Corporate governance green paper is a call to arms, September 1, 2017
1st September 2017
A modern economy requires productive, purposeful and long-term orientated companies based on a partnership between shareholders, managers and stakeholders. So the UK government’s response to its green paper on corporate governance is timely. It aims to create an “effective system of corporate governance which incentivises business to take the right long-term decisions” through greater stakeholder participation, fairer executive pay and superior governance in private companies.
But policymakers and business leaders should push on from this starting point.
The potential to radically reform UK business, to create an economy “which truly works for everyone”, extends far beyond these three channels. Using the green paper response as a call to arms will help UK business to deliver long-term value, in all regions and sectors. At The Purposeful Company, established by the Big Innovation Centre, we have been working on these challenges for two years. We have marshalled the world’s best evidence, combined with the insights of leading investors, executives, policymakers, consultants and academics, to design a set of policy reforms that will help make good Britain’s shortfall of purposeful companies. The crux of our approach is evidence that companies that invest in their stakeholders also deliver superior long-term returns to shareholders.
We welcome the emphasis on strengthening stakeholder voices in corporate decisions. But the starting point for this must be for the company to define and communicate its purpose — its reason for being and how it seeks to contribute to human betterment. Directors’ duties include promoting the success of the company, and this success must be defined. Having done so, the company then can determine which stakeholders are most critical, and thus which voices to seek, on what issues, and through which channels. While a company has a responsibility to all stakeholders, few corporate decisions will benefit every single one — spending more on employee training may reduce the innovation budget. A requirement to consider stakeholders equally provides little practical guidance for navigating these trade-offs.
Reorientating governance towards stakeholders extends beyond strengthening stakeholder voices. A board should highlight the strategic assets that are critical in delivering its purpose, and then invest in them and monitor the value they create. This could, in turn, lead to the creation of new board committees, such as a strategic assets committee, human capital committee and innovation committee.
The government’s response has highlighted companies’ responsibility to report on their Section 172 duties of the Companies Act to stakeholders, but many other aspects of the current reporting framework should be overhauled. At present, there is a substantial disconnect between reported measures of value and a company’s true value. Accounting systems must shift focus from tangibles to intangibles, from the short term to the long term, and from shareholders to stakeholders.
A standard objection is that intangible, long-term and stakeholder-focused metrics cannot be quantified. But the fact that something cannot be quantified does not mean that it cannot be measured. There are increasingly objective ways to measure stakeholder stewardship, such as customer satisfaction, employee engagement and environmental emissions. Moreover, any measures should be supplemented with narrative reporting in the strategic report. The new framework could involve a vastly expanded strategic report that covers purpose, strategy, intangible assets and performance indicators, and is assured to the same rigour as today’s financial reporting. This means that the audit profession needs to be challenged to quickly modernise the way it operates. In parallel, a modern economy requires a properly independent regulator that is not constrained by limited powers and resources. The Financial Reporting Council’s powers are weaker than other corporate regulators and this needs addressing. It is a priority for the economy that it should have full investigative and enforcement powers over listed and private companies.
We propose that the government works with the FRC to develop new frameworks for governance and reporting that are centred around the delivery of purpose and long-term value. But companies should not wait for legislation or redrafted codes to act. Evidence shows that treating stakeholders responsibly leads to superior long-term shareholder returns. So it is in companies’ interest to be on the front foot.
We do not underestimate the magnitude of the challenge. It is easiest to govern and report on short-term, tangible, shareholder value. But we do not underestimate the magnitude of the opportunity either. Capitalising on the momentum embedded in not only the government’s response, but also the energy for reform from business and society that the green paper has catalysed, can repurpose UK business and ensure that it creates long-term value for shareholders and society.
Alex Edmans and Clare Chapman are members of The Purposeful Company steering group