Home Finance How Should Boards Respond to the FRC’s 2016 Annual Report?

How Should Boards Respond to the FRC’s 2016 Annual Report?

by internationalbanker

By Nick Roi, Managing Director, Perivan Technology 

In January, the Financial Reporting Council (FRC) published its annual report, Developments in Corporate Governance and Stewardship 2016. The purpose of the document was to report on the quality of compliance within companies and boards, and to specify to business leaders in what areas it wants to see an evolution in corporate-governance behavior and reporting. 

The report’s release occurred against what the council called a backdrop of “failing public trust in business”. What did it mean by this? That poor governance practices among boards and businesses are resulting in lack of trust, and therefore lack of investment. That investment, it says, is essential for the wellbeing of the economy and for society. We must therefore take steps to rebuild trust to safeguard our future.  

The chairman of the FRC, Sir Winfried Bischoff, states within the document that “it is essential that the UK maintains its position as an attractive capital market with a strengthened corporate governance framework underpinned by effective regulation”. It is clear that the corporate landscape of Britain is changing, especially with the unknown implications of Brexit. Strong compliance has the ability to improve trust in business and promote a strong economy. The corporate-governance framework should continue to offer a practical approach that supports long-term business success and easy-to-use compliance. 

As part of the report, the FRC cast a spotlight on the role that company boards should take in setting business culture standards. The board, it argues, has a central role to play in the assessment and shaping of a culture that can impress stakeholders. 

How should the board be establishing and driving positive behavior? Here it sets out seven values that every board should action: recognise the value of culture; demonstrate leadership; be open and accountable; embed values and integrate them; assess, measure and engage desired outcomes and material to the business; align values and incentives; and exercise stewardship. By encouraging companies to focus on their corporate cultures in this way, boards can realise long-term benefits and can create productive and thoughtful sets of standards—as opposed to ones hurriedly reviewed and instated following a crisis. 

Interestingly, one of the key findings in the report is that while compliance with the UK Corporate Governance Code is high, those that do not follow the code give poor reasons for not doing so.  It is concerning that poor reasons are being given, considering the FRC specifically states in its guidelines that companies must provide clear reasoning when opting not to apply a provision within the code. It calls this “comply, or explain”, a provision that means businesses do have the flexibility to depart from the code if needed. It is an extremely important stipulation, meaning that companies are theoretically prevented from using false statements as “scapegoats”, an action that damages industry trust. It also provides essential clarity for stakeholders and shareholders: “Shareholders can understand the reasons for doing so and judge whether they are content with the approach the company has taken.” 

Without that clear reasoning, stakeholder confidence will drop, followed closely by public trust. As to why companies would choose to flout the guidelines, the FRC believes it is because the needs of shareholders is being replaced by that of stakeholders. A precarious strategy! It follows that more focused reporting by boards on how they carry out their responsibilities is needed. Of course, the emphasis on improvements cannot lie purely with the FRC—hence it has asked the government if it can have more oversight powers to help achieve this. 

It has also suggested several actions that businesses can take to restore trust. One of these is to make clearer the link between executive pay and performance, an area that is often quite unclear. It also argues the need for nomination committees to make the link between board composition and company strategy to ensure there is a diverse range of skills needed to deliver success. 

Another idea is to ensure that meetings run as efficiently as possible. Clear minutes, professional papers and clearly documented actions are vital to a well-run board or committee. Less time spent on administration means more time to deliver the reporting for which the council is looking, as well as ensuring that any decisions are discussed fully, and the right governance standards are maintained. 

One last tip is for boards to implement robust succession plans. Ensuring its current composition and any plans for new members are aligned with future business strategy will do wonders for stakeholder trust. Succession, it says, is an ideal opportunity to promote diversity within business—something that many companies have been criticised for lacking in recent years. If the board is well-educated and informed about the relation between diversity, strategy and business values, they will be in the best place possible to encourage diverse thinking within the company and escape the hazards of “groupthink”.

There are many such suggestions in the report to which every company should pay attention. But before actioning them, it is surely obvious that the first step must be to read the code and become familiar with the provisions made within it. In this way, if you do deviate from them, you should be able to deliver a solid explanation as to why.

There is yet another reason why organisations need to encourage greater transparency of the actions of the board, and that is to remain one step ahead. Should the council decide at any time to change or enforce its powers, those with comprehensive reporting in place will be in the best place to avoid negative actions or reprisals. After all, the FRC states at the end of its report that it will now be monitoring how boards are discussing culture in the boardroom.  

Now is the time for companies to sit up and take note of the UK Corporate Governance Code. Falling foul of FRC disciplinary actions would cause the very damage it warns against. Transparency, documentation and reporting, accurate reasoning and proactivity: these are the keys to promoting a culture focused on effective governance.


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