Unlocking the Code: What do the changes mean for you? Continued...

Continuing the thread on the changes contained in the revised UK Corporate Governance Code, this post will look at the implications of Section B.7:

Re-election

The previous 2008 version of the Code provided that directors should seek re-election at least every three years. It was following overwhelming support from institutional investors, who felt it would promote better engagement with shareholders, that the new Code now recommends the annual re-election of all directors of FTSE 350 companies.

The change is significant for most Boards; only a few listed companies already voluntarily re-elected directors annually. The IOD, among others, has expressed concern that the new provision encourages short-term thinking and creates the potential to destabilise the Board (http://press.iod.com/2010/05/28/iod-reaction-to-uk-corporate-governance-code-revision/).

It should be noted that, on past indications, the failure to re-elect directors is rare. The effect of the requirement, therefore, is largely to tilt the power balance towards investors as directors coming up for re-election could feel subtle pressure to engage, or at least to appear to engage, more with investors.

FTSE 350 companies should consider the exposure which may be created by the new recommendation for annual re-election of directors. For example, if an executive director is not re-elected this may trigger immediate termination provisions under his or her service agreement which may not necessarily work in the company’s best interests. This would have a serious impact on the continuity of the company’s business which, in the current market, could be very detrimental.

The ball’s in... whose court?

Last week, chairman of Leicestershire County Cricket Club Neil Davidson hit the news. He is refusing to step down amid calls from the head coach and team to resign on the grounds of alleged interference in team matters.

Davidson insisted, “My job as chairman is to represent the members ... the players are trying to set the agenda ... as a members’ club, it is the board who are supposed to run the club’s affairs on behalf of those members. I was appointed by the board, and am accountable to it.” (http://news.bbc.co.uk/sport1/hi/cricket/counties/leicestershire/8940096.stm)

Everything Davidson stated here is true. But the controversy raises bigger questions over the corporate governance practices in sports clubs. Where exactly do the interests of shareholders and fans overlap (bearing in mind that fans themselves are often shareholders)? Can and should the performance on the pitch and the performance in the boardroom be kept separate?

Closely related to this is the emergence of issue-centred groups that contribute to a debate about the future governance of various sports. An example of this is the campaign led and orchestrated by Manchester United Supporters Trust (MUST) to secure a meaningful ownership stake in their football club in light of the takeover of Manchester United by the Glazer family. The latter also led to the formation of FC United of Manchester (FCUM) a semi-professional football club set up by supporters, disaffected by the Glazer takeover.

The formation of MUST and FCUM can be located within a wider attempt by supporters to try and influence the running of the game - raising questions of regulation and control - but also of participation and exclusion, of the organisation and exercise of power in sports. There are now over one hundred supporter trusts across England, Wales and Scotland, formed as democratic, transparent, representative bodies for fans whose aim is to ensure supporter representation at boardroom level through the collective ownership of shares.

Sports clubs are notoriously poor, compared with other corporations, at complying with corporate governance regulation and codes of practice. One report found, for example, that less than a quarter of football clubs responding to their survey had an internal audit committee and, even where clubs had an audit committee, almost one third of those clubs reported there being no regular board review of risk assessment reports: practices which are now seen as foundational to good corporate governance. (Sean Hamil et al., (2004) "The corporate governance of professional football clubs", Corporate Governance, Vol. 4 Iss: 2, pp.44 – 51).

It seems that sports clubs would need to implement dramatic changes in order to come into line with the UK Corporate Governance Code. An alternative is for sports to be issued with a tailored set of guidelines that are more suited to reconciling the conflicts of interest underlying decision making in this sector, not unlike the guidelines published for the voluntary sector and building societies by NCVO and BSA respectively. Without some regulatory action, disputes over the division of responsibility, authority and fiduciary duty are bound to continue, with everyone wondering in just whose court the power lies.

Robert Swannell: the Gordon Brown of the Corporate World?

Stuart Rose is to step down as chairman of Marks and Spencer several months earlier than planned, the retailer recently announced, and will be replaced by current HMV chair, Robert Swannell.

