The vital importance of a holistic approach to governance

In the UK and US, the debate on governance over the past few decades has revolved around the relationship between shareholders and management. In the UK, this has particularly focused on the distinction between investors’ rights as owners of the shares and directors’ duties in control of the company as an independent entity. In the USA, the concern has been more to do with the rights of prospective buyers and sellers of the shares to adequate information about the company’s position, rather than the board’s responsibility for the proper running of the company. More recently, ESG has brought wider interests of society and the global environment into the picture.

Corporate Governance Relationships

 
A holistic approach puts the issue in the broader context of responsibility towards all parties with a significant interest in the business. These relationships are illustrated below.

What we see here are four groups:
 

1. The Board of Directors exercising supervision and accountability to the stakeholders for what the company is doing
2. The owners, customers and other stakeholders, all with an interest in what the company is doing
3. The company itself, which is supposed to deliver what its stakeholders want from it
4. The monitoring bodies:
   • The auditors, who are essentially checking on the performance of the Board through what the company has been delivering, and primarily reporting to the owners
   • The regulators, who check whether the company has been acting within the laws and regulations that apply to it.

 
Overall success comes when each of the four components successfully achieves its objectives. And successful corporate governance in the eyes of the general public means overall success for the business. Hence, we must describe corporate governance more broadly than simply equating it to compliance with laws and regulations. Successful corporate governance requires a holistic system which recognises the interests of the four groups comprising the corporate governance relationships.
 
Such a holistic system demands structuring, operating and controlling a company’s organization to achieve the following:
 

• A fundamental ethical basis to the operation
• Fulfilling the long-term strategic goal of the owners while balancing the interests of the other important stakeholders
• Considering and caring for employees past, present and future
• Maintaining excellent relationships with customers and suppliers and local communities
• Taking account of sustainability and the needs of the environment
• Complying with legal and regulatory requirements

 
Moreover, this should not be a separate discipline, but an inbuilt process of on-going corporate performance improvement using, but adapting, existing systems.
 
This holistic approach embraces naturally the fiduciary duties of Board members, and their requirement to exercise due skill and care in performing these duties, while placing them in the broader context of understanding and overseeing good management practices. It also places obligations on owners to keep themselves properly informed about what the company whose shares they own is doing, and how well the board which is supposed to be looking after the company’s interests is doing its job. Finally, it requires an audit process which is effective in meeting the expectations of the stakeholders with an interest in the business, which, of course, includes the regulators and the state.
 

Principles and Practice of Holistic Governance

It is important that there is a practical structure which can stand independent of in-house systems while linking to existing feed-back processes. The objective is to reinforce good management practices while providing the basis of a system for continuous improvement in performance in corporate governance. This will entail defining measurable metrics which provide the basis for management of the key factors and using external independent surveys to avoid organizational capture.
 
On the basis of the way successful companies conduct themselves, we can formulate a short set of rules regarding the practice of genuine good corporate governance. When we look at the record of successful organizations, we find they have to a great degree abided by these rules, and failed ones have to a large extent ignored them.
 
Specifically, we can say that holistic governance comprises five elements by which the performance of the company in terms of good corporate governance can be judged – what we can call Five Golden Rules:
 

1. An ethical approach which is in tune with the societies and cultures in which a company operates
2. Balanced objectives which fulfill the goals of all the key stakeholders
3. Strategic management rather than opportunism or clientelism driving the policy and decision-making process approach
4. An organization structured and resourced to deliver the strategic plan
5. A culture of accountability and transparency to all stakeholders.

 
This approach recognizes that the interests of different stakeholders carry different weight, but also that all stakeholders should be treated with respect. This isn’t as simple as it might be wished, as we can see by looking at the potentially conflicting aims of the main stakeholder groups:
 

• Owners:
  • long-term investors, some of whom look for regular dividends, hence possibly leading to corporate borrowing, others looking at long-term capital growth with minimal distributions and no new finance raising
  • short term shareholders who are most likely to be looking at rapid capital gains
• Customers: who will be looking at the company’s ability to survive and grow and to supply consistent quality products or services without making excessive profits at their expense; possibly with the more demanding requirement for regular innovation and hence investment
• Employees: who will expect security of employment, which in turn requires financial soundness, but not at the expense of restricting levels of remuneration
• Suppliers: who will look to financial soundness and the ability to pay their bills on time
• Bankers: who will be expecting financial soundness and security against loans, coupled with an adequate level of cover on interest payments
• General public: whose interest is likely to be in maintaining existing levels of employment in local communities or even in expanding them, which may conflict with the company’s need to restructure to preserve its future
• Government and regulatory authorities: who will be relying on compliance with rules and the payment of as much tax as possible.

