How to explain corporate governance shortcomings

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    One of the enduring adages of corporate governance is that it is a philosophy and not a tick box exercise. Company secretaries and corporate governance experts can often be heard stating this line and, like many clichés, it is often repeated because it’s true.

    A company can fulfil all the requirements of its relevant code(s) and not embrace the fundamentals of corporate governance and, more importantly, a company can deviate from its relevant code(s), but still have a sound approach to corporate governance at its heart. It is the second of these scenarios that I’m going to look at here.

    Despite not being a tick box exercise, the various codes of governance across the world are there for a reason; because they provide a sound framework from which to run a corporate governance regime. They also give a benchmark from which the company’s stakeholders, directors and company secretary can judge the performance of the company.

    In the UK, the main code is the UK Corporate Governance Code (in this article, the “Code”) but there are various other guidelines and codes that UK listed companies should bear in mind. These include the guidelines of various institutional shareholder bodies such as the Association of British Insurers and the National Association of Pension Funds.

    What all of these rules have in common is that they are not mandatory. They are guidelines that applicable companies will look to adopt but are free to deviate from if they feel that such deviation is in the interests of the company. The Code itself differentiates between the Main Principles, which are mandatory, and the supporting provisions which can be deviated from if good governance can be achieved in other ways:

    “A condition of [deviation] is that the reasons for it should be explained clearly and carefully to shareholders, who may wish to discuss the position with the company and whose voting intentions may be influenced as a result. In providing an explanation, the company should aim to illustrate how its actual practices are both consistent with the principle to which the particular provision relates and contributes to good governance.” – UK Corporate Governance Code 2010

    Yet, for a minority of companies, this option to explain deviations from the Code has been utilised without due regard to the above principle or the concerns of shareholders. Many explanations given by companies are substantial and useful to shareholders, yet a few are brief and dismissive. This has caused some concern and has led the Financial Reporting Council (the governing body of the Code) to carry out a discussion with relevant directors and company secretaries and to report on what constitutes a proper explanation under the Code.

    In the words of the report:

    [An explanation should be] full andinclude reference to context and coherent rationale. They should explain how the company isfulfilling the relevant principle of the Code and also whether deviation from its provisions istime limited. Ideally explanations should be sufficiently full to meet the needs of thoseshareholders who could not simply call up the company and ask for information, but largershareholders also saw them as the foundation for further dialogue that should engender trust.

    Even the best explanations though, are often considered to merely counter the deviation from the Code. Providers of company secretarial services often feel that a company that deviates from the Code and provides a good explanation should still only be considered on a par (form a corporate governance perspective) from one that has followed the provision.

    Arguably this goes against the idea that corporate governance is not just a tick box exercise. If done properly, limited deviations from the Code, coupled with full and complete explanations can show that the company is truly considering and embracing good corporate governance and this should be encouraged rather than criticised.

    Nick Lindsay is a UK corporate lawyer and director of Elemental CoSec, a provider of company secretarial services. This article is for informational purposes only and should not be relied upon as specific advice or acted upon without seeking legal advice.