Getting Corporate Governance Right

The debate about the shape of corporate governance after the banking crisis is beginning to take shape. The Financial Reporting Council published its UK Corporate Governance Code last week. According to the Code, Board Directors should face annual re-election in a move to create greater accountability in the wake of the recent financial crisis.

In addition, the Code also calls for greater clarification of the Board’s responsibilities with regard to determining and managing risk; ensuring that the composition of the Board has the appropriate balance of skills, experience, independence and knowledge to enable it to discharge its duties effectively; that there is a greater alignment between performance related pay and the long-term interests of the company and that the Board is appropriately trained, informed and evaluated.

While much of this sounds like sound business management, it has one fatal flaw. It fails to take full account of the changing nature of ownership of listed companies. In the period from 1998 to 2008, for which comparable figures are available, the UK long-term shareholding in listed companies (individuals, charities, churches, pension funds, investment funds, unit trusts) has fallen from 95% to 69% and short-term shareholding (banks, other financial institutions, other non-financial institutions) has increased from 5% to 31%.

This shift is dramatic and important. It means that longer term shareholders who might care about the stewardship of the underlying assets are being increasingly drowned out by shareholders with very little interest in the underlying assets or how they are managed long term. Their interest is for the share price to move in the very short term and this creates turbulence and pressure for senior management that negates the advice of the Walker Report that calls for longer-term governance and stability.

Listed businesses still have three year (long-term plans) and also an annual budget cycle, but their behaviour is mirroring the changes in stock ownership. We have seen a significant shift from annual and longer term planning to a focus on beating the market over three months and, in the last few years, a rise in daily and even hourly event planning. This short-term management focus has had a negative impact on all of us at work in listed businesses.

The future responsibility of listed businesses is therefore at stake. We need to see those shareholders with a longer term view (especially employee shareholders) moving to control sufficient shares in their businesses to provide stability and long-term planning.