Why UK corporate governance may have gone wrong

People are wary of criticising the system but not everyone believes in it, says Anthony Hilton.

How many people in business would agree privately with the following quote: ‘I believe the UK’s focus on corporate governance has become grossly excessive, which stifles determined leadership and diverts boards from what really matters in the business.’

And the next paragraph: ‘Undoubtedly there has been progress but governance has gone too far. And yet it would be very naïve to think people problems are eliminated, while the price that has been paid is a major weakening of our international competitive position, both in terms of the cost burden and, even more importantly, the speed and flexibility of decision-making – in particular, in comparison to Asian companies.’

Tough words, but what makes them particularly noteworthy is that they come from a businessman who has been a highly-successful senior executive in the engineering industry, being at various time the youngest chief executive of a listed engineering group, chairman of several mid-sized listed companies, a non-executive director at several others, and also with experience at McKinsey, in venture capital, with university spin-offs and in private equity.

This is someone who knows of what they speak.

His sentiment may be widely spread, or it may not. It is difficult to judge because being critical of the UK system of corporate governance is generally not considered a way to enhance your career, whichever level you are at.

Thus, executives climbing the ladder do not want to be critical because it would lay them open to the charge of being irresponsible, a potential loose cannon, or just too outspoken for their own good – none of which are likely to get you onto a job shortlist.

However, even when they reach the board, executives do not criticise governance processes.

This is partly because they are normally too busy doing everything else but also because they do not want to cause uncertainty among the fund management community – for fear that it would cause them to question the direction of the company and damage the share price.

Interestingly, retiring executives rarely comment on corporate governance either – sometimes because they want to put all that stuff behind them as they embrace a quieter life, or in contrast because they still want to remain active and hope to line up a non-executive position or two.

Here, as with the rising executive, they understand that being outspoken in this area would do them no good at all with the head-hunters and appointments committees, and would risk making their brand toxic in the fund management community.

So the above comments are unusual, if not for the sentiments expressed but for the fact that the issue has been addressed at all.

Time therefore to come clean in their provenance. They come from a book published earlier this year: Tragedy & Challenge: An inside view of UK engineering’s decline and the challenge of the Brexit economy.

“Codes and practices that might be good for one company in certain circumstances might be the opposite of what is needed in another company”

The author is Tom Brown, son of one of the most distinguished economists of his generation, Sir Henry Phelps Brown, and a 45-year career veteran of British industry. It ought to be the business book of the year. It will not be though, because it does not take any prisoners.

At root, Brown’s objections to governance have three interesting strands.

First, and fundamentally, he thinks the premise behind its evolution is flawed. Governance has developed by seeing what has gone wrong in one business and then drafting rules and processes to make sure it can never happen again anywhere else.

This is a good principle in engineering, which is governed by the laws of physics and in which failure can be designed out. It is not a good rule for business, which is a collection of people – all of whom are different and react to events and circumstances in different ways.

Thus codes and practices that might be good for one company in certain circumstances, might be the opposite of what is needed in another company or in different circumstances, at the same time bogging management down and curbing its ability to be nimble and react to new challenges and opportunities.

Brown’s second concern is that governance has destroyed the purpose of the board, so that it is no longer about running the business, but all about compliance and supervision.

This in turn has created a split into two opposing camps between the executive management team, who hopefully understand the business, and the non-executives, who by definition must have scant knowledge of it in order to be suitably independent.

These non-executives tend to be strongly financial in background – accountants, bankers and so on – which leads to an excessive focus on what the shareholder wants, not what the business needs.

It exacerbates the tension between short-term caution, cost cutting and negativity, versus long-term training, investment and expansion. Brown firmly believes the board’s main function should be to run the business, not deal with the shareholders and the City.

Finally, the proliferation of committees for audit, remuneration and executive recruitment has had the opposite of the intended effect.

Far from bringing specialist minds to bear and getting better decisions, the committee structure has created bureaucracies that embrace process, cover their own backs and take safe decisions. All this severely limits the ability of the chief executive to show true leadership.

A recent release from the Financial Reporting Council said that the UK Corporate Governance Code ‘has been a force for good and has made an important contribution to the high regard in which business is held globally’.

Not everyone agrees.

Anthony Hilton is financial editor of the London Evening Standard

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