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Why do we have corporate governance regulation?

by | Sep 22, 2015 | Corporate Governance, Corporate Governance Debates | 0 comments

What drives corporate governance regulation? Is it media focus, political pressure, or a need to ’do something’?

Or is it sound analysis leading to thoughtful prescriptions? I suspect that pretty much everyone accepts that the answer is somewhere in the former list. Why does it have to be like this?

 

Evidence-based medicine is a well-established movement in health care. Even the UK Government published a White Paper in 1999 (“Modernising Government”), admitting that it “must produce policies that really deal with problems, that are forward-looking and shaped by evidence rather than a response to short-term pressures; that tackle causes not symptoms”. Sadly this went the way of many well-meaning political initiatives.

The UK Corporate Governance Code starts;’The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver the long-term success of the company.’ Fine words, but how do we know that actually does this?

Corporate Governance regulators have not as yet woken up to the needs of evidence, analysis and proof. There was an outcry about executive pay. They reacted by asking the great and the good as to what should be disclosed, and then mandating it. The result is 30 pages at least in every annual report listing every last detail of directors’ remuneration. Where is the evidence that this has remedied the problem of excessive pay and payment for failure? I can see that investor interest and therefore pressure on boards has had an effect on boards, but such pressure was in fact the driver, not the result, of additional regulation.

Listed company directors now have to put themselves up for re-election every year now. This was because people thought it would be a good idea. Where is the evidence that this would help and where is the post implementation review that shows it was effective in what it set out to do?

Politicians and the media are baying for more diversity on boards. The regulators duly oblige by setting targets for more females. This time there are also claims of a statistical relationship between number of females on boards and good performance. Except that the statistics in fact are pretty dodgy, and fail to show a company performance improving over time as a result of the presence of more women (if you think about it, such a relationship would be quite extraordinary given the complexity of company profitability). Where is the post implementation analysis that shows company profitability in the UK has improved as the percentage of FTSE100 female directors has doubled? I’m not saying that there isn’t a moral or political case for female representation. If regulation is just political, then let’s not dress it up as rules for improved performance.

Would it be so hard to develop evidence-based regulation? This is what it should look like:

  • The original events that led to the ’need for regulation’ are thoroughly analysed, and their causes identified;
  • The theory is tested as to why the regulation will be effective against those causes, and what the possible impacts of the regulation might be;
  • The counterfactual is tested: what would be likely to occur if the policy were not implemented;
  • The impact of the new regulation is measured;
  • Both the direct and indirect effects of the regulation are identified;
  • The uncertainties and other influences outside of the regulation that might have an effect on the outcome are identified;
  • The analysis and tests is capable of being tested and replicated by a third party.
  • The regulation is tested to identify if it ever becomes unnecessary or develops unforeseen consequences.

This is a manifesto for good regulation. None of the current corporate governance rules would satisfy this standard. Yet, given the costs of implementing the governance rules, is it unreasonable for regulators to justify themselves with a bit of evidence?

Put simply, governance regulation should start with an analysis of what has gone wrong in companies, identify regulation to stop this recurring elsewhere, and then check that this is being successful. The analysis into what goes wrong at companies must be far-reaching and insightful, going beyond condemning individual directors and failures of risk management. It needs to look at culture and accept human fallibility.

We all need rules, but the regulators are perpetuating a lie in suggesting that rules improve performance. Football teams couldn ’t play a match without a common set of rules. But you won’t improve Manchester United’s performance by adding new rules to the game. Teams improve with better tactics, advice, and encouragement. Boards are teams too.

This would be the regulators’ toughest challenge. How can they go beyond rules and compulsion, to encouragement, best practice and helping boards? They need to accept the discipline of evidence, the limitations of rules, and open their eyes to the importance of culture and how to foster the right one. And that probably requires culture change at the Regulators themselves.