With thanks to Liz Reily of Accountancy Ireland)
The future of Ethics and Governance
As the new tax year takes off, our social media is overflowing with reflections on the past year and its learnings. Thoughts on governance and ethics take the long view and it is so delightfully tempting to make predictions. I’m proposing to look at trends for the upcoming year based on recent developments, with consideration on where the trends may lead our thinking . This article addresses corporate governance and the ethics agenda. It attempts to identify trends and issues which professionals are likely to see unfold soon.
Observations from the business of corporate governance
Intense activity from legislators and enforcers continues apace. There have been recent legislation updates, publications on corporate culture and on corporate governance and stewardship, and government requests for corporate governance reform.
Of high impact and concern for individual directors and boards are:
The broadening of directors responsibilities
The roles and duties of directors being more thoroughly defined
The inclusion of ethics and culture in more corporate governance conversations
The conversation between corporation and the state
These observations are made from new Irish legislation codifying directors responsibilities and recent reports from the Financial Reporting Council (FRC) in the UK. There is also heightened interest in ethics at the core of the corporate governance conversations, and this is evidenced in the observations from the FRC in Corporate culture and the role of boards, 2016 discussed further below.
Directors are now more specifically accountable than before, following the codification of Directors duties and responsibilities in the Companies Act 2014. The new Code of Practice for the Governance of State Bodies, August 2016, makes directors specifically responsible for all internal controls: financial, operational, compliance and risk management (P34). Previously directors specifically reported only on the financial controls and the broader responsibilities were implicit.
Corporate culture is also being defined as an area of specific responsibility for directors. Last July, the Financial Reporting Council of the UK published a document called, Corporate Culture and the Role of Boards: report of observations (July 2016). This interesting document comments that strong governance underpins a healthy culture, and that boards should demonstrate good practice in the boardroom and promote good governance throughout the business. The report examines some thought-provoking questions:
How can the board influence and shape culture
How does the board bring corporate values to life
Building trust with stakeholders
How can boards assess, measure and monitor culture
The report suggests that the tone from the top determines organisational culture; it suggests that boards should assess the culture and determine indicators thereof. The board is therefore responsible for the culture, values and ethical standards in their organisations. This gives the directors the very broad responsibility of not only setting the culture and values, but also of measuring and assessing organisational culture.
The report requests investors and other stakeholders to engage constructively to build respect and trust, and work with companies to achieve long-term value. Investors therefore need to consider carefully how their behaviour can affect behaviour of the company and understand how their motivations drive company incentives.
As board members, this leaves us with a brighter light being shone on our broad responsibilities to the organisation and the stakeholders while we are also charged with the ongoing quest for effective measures of corporate culture, and the implementation of corporate values throughout the organisation.
Corporate and individual ethics
In practice the role of the board in “bringing values to life” as discussed above, is problematic: for just over half of responses to the question “how frequently is ethics and culture a full board agenda item?” The responses were that 61.5% of boards do not regularly make ethics and culture a full board agenda item. (“Corporate culture and the role of boards, 2016). The survey responses were as follows:
Corporate values and ethics have been keywords in lamenting the recent large corporate scandals which continue unabated at home and abroad. Media reporting focuses not only on corporate governance and the board, but on ethical standards of the board and the individual directors: In a report by Reuters last September “Wells Fargo scandal reignites the debate about big bank culture”. In a scandal with huge reverberations, two former Wells Fargo employees filed a class action in California seeking $2.6bn or more for workers who tried to meet aggressive sales quotas without engaging in fraud and were later demoted, forced to resign or fired. “Wells Fargo knew that their unreasonable quotas were driving these unethical behaviours that were used to fraudulently increase their stock price and benefit the CEO at the expense of the low level employees,” the lawsuit said. All this was reported in The Guardian in September 2016.
