Flaws at the top: Your IoD Big Picture corporate governance needs to improve despite progress made since the Cadbury Report GOOD GOVERNANCE: PUTTING THE UK BUSINESS HOUSE IN ORDER As recent scandals from the City to the high street made clear, most of us know bad governance when we see it. But how do we spot good governance, what determines it and how can it best be facilitated? As the IoD launches its 2016 report, head of corporate governance Oliver Parry outlines why UK companies must move beyond the tick-box compliance culture

orporate governance has Good governance is as much about SNAPSHOT come a long way since Sir relationships, trust and transparency • The corporate governance Adrian Cadbury published as it is about codes and regulations. debate has become the preserve C his groundbreaking review into While this is embodied in the flexible of the policy community and boardroom best practice in 1992. The nature of the UK’s strong governance consultants. We hope to change UK Corporate Governance Code is framework, most of the FTSE this with the Good Governance now copied and replicated around the appears to have developed a system Initiative, which aims to answer world. The comply-or-explain process whereby governance is seen in pure two crucial questions: what is is used across Europe. And yet, despite compliance terms. FTSE companies good governance, and how do we the success of the Code, the UK market simply produce standard boilerplate measure it? is still experiencing shocking lapses statements year on year which tell • Governance cannot be reduced to a from HBOS through to Sports Direct. investors little. This is as far removed simple tick-box exercise and crude The saga at both of these companies as possible from the intentions of compliance. An individual director’s has shown that boards can comply Cadbury’s landmark report, which laid behaviour is organic by nature, and with all of the principles of the the foundations for a more practical driven by different factors: physical, Code and yet still experience big approach to governance. chemical, even inexplicable. governance problems. Another problem that has Regulators seem uninterested developed in this time is that the • The IoD’s aim is to provide directors with an understanding of the many in examining the effectiveness of debate around corporate governance factors that combine to determine governance in its present system. The has become the preserve of the policy good governance, so enabling them purpose of the 2016 Good Governance community and consultants. We to configure their organisations Report is, therefore, about taking a step hope to change this with the 2016 in ways suited to their strategic back and assessing what matters in Good Governance Report, published purpose. governance and, uniquely, whether jointly with Cass Business School one can measure governance. No and the Chartered Quality Institute. • There is a growing acceptance that doubt Cadbury himself would be Not only is this a groundbreaking dispersed shareholding leads to an fascinated with this project. After piece of research but we hope it will absence of stewardship by investors all, he identified that corporate stimulate debate beyond regulators and therefore poor accountability governance is as much about and government. of the board. behaviours as it is about complying Our approach includes two • Corporate scandals inevitably tempt with the principles of the Code. We important innovations. First, we governments to reach for regulatory are not claiming that this project will use a new list of indicators that goes solutions, all of which take directors’ solve all of the corporate governance beyond simple compliance with the time and attention away from their problems in the UK market but it is Code. Although the emphasis is on companies’ long-term success. the beginning of what I hope will public information, we combine If UK companies don’t get a grip, be a long and thought-provoking data contained in the annual reports government will – to the detriment discussion. Welcome to round two of with other sources. Second, the of free enterprise. the Great Governance Debate. weights assigned to the individual

60 Director November 2016 Your IoD Big Picture

A reliable index – a combination of individual indicators For each of the 100 companies, the table below reports the model score. capable of measuring the overall quality of a firm’s Full Ranking governance – is regarded as the holy grail of governance"