There are expected to be complaints from M&S’s army of loyal small shareholders, most of who appear to be charmed by Rose. The charismatic figure’s bravura AGM performances, where he delivers sparkling discourses on anything from lingerie to luggage, have earned him popularity with many during his two years of leadership, and the executive chairman is “adored” by the small shareholders according to retail analyst Neil Saunders.

Incoming Swannell, meanwhile, is not necessarily the first name that comes to mind for chairman of Marks and Spencer. Sky News City Editor Mark Kleinman believes that Swannell will not be as “high profile” as his predecessor. Saunders likewise commented, “he’s not as big a personality as Sir Stuart,” adding that the veteran investment banker has “a very tough act to follow.”

This has to raise the question, what exactly is the ‘act’ that we demand of any chairman? There are few statutory requirements for the role but the seminal 1992 Cadbury Report takes the view that:

Chairmen are primarily responsible for the working of the board, for its balance of membership ... for ensuring that all relevant issues are on the agenda, and for ensuring that all directors, executive and non-executive alike, are enabled and encouraged to play their full part in its activities ... Chairmen should be able to stand sufficiently well back from the day-to-day running of the business to ensure that their boards are in full control of the company’s affairs and alert to their obligations to shareholders (provision 4.7)

Though we talk of the chairman of the company, his or her role is actually to lead the board of directors. Through effective leadership, the chairman fosters an environment for establishing effective strategies to protect the company and move it forward. And for this, Swannell is well qualified.

Swannell has been an investment banker since joining Schroders in 1977 where he stayed through the takeover by US bank Citigroup in 2000. It was Citigroup that defended M&S against the Green takeover six years ago. Currently, Swannell holds non-executive posts on the boards of British Land and 3i Group as well as chairing FTSE 250 company HMV.

Perhaps it is rash to rain down with pessimistic predictions on the newcomer. Perhaps Swannell isn’t doomed to Brown’s demise simply for his lack of charisma, and, in the role of chairman, expressiveness can be replaced by experience and knowledge shown to outlive novelty.

Unlocking the Code: What do the changes mean for you? Continued...

Here we consider another of the changes appearing the new UK Corporate Governance Code.

Risk Management and Internal Control

A new, clearer statement of a board’s responsibility relating to risk is laid out in Main Principle C.2:

The board is responsible for determining the nature and extent of the significant risks it is willing to take in achieving its strategic objectives. The board should maintain sound risk management and internal control systems.

This idea is expounded in provision C.1.2 which states:

The directors should include in the annual report an evaluation of the basis on which the company generates or preserves value over the longer term (the business model) and the strategy for delivering the objectives of the company.

In other words, by setting out in layman’s terms the company’s strategy for generating long term value, a company can illustrate to investors, and other readers of the report, how the board has applied the new principle on risk.

The Code’s publishers, the Financial Reporting Council (FRC) have stated that it was not their intention to “promote particular methodologies for dealing with risk”; boards must merely recognise that it is their responsibility to consider how much risk the company can bear and how willing it should be to take risk on.

It makes sense to include this description in the same part of the annual report as the Business Review. This will not require a major change in reporting practices for most companies. Those that are properly applying the Accounting Standards Board’s voluntary Reporting Statement on the Operating and Financial Review will already be providing this information. See the Reporting Statement for detailed guidance on how this provision can be complied with.

Unlocking the Code: What do the changes mean for you? Continued...

This blog continues to consider the impact of the changes contained in the new UK Corporate Governance Code.

Time Commitment

No minimum time commitment for directors is prescribed by the Code, but the new Main Principle B.3 states:

All directors should be able to allocate sufficient time to the company to discharge their responsibilities effectively

Individuals who are non-executives in one company will often be executive directors in another – and vice versa. It is generally thought to be a good thing that an executive gets experience of the workings of another company and another industry.

However, it is important that the demands on the individual are realistic – the Code says that the board should not agree to a full-time executive taking on more than one FTSE 100 company non-executive directorship or the chairmanship of such a company.

A more encompassing guideline is that board members should limit their board memberships consistent with their ability to discharge their responsibilities diligently. More than three to four directorships could be burdensome, and may result in absences at board meetings and a lack of ability and willingness to act quickly in a crisis.