Closer to home, Fintan O’Toole expressed his outrage in the Irish Times, Jan 2, 2017: “ the appalling scandal in which the banks deceived at least 15,000 of their customers into moving from tracker mortgages to considerably higher interest rates, often at dreadful personal as well as financial cost. It is clear that this defrauding of customers was systematic and deliberate. It operated in 15 banks – essentially the entire Irish system – and so far as we know there is not one case of a “mistake” favouring the customer. It raises in the starkest way exactly what (Matthew) Elderfield was talking about: individual accountability for misselling and overcharging”.(Fintan O’Toole: Irish banks have got away with major fraud Gardaí have yet to investigate how thousands were tricked into switching mortgages Tue, Jan 3, 2017).
Apart from the human misery which we as a society are accepting, what this means for Ireland is that despite our high levels of compliance and regulation we have not created corporate and individual accountability nor a culture of ethical behaviour in our institutions. There is much to be done to align corporate culture and individual ethical standards.
In Leading with Integrity: A Practical Guide to Business Ethics: Ros O’Shea firmly puts corporate ethics as the responsibility of the individual directors on the board. She links individual leadership values to the values which filter down through the organisation. This conversation is likely to gain momentum in 2017 with the ongoing lawsuits; as we continue further review, question and discuss our ethical guidelines and our own professional ethics.
Corporate Governance reform
We can expect further Corporate Governance reform from the UK. Prime Minister Teresa May states that: “for people to retain faith in capitalism and free markets, big business must earn and keep the trust and confidence of their customers, employees and the wider public”. This quote is part of her introduction to the 2016 Green paper on Corporate Governance reform, which sets out a new approach to strengthen big business through better corporate governance. In the foreword, the UK Secretary of State Greg Clark summarises that “the Green Paper seeks views on three areas where we want to consider options for updating our corporate governance framework:
First, on shareholder influence on executive pay, which has grown much faster over the last two decades than pay generally and than typical corporate performance
Second, on whether there are measures that could increase the connection between boards of directors and other groups with an interest in corporate performance such as employees and small suppliers; and
Third, whether some of the features of corporate governance that have served us well in our listed companies should be extended to the largest privately-held companies at a time in which different types of ownership are more common.”
(Highlights are made by the author)
Certainly the thinking in the UK – surmised from this report, indicates that Adam Smith’s Wealth of Nations is left far behind, and society and democracy are not separate from, but are an integral part of, the values and actions of corporations. The wider societal responsibilities of companies and boards are under scrutiny. There is a recognition, certainly in the UK, of companies’ responsibilities to employees, customers, suppliers and wider society.
Diversity
Diversity on Boards remains an area of huge interest for researchers and policy-makers. We are starting to accept the causal link between board diversity and better profitability. The Green paper referred to above, suggests that board composition should better reflect the demographics of employees and customers. Implicit in that statement is a board more representative of the community it serves.
According to a Mckinsey report, workplace diversity would improve Gross Domestic Product (GDP) in the UK: “The Business Rationale Bridging the UK gender gap in work has the potential to create an extra £150 billion on top of business-as-usual GDP forecasts in 2025, and could translate into 840,000 additional female employees. In this scenario, the United Kingdom has the potential to gain 5–8 percent in GDP." Mckinsey, September 2016.
Robert Swannell, Chairman of Marks & Spencer is quoted in the Hampton-Alexander Review of FTSE Women Leaders: improving gender balance in FTSE Leadership, (November 2016). “I certainly believe having more diverse boards and senior teams is right and brings better perspectives, challenge and outcomes. It is right for business to reflect the world in which we operate and so we should just get on and do it."
Adam Smith’s support for maximising profits by harnessing employee expertise is replaced by boards, executives and management addressing and including the concerns of all stakeholders in the corporate world.
Stakeholder engagement
Considering the FRC statement below, directors are being charged with aligning the interests of business and society, as part of their corporate governance responsibility:
“We share the objective of wider stakeholder engagement by companies and are considering how corporate governance principles can best meet the demands of all stakeholders or be amended to do so. We look forward to responding to the Government’s consultation later this year and will propose measures to realign the interests of business and society”.
