In the aftermath of the WorldCom and Enron scandals, governments and financial regulators around the globe rushed through a whole raft of guidelines and laws, supposedly to protect investors. But did they really act with the best interests of business at heart? A new research report suggests not.
The study, entitled ‘The role of the board in creating a high-performance organization’, argues that pressure from investors for governance code compliance and short-term share performance is damaging board effectiveness. By diverting the board’s attention from its main strategic role, these demands are undermining the creation of long-term shareholder value.
The report’s authors, Dr John Roberts from Cambridge University’s Judge Business School and Don Young, a business consultant, believe the increasing pressure for companies to adhere to governance guidelines is misconceived. Recent research indicates that strategic mismanagement, rather than board malpractice, is easily the biggest cause of lost value.
A survey by Booz Allen Hamilton finds that of 360 badly performing companies, 87 percent of total value destruction was attributable to strategic errors, while only 13 percent of lost value was due to failures in regulatory compliance or board oversight. ‘There are some chairmen and boards trying to strengthen the strategic role of the board, but that means pushing against the tide of corporate governance box-ticking,’ says Young. ‘The problem is that the investment industry can’t see inside companies, where the main drivers for long-term value creation are located.’
Two years on from the Higgs review into the role of non-executive directors, the drive for governance code compliance is pushing some non-executives into a ‘policing’ role, which is creating divisions in the boardroom. Roberts argues that this goes against the non-executives’ primary role, which is ‘to provide complementary skills to experienced business people who can challenge executive thinking about business risk.’
The research, sponsored by the Corporate Research Forum and the Performance & Reward Centre, suggests investors who see conformity with governance codes as the key to an effective board are wide of the mark. ‘Governance codes get revised when there’s a failure or perceived failure, and the suggested solution is often to further increase the board’s control function,’ says Roberts. ‘But more regulatory controls can weaken effective control.’
‘This can lead to a kind of governance political correctness,’ adds Young. ‘People need to look beneath the codes at how the board actually works.’
The report, based on interviews with senior business people, finds that this emphasis on governance ‘box-ticking’ is often accompanied by pressure from investors for short-term performance. And Roberts thinks there is a risk boards could become too ‘investor-driven’ at the expense of good corporate strategy.
He also believes a well-oiled IR machine is ‘absolutely critical’ if boards are to get back on track. ‘The difference between good and bad IR centers on whether you are just trying to give investors what they want in a knee-jerk way, or you are developing your own internal relationship with the board, working out the long-term business strategy and then making sure that story is well communicated,’ he says.
Nevertheless, boards need to take a proactive approach rather than just reacting to investors’ whims. ‘You can’t let managing external appearances obstruct your main responsibility, which is to manage value maximization within the business,’ concludes Roberts.
