EU Corporate Governance: One size does not fit all
In an opinion piece on the recent EU green paper on corporate governance, Professor Alistair Bruce comments that the EU Corporate Governance Framework, which sets out the key governance challenges facing corporate Europe, raises few new questions. He warns that its aspirations will prove extraordinarily difficult to realise, as policymakers seldom get the outcomes they want. Alistair Bruce is Professor of Decision and Risk Analysis at Nottingham University Business School.
His latest research on executive remuneration will be presented at a Financial Services Research Forum Seminar at the London offices of Experian on October 11.
A version of this article originally appeared in the FT publication Investment Adviser as 'EU Corporate Governance: Transparency is key' on August 29 2011.
One of the principal aims of the recent EU Green Paper on corporate governance is to reduce the chances of Europe being dragged into another financial crisis as a result of shortcomings in the way companies are run. It hardly need be said that this is a noble objective, but the harsh truth is that anyone who sincerely believes in the prospect of effective pan-European regulation is likely to be disappointed.
Legislating for or otherwise encouraging better corporate governance practice is in itself extremely difficult and is frequently regarded by firms as an intrusion on their internal affairs. With widely differing national conventions and architectures to consider and jurisdictions that are exercised by such issues to sometimes significantly varying degrees, intervention on a European level is inevitably even more fraught.
Entitled The EU Corporate Governance Framework, the Green Paper sets out the European Commission's views on the key governance challenges facing corporate Europe. It follows 2010's Green Paper on corporate governance in financial institutions, which was on the whole very similar in tone and theme – that is, a litany of hand-wringing over well-established and probably quite intractable problems.
Of all the countries in Europe, the UK has arguably led the field in corporate governance. For around 20 years it has been agonising over the roles the business community and government should play. This is evidenced by a string of committees and associated reports, among them Cadbury, Greenbury, Hampel, Smith, Turnbull, Higgs and Walker, as well as the development of the Combined Code and the Stewardship Code as indicators of good practice.
The 2011 Green Paper therefore raises few questions that have not been entertaining students of corporate governance for the past two decades. Nonetheless, it is helpful to examine some of its main points with a view to understanding why its overarching aspirations will prove so extraordinarily difficult to realise – and in due course to explain why, as perhaps most infamously demonstrated within the financial sector, policymakers seldom get the outcomes they desire.
i. Boards of directors
Here we have all the increasingly familiar pleas, among them greater diversity, improved scrutiny of performance and enhanced commitment among non-executives. An analogous agenda was prominent in 2010's Green Paper, which criticised the highest levels of financial institutions for a lack of risk-management expertise, a failure to comprehend the complexities of business and general supervisory inadequacies.
Criticisms here include an overall paucity of shareholder engagement, tacit support for excessive risk-taking given the asymmetry of gains and losses, short-termism, the scarcity of incentives for active shareholders and the fundamental problem of free-riders.
iii. Comply or explain
The paper highlights the tension between the flexibility of the comply-or-explain approach and the desire for developing a common framework, underlining the need for increased engagement by regulatory agencies with deficiencies in governance practice.
In other words, then, nothing much new. How to get boards working more effectively, how to engage shareholders, how best to intervene to promote better practice – these are puzzles that have long fascinated certain jurisdictions while proving of comparatively little interest to others.
And there's the rub. The overwhelming suspicion has to be that these conundrums are most effectively dealt with at a national level. Differences between unitary and dual board structures, differences in pay components, differences in patterns of shareholding and/or blockholding – all militate against the sweeping, one-size-fits-all solutions of which the 2011 Green Paper dreams.
The fact is that to get beyond mere generalities and the senseless re-rehearsal of established governance concerns we need to recognise how remarkably context-specific the situation really is. Only this allows a proper and more forensic grasp of the problem and how solutions might be crafted within a particular national setting. And even then, it must be stressed, there is no guarantee of success – least of all in the financial sector.
By way of example, witness events in the UK in relation to the debate over executive pay. The 1995 Greenbury report criticised Executive Share Option schemes and recommended their replacement with tailored Long-Term Incentive Plans. The consequence? Corporates – financial institutions chief among them – shifted from relatively standard, well understood and quite simple ESOs to bespoke, highly complex and downright obscure LTIPs. The superior alignment between the interests of executives and shareholders that ESOs appeared to deliver was sacrificed: LTIPs were seen not only to damage that alignment but to sustain notably high levels of executive reward.
Similarly, the anti-bonus rhetoric from UK political leaders and regulators early last year has failed to translate into effective curbs on bankers' pay. Bonus levels in 2011 have been close to those in 2010, while base salaries are now significantly higher in anticipation of restrictions that have not materialised. This is a classic instance of a seemingly well-intentioned (and populist) intervention having unintended consequences.
Another may be the drive to transform the role of non-executive board members. The notion sounds honourable enough, but it overlooks important considerations. The attractiveness of a non-executive position diminishes as the responsibilities and accountabilities it entails are ramped up, and the independence of non-execs could be compromised if their incentives and rewards are increased to reflect the task's growing demands.
If even national-level and seemingly principled measures can occasion such inadvertent and maybe even damaging consequences, how naive is the prospect of EU-wide legislation? The concept is not so much pan-European as Panglossian.
Ultimately, there are still those companies that espouse good governance and those that resist it; those that genuinely strive to promote alignment between corporate stakeholders via remuneration arrangements and those that merely seek to inflate rewards irrespective of performance; those that genuinely seek out challenging non-execs and those that merely appoint decorative and compliant ciphers; those that are dedicated to openness and those that prefer to keep their internal dealings opaque. Short of far more interventionist legislative arrangements, this is likely to remain the case – and there is absolutely no reason why a particular set of arrangements that works in one context should translate to another.
If the UK's own governance standards and codes are widely admired and in part even copied then it is because progress towards respectability has been enabled by a domestically-focused approach that is sympathetic to considerations such as legal, regulatory and institutional frameworks, the composition of the institutional shareholding community, the nature of the equity market and the Stock Exchange rules that govern it, what is politically acceptable and so on. The understanding of governance issues and instruments in this country has thus improved enormously, as have the robustness of governance regimes and the transparency of company dealings and internal arrangements.
It is in greater transparency, in fact, that our best hope perhaps lies. If we encourage greater transparency then we may begin to see more involvement from institutional shareholders. But even then we must be prepared to accept that progress is likely to be slow and practices will be only nudged forward. To believe otherwise, to be blunt, is completely unrealistic.
Posted on Wednesday 14th September 2011