“The Financial Reporting Council (FRC) supports the need for change in the relationship between business and society. As the guardian of the UK Corporate Governance and Stewardship Codes, the FRC is keen to explore how it can ensure governance and investment are more closely aligned with the broad public interest” (FRC October 2016) These statements go way beyond the corporate social responsibility (CSR) programs which corporations heretofore were content with. Corporations are now charges with holding obligations to all stakeholders and being accountable to society as a whole. Similarly, directors are therefore held to account in relation to their obligations to all stakeholders. The UK Stewardship Code, not updated since 2012, but is under continuous review for its impact and implementation.
Directors - some key concerns
The broadening and better definition of the role and responsibility of directors is a likely interest area for the future as directors are increasingly responsible for a much wider range of legislation and compliance. Recent surveys show that role clarity, complexity, sustainability, changing business models, corporate culture and business reputation in the community are key concerns.
Recent research undertaken by Chartered Accountants Ireland published in the October 2016edition of Accountancy Ireland and written by Mary Halton, suggests that role clarity in the boardroom is a driving factor in board effectiveness. The article continues: “In theory, this should be a relatively straightforward issue, particularly in light of the significant legal, regulatory and good practice guidance available. In practice however, boards and their members face a number of challenges in delineating roles and ensuring that these are consistently understood by all”.
Increasing complexity and time commitment of non-executive directors’ roles is the key finding from a survey by the Institute of Directors in Ireland (IoD) of 385 of its members in 2016. The IoD surveyed NEDs from private state and public boards.
The Australian Institute of Company Directors surveyed their members in December 2016 on the issues most likely to keep them ‘awake at night’. The results were identified as follows in order of importance:
sustainability & long-term growth prospects
structural change/changing business models
corporate culture
business reputation in the community
legal and regulatory compliance Corporation and the state Corporate governance reform is underway in the UK and indeed in Ireland against a background of government-led reforms. There is a corporate interest in being more responsible and more state-like. This suggests that the lines between corporation and state may be blurring. Similarly, the US elections were beleaguered with accusations of corporations wielding influence on the outcome via large funding for the candidates. Certainly the future lies in greater regulation of corporations and greater expectations of corporate governance standards. This is also occurring when corporations are gathering more power, money and influence than sovereign states, and at a time when the workplace is becoming more transparent and more democratised. Penelope Kenny is a Chartered Accountant, she offers financial control and corporate governance implementation and consulting. She has recently written Corporate Governance for the Irish Arts Sector (2014) published by Chartered Accountants Ireland.
Chartered accountants are charged as professionals and often as board members to navigate in this increasingly political space, not just to direct and govern but also to influence, guide and comment on compliance and regulation. The duties and responsibilities of board directors are requiring more professionalism and more knowledge. We know our responsibilities do not increase or decrease with the size of the organisations we direct and govern nor with remuneration for these roles, yet those responsibilities are expanding. The boundaries of the study and discipline of corporate governance itself are widening and shifting. As we have seen from the UK prime Minister’s comments on the reform of corporate governance - better corporate governance is a driver for such issues as corporate responsibility, improved profits and more stakeholder engagement, to name but a few. Interesting opportunities abound.
Boards are under pressure to represent a more diverse opinion and to mirror the communities which they serve, meanwhile these communities are becoming more vocal. Peter Cosgrove of CPL showed the recent Chartered Accountants Tech Forum how employees at Mozilla effectively fired their CEO Brendan Eich, through social media pressure, looking remarkably similar to a form of popular voting. (Eich maintained a public stance against gay marriage in 2014 and employees disagreed.)
In conclusion
In 2016 we saw the rise of a populist, anti-establishment voter. In Ireland, the water charges were an example. The tussle between states and corporations was exposed with the Apple taxes and DeutcheBank fines in a dialogue between Europe and American legislative and tax authorities. As our corporations change in goals and purpose and our governments struggle with the corporate environment, this tectonic abrasion between corporations and governments looks set to continue.
Directors are showing interest not only in the business environment which delivers profits but also showing an increased self-consciousness about themselves as directors and their roles and responsibilities. Formalising this trend, the Board self assessment questionnaires mandated by the Code of practice for State bodies 2016 requires boards and the audit and risk committees of state boards to self-assess for effectiveness.