32 years after the Cadbury Report defined modern corporate governance rules, corporate scandals continue to happen. Another version of the Corporate Governance Code came out in January with yet more minor changes. Why isn’t corporate governance working and why do corporate failures keep happening?
Growing frustration is leading to demands for ever more regulation, but we’ve actually already got the benefits from good governance. Added pressure to do more is leading to just more reporting and random ‘good ideas’ for new rules that have no evidential-basis: Diminishing regulatory returns.
Running companies is difficult and humans make mistakes. Good governance increases the chances that boards make sensible decisions, but it has its limits. It can’t eliminate corporate failures; competition is often a zero-sum game.
But, even when directors are able and experienced, boards sometimes still make disastrous decisions or are far too late in spotting problems. Tesco and Carillion, for example, conformed closely to the governance code with quality boards, yet still got into trouble. What governance regulation would have stopped the Post Office scandal?
Corporate governance initially focussed on process and organisation. Later, attention turned to culture, with the 2024 Code now insisting: ‘a company’s culture should promote integrity and openness, value diversity and be responsive to the views of shareholders and wider stakeholders.’ Hard to disagree, but it’s not enough.
Culture is about group norms and behaviours, but boardroom decisions are taken by individuals who may be distracted, complacent, uninformed or stressed. A company may have a ‘good open culture’, but this won’t explain why the CEO takes a particular decision under stress or why directors don’t act faster to address problems.
The human element to decision-making is about understanding the effects things like poor communication, complacency, distraction, lack of knowledge, poor assertiveness, fatigue, pressure and stress. To understand why boards sometimes do the wrong thing, we must understand these.
Better understanding of human factors in the boardroom would provide new insight into how crises and failures start and develop, enabling us to enhance the training and developing of directors, raising awareness of the importance and impact of human factors on decision-making. This is not some cod psychology or academic goose chase. Understanding human factors is a meticulously researched, empirical area of knowledge that is crucial to how high-risk industries, such as aviation, nuclear and marine industries keep us safe.
It would also challenge existing governance rules that often have unanticipated consequences. For example, excess focus on reporting causes boards to wordsmith in place of talking about the issues themselves.
Another illustration is in company risk reports, which invariably make a telephone directory looks fascinating and certainly more useful: bland, complacent and meaningless. Understanding how companies handle risk to protect against human factors is exactly how high-risk industries achieve such impressive safety. People still make mistakes, but the systems are robust enough to catch and mitigate them. As the CAA says: “In order to reduce HF [Human factors] risks to aviation safety we must influence attitudes and behaviours while embedding HF thinking into everything we do.” Needless to say, board directors are every bit as human, fallible and stressed as airline pilots.
Corporate governance regulation has achieved a lot, but it’s reached the end of the road. To go further we don’t need more regulation, we need a better understanding of how individuals respond to different circumstances on boards. There is a huge body of work on such human factors already tried, tested and used successfully. Why on earth are we not applying this to the boardroom?
It’s time the boardroom became as safe as the skies.
This article appeared first in the Times on 3 April 2024.