Friday, 14 May 2010

How to prevent stunning failures of corporate governance?

Nat O'Connor: In a major speech on the economy to the North Dublin Chamber of Commerce, the Taoiseach said that "Individuals were left in dominant positions within individual financial institutions for too long a period. There were stunning failures of corporate governance and not enough turn-around in management personnel in those institutions."

There is a growing consensus that we need to put in place new rules and laws to prevent the recurrance of such stunning failures. But the detail matters. How can corporate governance be strengthened?

The Taoiseach's speech mentioned the "the outlawing of unforgivable malpractices", but specific commitments on new laws are limited.

One specific statement was "We must also ensure that there are new standards of corporate governance including limits on the timescale which any chief executive or chairman can serve in a bank. If legislation is needed to achieve this it will be introduced." (The alternative to legislation is to continue with the existing voluntary code of practice, which asks companies to comply or else explain in their annual reports why they did not comply).

When announcing the details of new rules on bank directors' corporate governance, the Taoiseach's speech merely states that "The Financial Regulator has recently announced new corporate governance rules. This involves a clear separation between the roles of chairman and chief executive and new standards relating to the composition of boards of directors."

But 'rules' are not the same thing as 'laws'.

The new financial regulator has made a number of addresses lately, including a presentation to the Oireachtas's Public Accounts Committee where he stated that: "Regulation in Ireland was not robust enough to prevent the asset bubble and the Financial Regulator‟s reliance on some boards and management to meet their corporate governance responsibilities was misplaced." Most of his speech focuses on the strengthing of the supervisory and regulatory rules and procedures of the financial regulator, such as improving skills, implementing a new risk model, building enforcement capacity, etc.

Yet, regulation is not the same thing as corporate governance. The latter is when companies take it upon themselves to have a robust mechanism where tough questions are asked, and decisions scrutinised, in the long-term interest of the company and its stakeholders. The regulator may sometimes check up on governance, but good governance its valuable for companies for its contribution to the long-term success of their enterprises.

There are also some mixed messages in the regulator's speech. At one point he says that "The cost of regulation will undoubtedly rise. But judged in the context of the huge cost of a financial crisis, the increase in the cost of regulation must be seen as a price worth paying." Yet later on, he states that "Ireland needs to be wary of the Sarbanes Oxley experience. It is important to be cautious about new measures which could significantly increase costs, especially if the standards being audited are too vague or extensive."

There are two points to raise about the above. Firstly, they mostly address financial institutions and do not necessarily apply the same level of rigour to other areas of corporate governance. Secondly, while there is a strong focus on rules and regulation, very little substantive legal change is proposed for corporate governance. Indeed, very little is being said about how companies run their affairs.

On the specific question of loans, the regulator may have identified one of the 'unforgivable malpractices' that the Taoiseach wants outlawed. The regulator said that "Loans to bank directors and senior management have been subject to abuse and excess, if not outright subterfuge." He is proposing a legal code of practice to ensure lending occurs on an 'arm's length' basis.

The only other mention of legal requirements are the Taoiseach's proposal to legislate, "if necessary", for limits on the length of time directors serve on boards.

TASC's Mapping the Golden Circle research identified that the potential risks to good corporate governance are present in Ireland, including directors potentially having a lack of time and facing divided loyalties. And also excessive remuneration and a lack of diversity on boards lending themselves to 'groupthink' and other potential risks. Chapter 6 of TASC's analysis looks at corporate governance in more detail.

TASC proposes that new, stronger legislation on corporate governance is needed to protect the public interest, not only for financial instituions, but for all private companies.

TASC's specific proposals include:
- Limiting the number of multiple directorships a single person can have. The law in Ireland currently allows 25 (where a group of subsidiaries only counts as 1). The regulator has suggested 3 maximum (in the financial sector).
- Limit remuneration
- Require boards to have 40 per cent women (like Norway, France and Spain).
- Require boards to have employee representation (like some US States, Germany and many other European countries).

TASC also argues that State-owned bodies should come under stronger law about corporate governance, not weaker (as is the case at present, at least in some areas like the amount of information made available in their annual reports).

These are not outlandish suggestions, but rather reflect successful models of corporate governance from other countries. When we consider how many hundreds of thousands of people lost their jobs or lost massive parts of the their pension funds or lost their investments, it should be clear that the public interest matters. We are all stakeholders in the good, open governance of businesses. Hence it is time for strong legislation to make it clear to the boards of directors across the private sector the standards and ethics that are expected of them, including protecting all stakeholders and respecting the wider public interest.

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