Corporate governance a key factor

 

The concept of corporate governance is relatively new, having grown from the "fat cat" syndrome in Britain during the early 1990s.

Corporate governance has no basis in law, but is a vague, foggy, undefined concept arising from the view that it was wrong that some chief executives of recently privatised public companies - particularly the local utilities- earned huge salary increases simply because their companies were privatised.

What particularly concerned investors was the fact that, despite such high salaries, the organisations were deemed to under-perform. Sir Richard Greenbury, the former high profile chairman of Marks and Spencer, chaired a report setting out "best practice" in the area of director remuneration. This report was followed by the Cadbury report outlining "best practice" in several other areas of board activity. Both of these reports were consolidated, with some additions and subtractions, by the Hampel report which is also known as the combined report.

Corporate governance has, therefore, taken a significant step forward following the incorporation of the Hampel report into the Irish Stock Exchange rules last March. Improved standards of corporate governance, like "motherhood", cannot be argued against. It is critical for a small economy such as Ireland, which is seeking to develop business in the more sophisticated sectors, that we are seen to operate to the highest standards.

In the past we may have been open to the accusation that we worked to lower "Irish type" standards than to better international standards. This is no longer the case, as with the control of the International Financial Services Centre, which is recognised as being regulated to the very highest standards and has become a blueprint for others to copy. Within the EU, Ireland and Britain have far and away the strongest standards, approaching those of the US.

But does improved corporate governance help management to improve performance or shareholder value? There is nothing to suggest that this is so. Indeed, it is worth noting that at the same time as governance comes to the fore in Ireland, institutional investors are investing more outside Ireland, particularly in the less well governed EU. It does make good investment sense - no currency exposure- to diversify a portfolio into Europe, where stock performance is more important than the quality of governance. Can anyone imagine a chairman excusing a poor trading performance by pointing to the high standards of governance in the organisation? Management must, therefore, take a common sense approach, be appropriately mindful of governance aspects without allowing them to dominate meetings or thinking, whilst focusing on managing the business.

It would be very regrettable indeed, and directors would be failing in their duty, if decisions were taken on the basis of "best practice" rather than what is right for the organisation. Directors and management must focus primarily on the best course of action, with best practice a secondary consideration. The Hampel report does facilitate non-compliance, which is appropriate, though requiring that an explanation be provided.

Quite a large portion of the combined code is taken up with the subject of directors' remuneration which has come under the spotlight in Ireland recently, with the Government announcing that it will legislate for the publication of each individual director's remuneration package. In both Britain and the US this is the practice, though not in any other EU state. The arguments being put forward against such disclosure in Ireland are:

Institutional investors are not seeking such disclosure.

That such disclosure will put upward pressure on salaries for those below director level.

That salaries of all directors will gravitate towards the highest rather than the lowest.

Argument 1 and 2 may be valid but are difficult to evaluate, while number 3 will very likely be the case. In similar industries and competing companies, pay may become a measure of quality. "We are better than our competitors, therefore it is wrong that our directors earn less" may be the thoughts of many executive directors. This is corrected, either by increasing pay or perhaps directors moving between competing companies. Disclosure of individual pay levels becomes, in effect, a price list for executives.

Best practice indicates that pay levels should reflect performance. Where profits, earnings, shareholder value or share price are growing strongly, then management should share in and be rewarded for such performance and be motivated to further grow the business.

This represents a win, win situation for investors and management alike. Management is creating wealth and being rewarded in line with doing so. Equally, where management is dissipating a company's wealth it too should suffer financially.

The combined code recommends the separation of roles of the chief executive and chairman and speaks of "independent directors". In the US the role of CEO and chairman are usually combined in the larger, more successful companies. In Ireland the issue of role separation usually only arises when a company is under-performing. Most shareholders are quite satisfied once the expected returns are being achieved. It is appropriate that no one individual or small group should have unfettered power. However, management performance will not improve either if, as a result of good governance, the board is factionalised with various groups understanding their role as solely that of carrying out a specific watchdog role on certain designated areas.

Under law all directors, executive or non-executive, have the same obligations, rights and duties. The ideal principle of best practice should be that the board acts as a unified team in the best interests of the company's welfare. The balance between executive and non-executive directors is continually raised. The recommendation that certain committees should contain a majority of non-executive directors could be construed as insinuating that executive directors need to be supervised, or controlled, by strong non-executives.

It is worth pointing out that such committees do not have the power to decide or commit the board. Only the full board has this power. On the other hand, there is the view that non-executives, especially in highly sophisticated or high tech industries, simply do not understand the business sufficiently well to contribute meaningfully.

Neither of these situations should be allowed to arise. If a director needs such careful supervision, should he be on the board in the first place?

It is realistic that individual directors will have particular areas of expertise and that work will be divided accordingly. However, where an individual is out of his depth he should not be on such a board. The collapse of the British company Queens Moate is an example of a company fully compliant with the principles of good governance. However, some of its directors simply did not understand the business.

The fact is that compliance does not imply profitability. This issue comes down to a question of balance and common sense. Different skills and backgrounds are needed and should be moulded together to achieve a well balanced team focussed on producing shareholder value over the long term.

Management must act using common sense and balance, acting in good faith for the long-term interests of the organisation. The combined code provides worthwhile guidelines and principles, which since they are incorporated in the Stock Exchange rules, must be considered by management.

However, investors will not thank management for doing anything other than acting in the best interests of the company. Adhering to good governance will be viewed as secondary.

Tiarnan O'Mahoney is a director of Anglo Irish Bank. The views expressed in this article are personal.