Rank Name Model Rank Name Model components are inferred on the Crucially the GGI was focused on decisions within firms and investment Score Score basis of surveys of customer, investor adding to the understanding of good decisions across them. 1 Plc 793 51 Plc 722 and employee assessments of the governance by triggering a wider Over the past 20 years, academics quality of the corporate governance debate with the publication of the and practitioners have made several 2 Plc 778 52 Rexam Plc 722 regime of the rated companies. This initial findings of our research. In attempts at producing CG indices, 3 Plc 775 53 Wolseley Plc 722 methodology automatically adjusts 2015, the standout, but unsurprising, so far with limited success. Existing 4 Plc 769 54 Centrica Plc 720 for the perceived importance of conclusion of the research was indices have often been criticised for 5 763 55 Group Plc 720 different governance mechanisms and that defining and measuring good adopting a kitchen-sink approach to 6 762 56 RELX Plc 719 implicitly creates a link between the governance is not easy. the problem by simply combining large numbers of indicators (typically 7 DS Smith Plc 761 57 719 index and firm performance. This will As Ken Olisa, chairman of the GGI also significantly reduce the scope for and deputy chairman of the IoD, has between 50 and 100) and using an 8 Group Plc 758 58 Plc 717 gaming and preserve the relevance of said: “This is because we have come to arbitrary weighting scheme to produce 9 Plc 755 59 Stock Exchange Group 715 the index over time. realise that the structures that drive CG index scores for companies. Critics 10 Plc 755 60 Inmarsat Plc 715 The Great Governance Debate is behaviours are essentially organic.” have also argued that the tick-box 11 Plc 750 61 Easyjet Plc 714 now seen by investors and corporates As with any other living organism, a approach used to compile the basic CG 12 RSA Insurance Group Plc 750 62 Carnival Plc 713 alike as a set-piece event, with particular action is the result of the databases for such indices can easily be interested parties holding their breath interaction between many separate gamed by companies. Our approach, 13 Plc 750 63 Babcock Intl Group Plc 711 in anticipation of the report. And we elements. An individual director’s as demonstrated by the 2015 and 2016 14 Marks & Spencer Group Plc 750 64 WM Morrison Supermarkets 711 know from our own engagement with behaviour is driven by a host of reports, moves beyond this. 15 Smith & Nephew Plc 747 65 Plc 711 companies that there is widespread different factors: some physical, some For this second report, we have 16 Plc 746 66 Plc 711 support for the initiative, even if chemical and some inexplicable. It continued our successful partnership 17 Intercontinental Hotels Group 745 67 Shire Plc 706 they do not always agree with the would therefore be naive to believe with Cass Business School and we have that, when many directors get refined our methodological approach. 18 Group Plc 744 68 706 methodology. Over the coming years we will look to build on the report, together, their collective behaviour Specifically: 19 744 69 BAE Systems Plc 706 with an investible index still the can be reduced to a small list of code- • We are using a refreshed list of 20 Plc 742 70 Plc 705 ambition. For now, however, we can defined mechanistic items susceptible indicators that assesses factors well 21 Group Plc 740 71 Plc 704 reflect on this year’s report. There are to a tick-box analysis and a red-top beyond simple compliance with 22 Benckiser Group Plc 739 72 Group 700 two crucial questions surrounding the call to action. the Code. 23 