Corporate governance: an introduction

Organisations require effective leadership to enable long-term performance towards meeting both financial and non-financial objectives. Corporate governance is an important component of firms that wish to deliver value for their multiple stakeholders, and as such requires attention and commitment if the principles and concepts of corporate governance are to be implemented effectively.

Corporate governance considers the way by management works to deliver against the businesses strategy. Outcomes of good delivery include financial returns, positive social and market impact, and increasingly leadership across supply chains. Given that organisations are more and more complex, often tackling multiple risks, corporate governance principles form the basis of leadership and management, and the relationship that organisations have with their stakeholders.

Future HR professionals at all levels will require a strong understanding of the way their organisation is governed; and in particular how leadership operates against the relevant regulations and codes. By using relevant guidelines, all organisations of every size and sector may benefit, and as such so will the workforce.

Corporate governance is necessary for effective, entrepreneurial and prudent management that can deliver the long-term success of a company.

Effective governance involves supervising the management of a company and managing risks so that business is done competently, with integrity and with due regard to the interests of all stakeholders. It embraces regulation, structure, best practice and board ability.

In the UK, the Companies Act 2006 is the overarching legislation which sets out the legal requirements for corporate decision making, and the consequences of getting it wrong.

The UK Corporate Governance Code (the Code) then sets out standard of good practice aims to achieve more open and rigorous procedures, and requires all companies with a premium listing of equity shares in the UK to report on their application of the Code in their annual report and accounts.

The UK Corporate Governance Code is complemented by the UK Stewardship Code which sets out the principles of effective stewardship by investors and in so doing, assists institutional investors to better exercise their stewardship responsibilities.

The Financial Reporting Council (FRC) monitors the Codes and publishes an annual report on their impact and implementation. The FRC requires listed companies to disclose how they have applied the principles and whether they have complied with the provisions – a ‘comply or explain’ approach.

The Code provides a guide to a number of key components of effective board practice including:

• Leadership: every company should have an effective board which is collectively responsible for the long term success of the company.
• Effectiveness: the board should have the appropriate balance of skills, experience, independence and knowledge of the company to enable them to carry out their duties effectively.
• Accountability: the board should present a fair, balanced and understandable assessment of the company's position and prospects
• Remuneration: executive directors' remuneration should aim to promote the long term success of the company and performance related elements should be transparent.
• Relations with shareholders: there should be a dialogue with shareholders based on the mutual understanding of objectives.

The Business, Energy and Industrial Strategy (BEIS) Committee has published recommendations following an inquiry launched in 2016 into the governance of UK companies. If these changes are implemented, it will mark one of the most significant changes to corporate governance in recent years, with new reporting obligations for directors, clarification on the role of non-executive directors, and further transparency on company engagement with stakeholders.

Corporate governance is important as it helps to foster cooperation internally and promote the image of the company to its stakeholders and the public. Since its introduction, the UK Corporate Governance Code has contributed to an improved framework in the UK which encourages internal discussions, company discussion with stakeholders, and promotes ethical business practices.

All of this helps boards to think comprehensively about their responsibilities and the implications of board decisions, for both stakeholders and individuals. This can help ensure that the business operates in accordance with applicable laws and regulatory frameworks.

For company directors, it can also help reduce the risk of personal liability arising out of breach of the various duties that directors owe under the Companies Act 2006. The Act sets out a number of obligations including duties to:

• promote success of the company
• exercise independent judgement
• exercise reasonable care, skill and diligence
• avoid conflicts of interest
• not accept benefits from third parties
• declare interests in proposed transactions or arrangements.

Good corporate governance ultimately furthers the UK's reputation as a safe place to do business and makes the country more attractive both for those living in it and those looking to invest in it.

Directors have a responsibility to promote the success of the company and are individually responsible for their actions. There are civil consequences in the event that a director breaches any of the duties. The duties are enforceable by:

• damages or compensation for the loss suffered by the company
• restoration of company’s property
• an account of profits made by the director
• cancelling a contract, if the director failed to disclose their interest.

A failure by a director to declare their interest in an existing transaction or arrangement is an offence and may give rise to a fine.

But of course the board should be thinking collectively and working towards compliance with the UK Corporate Governance Code. This says:

‘Every company should be headed by an effective board which is collectively responsible for the success of the company. The board’s role is to provide entrepreneurial leadership of the company within a framework of prudent and effective controls which enables risk to be assessed and managed.’

'The board should set the company’s strategic aims, ensure that the necessary financial and human resources are in place for the company to meet its objectives and review management performance. The board should set the company’s values and standards and ensure that its obligations to its shareholders and others are understood and met.’

Public sector boards

Outside private and public companies boards of directors exist in the public, charity, health and voluntary sectors. Though the aims of these organisations are very different from those of commercial companies they still require the same management and accountability in the form of robust corporate governance.

Public sector bodies, such as the Cabinet Office, have produced guidance and case studies on corporate governance issues for public sector boards and for people wishing to take up public appointments.

