The writer is professor of corporate law at the University of Cambridge
The Financial Reporting Council has announced a fresh review of the UK Corporate Governance Code, indicating that it will strengthen and expand it. The FRC, likely to be absorbed soon into a new, more powerful regulator — the Audit, Reporting and Governance Authority (ARGA) — should bestow a wholly different parting gift: abolition of the code.
The current version clocks in at 4230 words, compared to the Cadbury Committee’s trailblazing 748-word 1992 Code of Best Practice and the 2919-word Combined Code issued following the 1998 Higgs Report. A longer code would not be a cause for concern if it was adding value in the corporate governance realm. This is unlikely. Despite years of research, there is no definitive evidence that “better” corporate governance yields better corporate performance. Given this, various problematic features of the existing code collectively justify abolition.
First, the code is irrelevant in material respects. Much of what it says duplicates what is mandated elsewhere, particularly regarding boardroom audit committees and executive pay. It also incorporates numerous platitudes that merely affirm widely-accepted governance propositions. Yes, “the workforce should be able to raise any matters of concern” and “non-executive directors should have sufficient time to meet their board responsibilities.” This is corporate governance 101: does it need to be codified?
In addition, “comply-or-explain”, long a hallmark of the code, does not function as anticipated. Premium listed companies can opt not to adhere to a code provision so long as they disclose the rationale. Expectations of compliance, however, make the benefits largely illusory. For years investor “box-ticking” has pushed listed companies toward blind or grudging adherence. The FRC has reinforced the pattern by emphasising that non-compliance should be temporary.
Next, stakeholders feature prominently in the code in a manner that fits poorly with its operation. A revised version will probably introduce sustainability and ESG features; the current one already refers to “workforce” 13 times and “stakeholders” six times, up from zero and one reference in 2016. But the code is an inherently flawed stakeholder protection mechanism: enforcement depends upon shareholders lobbying for change when they deem deviations to be unsatisfactory. Shareholders may sometimes be stakeholder-friendly but most investors will treat maximising returns as their priority.
A final strike against the code is that it allows policymakers to pass the buck. According to a recent UK government report on trust in audit and corporate governance, the code beneficially permits the testing and refining of regulatory innovations. In fact, it rarely performs this function. Much more likely is for policymakers to use it to duck hard policy choices, such as when Theresa May’s 2016 commitment to worker representation on boards was translated into a provision affording companies plenty of latitude.
Abolishing the code need not mean full deregulation. The Financial Conduct Authority’s Listing Rules could be amended to mandate disclosure of high-priority corporate governance arrangements and allow tailored solutions. Perhaps this would help to encourage companies to list on the London Stock Exchange and encourage others to stay put at a time when the UK stock market is in decline.
Self-regulation in equity markets has been marginalised considerably since the Cadbury code. ARGA’s absorption of the FRC is probably a move in the same direction. Ditching the code in favour of concise, governance-related disclosure requirements for listed companies would align UK corporate governance with modern regulatory trends.
Bobby Reddy contributed to this article