found way of constructing a governance regime that prevents knowingly or negligently misleading statements about a company’s financial position and board effectiveness.

The new 2018 Code may at first sight offer little improvement in this respect. But there is some scope for optimism;. requiring, as the new Code and new draft legislation do, boards to make public statements on how they have had regard for various stakeholder interests and other factors set out in S172 of the 2006 Companies Act could make it harder for boards to flout the interests of employees, contractors and pension funds. A company which makes misleading statements runs the risk that stakeholders, including employees, will call foul. In the Twitter age this could mean rapid significant negative publicity for the company and public censure for directors. The requirement for boards to assess and monitor culture may also help; if boards actually look for culture risks they may help spot a culture which, for example, encourages misplaced optimism and discourages staff from raising concerns.

Ultimately whether or not a company thrives or fails is down to the leadership of the board and particularly the chair and the CEO. CEOs are paid to be optimistic and take calculated risks. It is largely up to the chair to ensure that this is in pursuit of long-term value creation and that the board sufficiently understands the risks being run and provides proper checks and balances. Unfortunately not all boards want to understand the risks properly. The more you look the more you are expected to know. Chairs and non-executive directors may hope that nothing blows up while they are in office. Like Ostriches sticking their heads in sand they may choose not to ask the right questions thinking that ignorance is a reasonable defence provided they can demonstrate they went through the motions.

This may work in a court of law but not in the court of public opinion; it is hardly professional nor can it be particularly satisfying. A more thorough approach to risk involves boards and senior executives thinking outside their normal boxes to think the unthinkable and ask what could bring the company down or break the business model and what could be done to make the business model more resilient. The new FRC Guidance on Board Effectiveness invites boards to consider using scenario analysis to help assess the strategic importance and potential impact of challenges and opportunities. The guidance also encourages boards to test key decisions for alignment with values and consider the risk that a decision could encourage undesirable behaviours. This is good advice. SAMI Consulting is the home of scenario planning and helps organisations to make robust decision in uncertain times. Its governance experts can help boards who want to do more than go through the motions to ensure that risk governance not only ticks the box but can make a real difference.

Written by Paul Moxey, SAMI Fellow and Visiting Professor of Corporate Governance at London Southbank University.

The views expressed are those of the author and not necessarily of SAMI Consulting.

SAMI Consulting was founded in 1989 by Shell and St Andrews University. They have undertaken scenario planning projects for a wide range of UK and international organisations. Their core skill is providing the link between futures research and strategy.

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