ARM Holdings Plc 737 73 Royal Bank Of Scotland Group 699 initiative: why have we chosen to do A reliable corporate governance • The Perception Survey this? And what lessons have we learnt? (CG) index – a combination of from which we derive the list of 24 Plc 737 74 BP Plc 694 Let’s begin with the first. individual governance indicators instrumental factors is based on a 25 Capita Plc 736 75 Direct Line Insurance Group 694 The IoD is required by its Royal capable of measuring the overall wider and arguably more expert 26 Merlin Entertainment Plc 736 76 HSBC Holdings Plc 693 Charter to promote the study, research quality of a firm’s governance set of commentators. It is used to 27 Plc 734 77 Plc 691 and development of the law and – is regarded as the holy grail of identify correlations between experts’ 28 Legal & General Group Plc 733 78 Randgold Resources Ltd 689 practice of corporate governance. With governance research. Ideally a perceptions of good governance and that in mind, the Good Governance CG index would measure all of objectively measurable factors. 29 Plc 733 79 SSE Plc 689 Initiative (GGI) was aimed at answering the characteristics that matter for • The weights assigned to the 30 Old Mutual Plc 733 80 Pearson Plc 687 two crucial questions: what is good corporate outcomes, and would be a individual components are inferred 31 Standard Life Plc 731 81 Plc 686 governance and how do we measure it? valuable tool for informing both CG on the basis of surveys of customer, 32 Plc 731 82 Plc 686 investor and employee assessments 33 DCC Plc 730 83 685 of the quality of the corporate 34 St James's Place Plc 729 84 Provident Financial Plc 683 Figure 1: CG Factors governance regime of the rated AREA OF companies. 35 Astrazeneca Plc 729 85 Sainsbury (J) Plc 681 GOVERNANCE • We have been much clearer in 36 Pennon Group Plc 728 86 Plc 679 our explanation of how the rankings 37 Plc 728 87 678 are produced. 38 BHP Billiton Plc 728 88 Plc 675 39 GlaxoSmithKline Plc 728 89 TUI Ag-Di 673 BOARD AUDIT & RISK / REMUNERATION SHAREHOLDER STAKEHOLDER The result is a workable hypothesis EFFECTIVENESS EXTERNAL & REWARD RELATIONS RELATIONS describing, within the limits of what 40 BT Group Plc 727 90 Sky Plc 672 can currently be measured, what 41 Plc 727 91 Dixons Carphone Plc 671 constitutes good corporate governance 42 Plc 725 92 Worldpay Group Plc 665 For example: For example: For example: For example: For example: and how the many variables can 43 ITV Plc 725 93 SABMiller Plc 664 Separate CEO & Years with current audit Director salary - total Return on shareholder Most admired be measured and judged. This is a chairman company executive directors fund companies 44 Plc 724 94 Travis Perkins Plc 661 Number of audit Ratio of fees for Director remuneration % of shares held Inclusion in RobecoSam very long way from the currently committee meetings in non-audit/audit work to - CEO by single largest Sustainability Yearbook 45 Intl Consolidated Airlines Group 724 95 Investec Plc 661 widespread box-ticking regulatory last year auditors Ratio between CEO shareholder 2016 approach to the topic. The Financial 46 GKN Plc 724 96 WPP Plc 660 % of non-executive Change in rating score in remuneration and directors last 12 months market cap Reporting Council (FRC) does, of 47 Plc 724 97 Plc 655 Average number of Number of profit course, allow for “explanations”. 48 Plc 724 98 Rolls-Royce Holdings Plc 648 boards a director sits on warnings in last 12 Nevertheless, due to its focus on months 49 Imperial Tobacco Group Plc 723 99 641 the Code, many FTSE 100 companies 50 Coca-Cola Hbc Ag-Di 723 100 Plc 603 see governance in pure compliance