Worth noting on the topic of time commitment, is this comment by Ed Marks, President of Marks Consulting Inc.:

A director’s role in a troubled company is very different from that of a director of a healthy business. The increased emphasis on directors assuming larger roles in managing a company’s affairs means that their responsibilities and time commitments must also increase. Troubled companies require deeper involvement from their boards

Also bear in mind: risks of incurring director liability may rise when the number of board memberships increase beyond a manageable level.

The issue of time commitment links to the new emphasis placed on performance evaluation in the 2010 Code. Part of the appraisal of individual directors should ask the question, are they giving the job the time it requires?

Unlocking the Code: What do the changes mean for you?

The UK Corporate Governance Code, in effect from 29^th June this year, replaced the previous Combined Code. It applies to all companies with a premium listing on the London Stock Exchange regardless of where the company is incorporated. Over the next few blogs, I’ll look at some of the major changes contained in the latest revision and what they might mean, practically, for any particular company, starting with:

Diversity on the Board

The new Code makes explicit for the first time the need for gender equality, and diversity generally, to be taken into account in hiring decisions. Provision B.2 Supporting Principle states:

The search for board candidates should be conducted, and appointments made, on merit, against objective criteria and with due regard for the benefits of diversity on the board, including gender.

Responses to this addition have been plentiful and various. Regardless of whether you believe this advice should or should not have appeared in the Code, the fact remains that, at present, only 10% of directors in Britain’s top 100 companies are women, and 25 of these top firms have no women board members at all: shareholders and other readers of the Code are going to ask questions of under representative boards.

Because the new requirement is phrased as a principle, not a provision, companies will not be forced to explain publicly the absence of women directors. This is not tantamount to a get-out or loophole; instead, it means that companies have the time to work on building a diverse board membership. There is no pressure to appoint new directors purely for their contribution to gender or ethnic diversity (as the IOD pessimistically predicts: http://www.continuitycentral.com/news05179.html).

Boards skewed towards the white, British male should take action now to amend their nomination committees’ processes. Descriptions of the role and capabilities required for a particular appointment should be carefully prepared, open advertising employed and/or an external search consultancy engaged in the recruitment process. If these behaviours become established and well-used, diversity will be a natural outcome. Take care of your nomination procedures and board diversity will take care of itself.

A closer look at the board review process...

What are our directors bringing to the (board) table?

Having considered the foundational issue of who should carry out the review, and established the underlying governance structure, we turn to the question...

What does a board review involve for individual directors?

Within the broader review of the entire board (to be discussed later), the contributions of each director must be assessed.

Many director appraisals are currently conducted in an informal way, with the chairman personally assessing each director’s performance and commenting privately to the director involved. But the pressure is on for director appraisals to be more formalised. A board policy decision, with the full support of all the directors, is needed to introduce such a process.

With the support of board members obtained, the next step is to clarify the criteria to be used for the evaluation. The chairman should outline the purpose and process of the assessment. Desirable director attributes and core competencies can provide a pro forma for the individual appraisal. The chairman’s statement laying out expectations of time commitment, skills, specific expertise and experience provided at a new director’s appointment, should be revisited, especially in light of any changes in the company’s strategic situation.

In a formalised director performance review, the data collection stage follows. This might involve interviewing each director to discuss their experiences as members of both the main board and any committees. Information is also obtained by analysing attendance records, and board and board committee minutes, looking for innovative contributions to discussions and decisions.

Sometimes peer-review techniques can add value to the process. Taking this further, a 360 approach could be beneficial, involving too the opinions of external auditors, institutional investors and company staff who have come into contact with the director.

Following the data gathering, a confidential report to the chairman will be drafted. Given the personal nature of the report, most chairmen will discuss the relevant portion with each director one-to-one. The discussion should cover a strategy for further personal development activities, such as committee leadership or membership on other boards.

Adopting an annual routine of director evaluation not only ensures compliance with many codes and listing rules, but is as vital for healthy governance as are long established executive appraisal systems for healthy management.