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A Question of Corporate Governance

Do corporations need guidelines or regulations?

Published in 2013 London Super Lawyers magazine

For the past few years, the phrase “improved corporate governance” has caused concern in Britain’s company boardrooms. Its definitions are bewilderingly manifold. “Every aspect of corporate governance, from the issue of bonuses and remuneration through to accountability and the respective responsibilities of directors and management, has become a key focal point for investors,” says Covington & Burling corporate partner Simon Amies.

The financial crisis started the dominoes toppling. Previously trusted brand names—The Royal Bank of Scotland, Northern Rock, UBS, Barclays—were forced to show weak poker hands. Then came the “shareholder spring”: the protests voiced against the astronomical salaries senior managers awarded to themselves. In 2012, for example, the Association of British Insurers issued a rare “red top” warning after the mining company Xstrata proposed a $270 million payout to retain Xstrata managers—unrelated to performance—in the event of its merger with Glencore International. It was, says one lawyer “sort of extraordinary that in the current climate they thought they’d be able to squeeze that in.”

The government has been keen to make admonitory noises about failures in corporate governance but reluctant to meddle—adhering to the underlying principle that once it has established basic standards of transparency and good practice, government should refrain from interfering.

Of course, as Norton Rose’s Robin Brooks points out, “In the short term, good governance and return are not necessarily linked. Quite often, investors are looking for the assurance that comes out of association with a dominant individual”—for example, a majority shareholder or a CEO that commands the respect of the market.

This conundrum is amongst those considered by the Kay Review, which was commissioned in the wake of the takeover by Kraft Foods of Cadbury, a UK confectionery business established under Quaker principles in the early 19th century, and a byword for an old-fashioned, philanthropic approach to business. The takeover was widely criticised—especially after the company’s new owner reneged on pledges that it would not close a long-established factory.

The underlying theme of Professor John Kay’s report is the need to reshuffle priorities within the business world and put an end to a culture which rewards failure and under-invests in product development, employee skills and customer reputation.

This “myopic behaviour,” Kay writes, “is the natural human tendency to make decisions in search of immediate gratification at the expense of future returns, decisions which we subsequently regret.”

Kay’s recommendations are welcomed by the government, which is drawing up good practice guidelines—not regulations—accordingly. To the detractors of this approach, it too closely resembles a code of honour appropriate to a Pall Mall club.

Yet failure to respect the corporate governance code is not to be disregarded. “Corporate governance for listed companies is premised on adherence to the principle whereby they are required to either comply with listing requirements or explain why they have chosen not to do so,” says Amies. He points out that the only real penalty for neither complying nor explaining is the resulting distrust of potential investors.

The problem is compounded, says Amies, “when companies come to London markets, and understand that the corporate governance rules are not a hard and fast law, and so think, ‘Not all UK companies comply, so why should we?’”

Marcus Young, a senior associate at the London office of King & Spalding with experience advising public companies, agrees that many of the most notable corporate governance issues are related to resources companies from outside the UK that typically, he says, “have very opaque ownership structures.” He is optimistic that some of the steps promised by the Financial Services Authority will help improve standards, including the FSA’s pledge to more firmly enforce the rule that a listing company floats at least 25 per cent of shares.

Plus, he says, there’s been a genuine shift in the way corporate governance is perceived: “In-house counsel approach us much earlier when they have concerns,” he says. “They’re facing much greater regulatory headwinds today than they were some years ago, and are very much more proactive about managing risk. … Risk is now much more tangible for senior managers and executives because it is now more likely that personal liability may attach to such individuals, and these concerns are reflected by in-house counsels’ increasing emphasis on risk mitigation and prevention at an early stage.”

Failures in corporate governance will always be a part of the rough-and-tumble of business. As Amies notes, “It’s only when things go wrong that people start picking up on these things. But good corporate governance is absolutely no guarantee of success.”

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