62 Director November 2016 November 2016 Director 63 Your IoD Big Picture

The increasing regulatory burden not only takes up boardroom time, but it also makes NEDs nervous and less likely to take risks" Mark Goyder, Tomorrow's Company

terms and it has mainly been reduced BY ESTELLE CLARK Responses/ratings by affiliation to the production of boilerplate HEAD OF PROFESSION, CQI St Paul's in the City of London. Boardrooms in the paragraphs in annual reports. Like Responses Ratings The IoD has initiated UK's financial centre have the FRC’s recent report on corporate a vital debate around been rocked by corporate culture, the IoD’s aim is to provide governance. A common governance scandals Institute of Directors 508 1,376 directors with an understanding criticism of the UK FTSE 350 company secretary 54 151 of the many factors that combine Corporate Governance Institute of Chartered Secretaries and Administrators 35 77 to determine good governance, so Code is that it has led enabling them to configure their to compliance with a Journalist 18 72 organisations in ways that suit their limited set of mechanistic Association of Chartered Certified Accountants 11 22 strategic purpose. We hold that good corporate governance Tomorrow's Company Good Governance Forum 4 5 governance isn’t a question of meeting factors and has ceased to minimum requirements but rather the provide the level of confidence in performance that Chartered Institute for Securities and Investment 7 2 consequence of tuning many variables organisations and their stakeholders require in our The Investment Association 5 8 to produce optimal performance. fast-moving and globalised world. CFA Institute 2 0 But this doesn’t mean this year’s While some might argue that these factors were never designed to be predictors of behaviour report is perfect. We recognise there Institute of Chartered Accountants in and Wales 29 109 and culture in the context of 21st-century business, is room for improvement. However, Other 71 155 others may say they remain relevant. Society rightly it is crucial to acknowledge that believes that a corporate fish rots from the head, a Total 744 1,977 since the Cadbury Report, with complex operating environment being no excuse each new corporate scandal the for doing business at the expense of doing the right temptation has been for the regulator thing. And society not only judges but also sentences business model, customer trends and, GGI is imperfect. It is an emergent Top decile to introduce further layers of rules organisations through deterioration in reputation and most important, the engagement, hypothesis; it cannot claim to be or recommendations, all of which an impact on business value. Indeed, a head with a motivation and performance of definitive. It is by the process of Rank Name Total Score require the attention of the directors. weak nervous-system link to the corporate ‘body’ people in the business.” publication, challenge and counter As the board spends more time can no longer be accepted as a reasonable way of The challenge now for boards challenge that it – like the usefulness 1 Smiths Group Plc 860 navigating this, it has less to spend on going about things when the body’s actions and and regulators is to remain faithful of boardroom conversation – will 2 Rexam Plc 850 the long-term drivers of value. decisions compromise the organisation’s intent and to company law – which says that ultimately improve. Nevertheless, our Indeed, as Mark Goyder of its stakeholders’ interests. directors owe their duty to the approach is an important step forward 3 Auto Trader Group Plc 850 Tomorrow’s Company has explained: So, how does the head of a large complex company, not to shareholders – and in trying to assess the importance of 4 Compass Group Plc 843 “The increasing regulatory burden organisation ensure that the operational body is fit to the spirit of the Code, without CG risk factors and, we hope, a key not only takes up boardroom time, to deliver strategy and to take account of the balance allowing time and energy spent on contribution to the debate. 5 Ashtead Group Plc 833 but it also makes NEDs nervous of stakeholder needs? Put another way, how do the following its every letter to distract Finally, it is important to 6 National Grid Plc 832 and less likely to take risks. NEDs executive and non-executive teams have confidence from their focus on promoting the remember that the UK market faces become focused on getting through that the organisation does not have a horsemeat long-term success of the company. a challenging time: a combination of 7 Legal & General Group Plc 825 scandal waiting to emerge in its supply chain? the regulatory process to discharge Goyder adds that the issue for the corporate failings and the new prime 8 Unilever Plc 823 How can it be sure that ever-shorter cycle times their duties and there is then a are not resulting in product design decisions that GGI is the challenge that “faces all minister’s commitment to reforming 9= Investec Plc 817 steady shift of boardroom time away compromise safety or compliance requirements? And innovation in measurement”. The governance mean that British from essentials such as innovation, most important qualitative factors – companies, especially those listed on 9= Worldpay Group Plc 817 how will it understand the potential impact of its own competitive opportunity and threat, decisions on the operation and its stakeholders? for example, the quality and impact the UK stockmarket, will either have The Chartered Quality Institute (CQI) and its of boardroom conversation – need to reform themselves and improve, community of 20,000 quality professional business measuring but are hard to measure. or face government and regulatory Bottom decile Ratings by relationship with partners exist to provide that insight and confidence The less important process factors – intervention. We wholeheartedly want company through a closed-loop system of operational such as the frequency of committee to avoid the latter, but companies do Rank Name Total governance, assurance and improvement. This acts meetings – are easier to determine and need to grasp the nettle. We hope this Score Ratings as the nervous-system link between leadership tend to be dominant. report and the subsequent editions 91 Berkeley Group Holdings 613 teams and their organisations, answering key There is also the risk that the will ensure boards across the FTSE Customer 687 questions for all: 92 Mondi Plc 600 factors chosen as proxies for good strive to improve their governance Investor 302 governance prove to be outdated. For arrangements and that the debate goes 93 Sky Plc 583 • Is leadership intent defined so as to capture the example, in the real world there is a some way to changing behaviour. Supplier 222 full range of stakeholder requirements? 94 RELX Plc 567 growing acceptance that dispersed Media 108 • Is leadership intent effectively implemented, shareholding leads to absence To read the report, visit 95 Glencore Plc 557 producing the desired outcomes for the of stewardship by investors and iod.com/news-campaigns/ Employee 26 96 Royal Bank Of Scotland Group 548 organisations and its stakeholders? therefore poor accountability of the good-governance-report • Is there a culture of objective evaluation and Analyst 35 board. Yet in the criteria used by the 97 Carnival Plc 542 a commitment to continually improve? proxy agencies and the GGI itself the Oliver Parry is the IoD's head of Regulator 9 98 Shire Plc 540 corporate governance In line with our Royal Charter, the CQI will be working presence of a dominant or anchor 99 Tesco Plc 526 Other 588 over the coming months and years to help business shareholder is judged to be bad. @OliverWParry As the IoD and all who sit on its If you would like to take part in Policy Voice surveys, Total 1,977 leaders reinvigorate operational governance. 100 Hikma Pharmaceuticals Plc 500 advisory panel have accepted, the visit iod.com/policyvoice

The CQI sponsors the 2016 Good Governance Report and contributes to the Great Governance Debate. 64 Director November 2016 November 2016 Director 65