Managing by these Principles

 
To achieve consistent and improving corporate governance, the Board must have in place a monitoring and reporting mechanism which permits accurate observation of corporate governance performance and encourages continual improvement. This monitoring mechanism must be based on measuring the company’s performance in regard to the five principles above, and, of course, compliance with rules and regulations is part of this.
 
Specifically:
 

• The company’s performance in regard to the five Golden Rules must be measured regularly –preferably continuously - by an on-going process of stakeholder engagement
• Performance must be determined by taking the views of the key stakeholders
• These views must be gathered by independent survey, thereby avoiding “capture” by the company’s internal systems and vested interests
• The results of the survey must be reported to the office of the chairman for consideration by the board and communicated with the key stakeholders in an open and transparent way
• Finally, the directors in preparing for their board meetings must properly brief themselves in order to carry out their legal and fiduciary duties and the company must have systems in place to facilitate this, including effective Risk management.

 
The effectiveness of the Board, and the relationship with the owners and employees are key determinants of whether the principles constituting good corporate governance are being followed. However, a further important consideration is the framework of law and regulation under which a company operates, in various jurisdictions around the world for larger businesses, and the practicality of the regulation and zeal with which regulators monitor the companies under their supervision. Similarly, the role of the auditors in supposedly keeping the company on the straight and narrow has come under serious question in the past few years. Some examples illustrate these shortcomings and make the case for auditors and regulators to broaden their own approach to their tasks.
 

Regulators’ failings and shortcomings

 
Regulation per se is not the answer to the demand for good corporate governance. There are many examples where regulation has failed. Here we simply summarize some examples.
 

• In the US, Lehman complied with all the required regulations until it ran out of liquidity as market conditions suddenly left it exposed. The regulations of the time failed to highlight this exposure, and have subsequently been beefed up.
• In Japan, Kobe, a pillar of the industrial establishment, admitted that it had been misrepresenting the results of product testing for years. The regulations were, quite simply, flouted, and the regulator failed to pick this up.
• In Australia, the banking authorities accepted the good behavior and prudence of the major banks through the aftermath of the global banking crisis, only to discover, through whistleblowing, that some very bad practices indeed had been going on for years.
• And as a final example, in the UK in 2017, a terrible fire destroyed the Grenfell Tower block of residential flats in West London, causing nearly eighty deaths. The cause was the cladding which had been installed a few years earlier to improve insulation, and which proved to be highly flammable. The search for scapegoats ranged from inadequate regulations to installers fitting non-compliant materials, but there was no challenge from the regulatory bodies prior to the catastrophic fire.

Auditors’ failings and shortcomings

 
At the time of writing, the auditing profession is under attack as never before. Summing up, we can say that corporate governance is tangled up with audit, so it is reduced to box-ticking compliance. There is a failure of audit to reflect a wider assessment of companies, and the result is that companies’ performance is signed off as satisfactory when there are underlying problems which are potentially fatal. And the general public can’t understand why this happens.
 
A few examples illustrate this.
 

• BHS notoriously had an unqualified audit report from PwC shortly before it was sold for £1 and went bust a year later.
• Carillion similarly was signed off by KPMG a year before it ran out of funds and went bust.
• Wells Fargo had been audited by KPMG and its predecessor companies for years without them spotting its fictitious accounts creation.
• There are also related questions now about these firms providing aggressive tax avoidance advice to clients which have stretched the bounds of acceptability to breaking point. This can easily be considered unethical behavior and not compatible with their role as auditors of professional standards in their clients.

Good corporate governance starts with values & purpose

In summary, the vital starting point in governance is an ethical culture, as most serious problems with corporate governance start with failings here. With this in mind, running the business successfully cannot be simply about a focus on market domination or shareholder value. And good corporate governance is not simply about the relationship between directors and owners, but about the ethos of an organization and fulfilling its clearly agreed goals. 

To arrive at universally acceptable goals, there has to be a process of identifying the different needs of key stakeholders, and, as much as possible, harmonizing them. This is the starting point for the smooth running of the business – keeping all parties in tune with the goals of the business and thus with each other.
 
A system of holistic corporate governance as outlined above, and exercised by the Board in an ongoing relationship with key stakeholders and the wider community, would bring most failings and malpractice into the open at an early stage. Boards cannot rely on compliance, as regulation and audit will always be playing catch-up.