Voluntary sector boards

The boards of voluntary or charitable organisations play a similar role to those in the public and private sectors. The positions are often unpaid but that does not mean that they are not as important. There has been much interest in developing good governance, including effective people management and development practices, in voluntary organisations. The National Council for Voluntary Organisations has produced guidance and advice on trustee and governance issues.

Composition of the board

The size and complexity of the organisation will usually determine the size of the board. In a small company the board may consist of just the managing director (MD) and one other. In larger organisations it could comprise the chair, chief executive, executive directors (EDs) and non-executive directors (NEDs).

From October 2015, the Small Enterprise, Business and Employment Act 2015 dictates that a corporate entity may not be a director of a company. There will also be a minimum age of sixteen years. Directors are recruited according to the mix of skills and attributes they can contribute towards making the company successful and profitable. The UK Corporate Governance Code recommends that within all listed public limited companies, the board should include an appropriate combination of executive and non-executive directors (and, in particular, independent non-executive directors) such that no individual or small group of individuals can dominate the board’s decision taking. The Code also recommends that companies below FTSE 350 should have at least two independent non-executive directors.

The role of the chair is to lead and manage the board, to be responsible for setting the board's agenda and to ensure that meetings are conducted properly, order is kept, the agenda is followed, items are discussed and decisions made.

The chair is appointed in accordance with the articles of the company. The chair has a crucial role in ensuring that the executive directors and non-executive directors work together with a common purpose, using their different skills and competences, and promoting openness and debate. The Cadbury Review likened the role of the chair to that of an orchestra conductor – striking a balance between focused discussion and general debate for the overall effectiveness of the board.

The Code recommends that the chair should be independent and a chief executive should not go on to be chair of the company. The duties of each should be clearly set out in writing and agreed by the board.

The Code recommends that the chairman should be responsible for the leadership of the board and for ensuring effectiveness in all aspects of its role.

The executive directors (EDs) will run the company's business and will often be directors of functions such as finance, HR or operations. Much has been written on which functions should be represented at board level and it is for each organisation to decide what is right for it.

However, EDs with certain titles should be aware that in light of the new directors' duties they will be judged to have the required specialist knowledge to carry out those roles.

Non-executive directors (NEDs) have the same duty of care as EDs. Therefore before taking up any director appointment, it is vital to undertake a personal 'due diligence' to understand the company and the expectations placed on NEDs.

The board may decide to delegate some of its authority to committees. The committees usually established are:

• audit committee
• nomination committee
• remuneration committee and, in some cases,
• ad hoc/special committees for a specific task.

Each committee will have terms of reference and will normally report back to the board at agreed intervals. Each committee should also have the appropriate balance of skills, experience, independence and knowledge.

Audit committee

The governing principles for audit committees in the Code are based on the conclusions and recommendations of the Smith Report. The Code recommends that at least one member of the audit committee should have recent and relevant financial experience.

The Financial Reporting Council’s Guidance on Audit Committees was provided in December 2010 and updated in September 2012. It's designed for companies to use alongside the Code to assist implementation. The focus is to assist boards in dealing with their audit committees and to assist directors who are on those committees.

Nomination committee

The nomination committee undertakes the selection of all new board appointments. Once the recruitment and selection process is complete the committee will recommend new appointments to the board. The Code recommends that the nomination committee should have a majority of NEDs.

Remuneration committee

The remuneration committee sets the remuneration for the EDs and the board chair. The Code recommends that only NEDs should sit on the committee and that the remit should include the monitoring of remuneration packages of senior managers who are not EDs.

The case Newcastle International Airport Limited v Eversheds LLP referred to the fact that NIA’s remuneration committee had five NEDs and it complied with the Code, in particular Code B2, (although strictly speaking it did not apply to the company). This case highlighted the need for the NEDs to read and understand papers setting out proposed remuneration arrangements and to challenge them, rather than the remuneration committee being seen as a rubber stamping committee. £8 million bonuses were claimed by two EDs without it being appreciated by the committee or its shareholders.

Contacts

Institute of Directors website - briefings on corporate governance (some briefings are available to IOD members only)

Books

CHARTERED INSTITUTE OF PERSONNEL AND DEVELOPMENT. (2016) A duty to care? Evidence of the importance of organisational culture to effective governance and leadership. London: CIPD.

MALIN, C.A. (2015) Corporate governance. 5th ed. Oxford: OUP.

SIMPSON, J. and TAYLOR, J.R. (2013) Corporate governance, ethics and CSR. London: Kogan Page

Visit the CIPD and Kogan Page Bookshop to see all our priced publications currently in print.

Journals

MOULDS, G. (2016) Linking governance and management. Board Leadership. Vol 2016, No 148, November/December. pp1-8.

OLIVER, C. (2016) Being real about governance. Board Leadership. Vol 2016, No 143, November/December. pp4-8.

PARRY, O. (2016) Good governance: putting the UK business house in order. Director. Vol 70, No 3, November. pp60-65.

CIPD members can use our online journals to find articles from over 300 journal titles relevant to HR.

Members and People Management subscribers can see articles on the People Management website.