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UK Corporate Governance Code

Against the backdrop of an ongoing government review into the Code, Konstantinos Stathopoulos explains how academic research is helping shape the debate.

As Professor of Accounting and Finance Konstantinos Stathopoulos admits, it is virtually impossible to build a fail-safe financial system that prevents corporate failure or scandal. Indeed we only have to look back to the 2008 financial crisis to see how governments and regulators alike can be completely wrong-footed by events.

A decade on from that crisis and regulators across the world are still grappling with its after-effects and how they can make their corporate governance systems stronger. Even in the UK, where the Corporate Governance Code is recognised the world over as a standard setter, regulators are looking at how they can further improve it.

As such the Financial Reporting Council (FRC) has embarked on a major review of the Code which will become effective from January 2019. In parallel to this review, the FRC is also reviewing its Stewardship Code which looks at principles of effective engagement between institutional investors and public firms.

Prof Stathopoulos has been researching these areas for many years and says the Code has broadly served the financial community well over the past 25 years. “However new business trends are emerging and there are important issues that need to be debated and which need to inform the new Code. For example, with large private firms increasingly choosing not to list their shares in equity markets, and new director responsibilities and duties stretching boards’ ability to be effective monitors, we need to update our thinking and practices from a policymaking and business practice perspective.”  

Ambition

In particular he believes it is time for the Code to be more ambitious in relation to outstanding problems such as director independence and what he terms the ‘busyness’ of so many company directors.

“What we have seen in recent times is directors taking non-executive positions at a number of different companies. But what the research has also told us is that busy boards lead to worse long-term performance and oversight. Busy boards are also less likely to fire underperforming CEOs and typically award higher pay.”

He says at the moment the Code’s provision is that full-time executive directors should not take on more than one non-executive directorship in a FTSE 100 company or equivalent. “But what about executives holding multiple positions at FTSE 250 companies? There is nothing to stop you having multiple directorships.”

He adds that there is very little evidence that board independence is actually board enhancing. “In my view this has more to do with the Code’s definition of independence. For instance, it doesn’t take into account the impact and significance of social networks, other than through extreme cases, such as close family ties. Indeed social networking at the board level has been shown to actually damage firm value. Even though social networks facilitate the effective exchange of information, they also encourage groupthink and lead to fewer checks and balances.

“At the end of the day you are less likely to challenge a friend in a boardroom setting. Also, although there is evidence that nominally independent directors can improve some governance outcomes, there is little evidence that they improve long-term firm performance.”

Going private

Meanwhile the government has established the Coalition Group that will develop new corporate governance principles for large privately-owned businesses. Prof Stathopoulos says this is prescient given the increasing number of ‘mega’ large businesses that are now privately backed by investors such as private equity or hedge funds.

He personally believes it is a missed opportunity for the new UK Corporate Governance Code not to apply to large private firms. “I have actually invited the FRC to apply the Code for listed companies to very large private firms but there is a reluctance to do this at the moment. The view is that this would be too intrusive.

“I would argue that there is a significant need for large private firms to adhere to the same standards as listed companies. Some private firms are now so large that they have a major societal impact, especially when things go wrong, such as we saw with the collapse of retailer BHS which ran a huge pension scheme. In that sense, having too many tiers in standard setting is not optimal. Despite the differences in the nature of governance problems faced by public and large private firms, the inherent flexibility of the Code could be used to good effect.”

Another factor in this wider debate is the power that certain individuals can wield over large companies, even if they are listed on stock exchanges.

For instance some of the largest tech groups have created dual class share structures which allow their founders to retain a greater percentage of voting rights. Prof Stathopoulos points to the example of Facebook where Mark Zuckerberg controls the majority of voting rights even though he owns less than one per cent of the company’s publicly traded stock. “There has even been talk of the London Stock Exchange allowing such structures for premium listings in the UK which would be a very retrograde step in terms of corporate governance.”

Informing the debate

Alliance MBS has been at the heart of these debates, and earlier this year co-hosted a major event in Manchester with the FRC for businesses and investors.

As Prof Stathopoulos adds: “The conference set out to bring parties together in the same room to debate these issues and try to be more ambitious about what we want to achieve in terms of the changes to the Code. Personally, I am really passionate about corporate governance research because we cannot have well-functioning financial markets without corporate governance. We need to make sure that the UK continues to play a leading role in setting out appropriate frameworks of best practice, and academic research can and should inform these debates.”