Corporate governance review: Ditch the boilerplateby
Julia Penny summarises the Financial Reporting Council’s advice to put more emphasis on meaningful narrative in corporate reports.
The November 2020 Review of Corporate Governance Reporting from the Financial Reporting Council (FRC), which examines the first year of compliance with the 2018 Corporate Governance Code (the Code), starts with a foreword by the regulator’s new CEO Sir Jon Thompson.
The former HMRC chief executive brings a breath of fresh air in his direct assessment of both the good and the bad in corporate governance and its reporting. Sir Jon recognises there have been some excellent examples of reporting, but his overall assessment is that most reports do not demonstrate the high quality of corporate governance that the FRC expects.
In particular, he took issue with formulaic approaches, where strict compliance with the code resulted in a box-ticking mentality rather than concentrating on achieving good governance. This approach, he writes, “is a disservice to the interests of shareholders and wider stakeholders and ultimately is not in the public interest; it undermines trust”.
Several of these phrases have also cropped up in relation to problems in audit. To have strong, trustworthy businesses requires first that companies are well run, that is, have good corporate governance. Secondly, the auditor’s role is to add a layer of assurance over what the business reports in its financial statements, though auditors have limited responsibilities for other aspects of reporting.
Both these aspects need to work well. Directors of listed companies in which individuals, investment and pension funds invest, must take the governance of their companies seriously. And auditors must call out in their audit report, if anything being reported is not true and fair or otherwise compliant with the relevant standards or legislation.
Corporate reporting should be underpinned by the principles of transparency, clarity and integrity and give a true overview of the company’s business model and operations, structure, activities and performance, explains the report. This gives companies an opportunity to explain their unique story to their stakeholders. Far too often, all they offer is a series of compliance-driven boilerplate statements. The FRC is clear that this is not enough, and companies must move towards meaningful narrative about their compliance with the Code.
The Code is strongly regarded and perhaps offers one reason why companies have increasingly sought to “comply” rather than “explain” any non-compliance. But the FRC emphasises that not all companies are the same and there may be genuine reasons for departing from the code and explaining the reason. This is why the Code is just that, a code, where the provisions are recommendations rather than requirements.
So rather than just wriggle around to state they are fully compliant, when really they are not, companies should clearly explain the reasons for any non-compliance.
The FRC sets out its arguments in a clear, easy to read format and I fully recommend that anyone involved in corporate governance reads the report in full. To give a flavour of some of the key recommendations here are some of the areas where the FRC expects better reporting:
- Companies should have a well-defined purpose and clearly show the progress towards this
- There should be discussion of issues raised and considered, and feedback received, from engagement with shareholders and employees
- There should be clarity in showing the impact of engagement with stakeholders on decision-making, strategy and long-term success
- Increased focus is needed on assessing and monitoring culture, including metrics
- Increased attention and better reporting of succession planning, diversity and board evaluation is needed
- Reports should clearly show the impact of engagement with shareholders on remuneration policy and the outcomes; and
- Clearly show the impact of the engagement within the workforce in relation to executive remuneration policy.
There are several references to the impact of engagement, rather than just the fact of the engagement itself. After all, if there is engagement with others but it has no impact on decision making and actions, then arguably what is the point?
Instead the report suggests that including examples helps to tell the story of how actions have been influenced by those discussions. For instance, if the company recognises that there is a lack of diversity, what has it done about this? To merely state that the organisation values diversity, but then to present a board or workforce which is not diverse, does nothing to create good corporate governance.
This will perhaps seem a big shift for a number of companies, moving to a higher level of engagement with the requirements and genuinely asking the difficult questions about the quality of the company’s governance. The FRC recognise that in next year’s reviews the impact of COVID-19 will be significant. Some companies may be tempted to think that it is more important to concentrate on such current challenges but the requirements of good governance are not meant to distract from issues such as this, but to help boards tackle them effectively.
Tougher regime on the way?
Many of the points in this report are not really new and again, perhaps this strikes a chord with what has been seen in the FRC’s reviews of audits - what you might call a repetitive failure syndrome.
What might change in future though, is that when the FRC becomes the Audit Reporting and Governance Authority (ARGA), it will have new powers to engage with companies about the quality of their governance reporting. This might stop the rot earlier and prevent companies being run in a way that increases the risk of disorderly failure or misreporting of results and financial position. Because although the review is of what is reported, this is inextricably linked with the underlying good, or not so good, governance of these companies.
You might also be interested in
Julia Penny is the principal of JS Penny Ltd which provides technical and training consulting on anti-money laundering procedures, auditing and financial reporting. Julia is a member of ICAEW Board and Council, chair of the ICAEW Ethics Advisory Committee and past chair of the ICAEW...