The Financial Reporting Council (FRC) has finalised its two-yearly review of the UK Corporate Governance Code (Code). What is interesting is not the much-heralded changes – around organisational sustainability, risk, and remuneration – which has generated the most commentary, though hardly anyone can have been surprised with the outcome. If you haven’t seen the new Code, the FRC’s press release and related documents are at https://www.frc.org.uk/News-and-Events/FRC-Press/Press/2014/September/FRC-updates-UK-Corporate-Governance-Code.aspx
Arguably the most important change which appears in the 2014 revision concerns a less tangible aspect of organisational life. Paragraph 4 of the Preface to the Code states that:
One of the key roles for the board includes establishing the culture, values and ethics of the company. It is important that the board sets the correct ‘tone from the top’. The directors should lead by example and ensure that good standards of behaviour permeate throughout all levels of the organisation. This will help prevent misconduct, unethical practices and support the delivery of long-term success.
The appearance of this paragraph in the Preface, rather than the main body of the Code, serves only to emphasise the points made, rather than side-line them. The FRC is making it clear that the commentary refers to all of the Code content, and directors are expected to take particular note.
The emphasis on culture, values and ethics often causes directors to feel uneasy, not because they would disagree with any of the sentiments. With few exceptions, most directors understand that they should act with total integrity, and be perceived to be so doing. Directors will always strive to do the right thing.
The problem, or difficulty, is to ‘ensure that good standards of behaviour permeate throughout all levels of the organisation.’ I recently attended a briefing on the developing Anti Bribery and Corruption regulatory agenda in the UK, and the same point was made. How can a board know, with confidence, that everyone else in the organisation is following their lead, and how will they measure this, and provide the evidence when called on to do so?
One of my favourite Einstein quotes is that “The difference between stupidity and genius is that genius has its limits.”
Whether through wilful behaviour, or stupidity, organisations can get themselves into all kinds of difficulty, and the reason will often be around issues of culture, values and ethics. Conscientiously cultivated, these attributes have been the source of organisational success, but when cynically (or stupidly) ignored have led to the sowing of seeds of governance dysfunction, loss of value, and loss of reputation. In all sectors.
The solution? An organisation should put in place proportionate procedures to instil culture, values and ethics. This means recruiting the right people into the organisation – starting at board level; incentivising the workforce properly; periodically assessing the risks to the organisation as well as stress-testing the systems; training and developing staff; and monitoring progress. Most of all, a board needs to understand the absolute importance of its leadership role, of communicating its wishes, and of leading by example. As the Code says, ‘tone from the top’.
Interesting thinking from the FRC, even if it is not totally joined up
These issues – organisational sustainability, risk, remuneration – and, now, culture, values and ethics, should be viewed in the wider context of comments the FRC makes in its recent ‘Guidance on the Strategic Report’, and its ‘Guidance on Risk Management, Internal Control and Related Financial and Business Reporting’.
The former requires boards to report annually on ‘Principal Risks’ whether they have their origins in “strategic decisions, operations, organisation or behaviour, or from external factors over which the board may have little or no direct control”, such risks being those “that can seriously affect the performance, future prospects or reputation of the entity”. The latter asks a board to consider “whether it, and any committee or management group to which it delegates activities, has the necessary skills, knowledge, experience, authority and support to enable it to assess the risks the company faces and exercise its responsibilities effectively. Boards should consider specifically assessing this as part of their regular evaluations of their effectiveness.”
There is a common thread here, though I’m not sure the FRC has provided the linked-up thinking. Issues of culture, values and ethics (as set out in the 2014 Code Preface) are related to behavioural risk, which leads inevitably to reputational risk. The board is asked to identify its capability in addressing these issues, and to accept challenge on the point in their evaluation.
The company secretary to the rescue
The company secretary is the individual who is best placed to manage this agenda, which is one of those multi-disciplinary governance issues where the company secretary’s knowledge of regulation, guidance, compliance, risk and corporate culture and history makes them indispensable in evaluating, and recommending, the best possible outcome for the company. All other interests – whether from a risk, finance, audit, HR or corporate affairs background – do not have the overall breadth of understanding and vision to handle the complexity of the issues and put in place, and ensure the integrity of, the policies, processes and systems which will define the company’s profile and positioning.
This requires not just an active approach from the company secretary, but firm leadership. Indeed, if the company secretary doesn’t own both the practical and strategic aspects of this area of accountability, in order to advise the board – including on performance – who else will?
Paragraph 4 of the Preface to the Code need not now appear so daunting.