The Financial Reporting Council (FRC) is consulting on revisions its Corporate Governance Code (the Code) and Guidance on Board Effectiveness (the Guidance). The changes proposed by the FRC reflect their increasingly deep understanding of the root causes of company failures. These changes develop the FRC's leadership on governance thinking to reflect the FRC's groundbreaking Guidance on Risk. Our survey of Annual Reports shows that most companies have made poor progress towards meeting the FRC's guidance. And board composition still has far to go.
The FRC's has put 'long term success' of the company at the heart of its thinking. Their approach has two strands. The first confronts the historic priority given to shareholders. It begins to tackle the undesirable drivers of short-termism, including weak design of incentives granted to C-Suites. And it recognises the pressure from investment managers whose own incentives are, reportedly, very short term.
You can think of the second strand as the result of reverse stress testing for risks to 'long term success'. Exploring answers to the question 'what risks our long term success?' will take you in many directions. Some will be specific to your organisation: changing markets, evolving consumer tastes, new sources of supply, increased competition and much more. But others will flow from the fact that, whatever your organisation does and however it is structured, its fate ultimately depends on the actions and inactions of people. Most major failures are, at their root causes, system failures. Since leaders are the ultimate deliberate or inadvertent creators or drivers of all the systems in their organisation, it follows that leaders really matter.
This is why the FRC's renewed focus on leaders and people-systems is so desirable.
The FRC's proposals respond to almost all the types of corporate vulnerabilities we catalogued and illustrated in our book "Rethinking Reputational Risk: How to Manage the Risks that can Ruin Your Business, Your Reputation and You". The revisions are thus also apt to encourage boards to strengthen their reputational resilience. This makes it a double pleasure to be able to echo Sir Win Bischoff's own praise for "Rethinking Reputational Risk”. We much endorse the FRC's recommendations to business leaders. It is instructive to see the FRC handle the subject with such conviction and clarity.
In our more detailed note here we explain the FRC's new approach under six headings:
- Long term success for the benefit of all stakeholders
- Board composition, diversity, skills and challenge
- Leadership, Values, Culture and Behaviour
- Interacting with the workforce and other stakeholders
- Setting Pay
To give you some flavour, the FRC laces its proposals with over seventy perceptive questions for boards to consider. Examples include:These signs are all too familiar.
- How have [our] values and behavioural expectations been reinforced in our recruitment, induction, performance management, incentives and reward policies, processes and practices?
- How are we testing this with new recruits and the existing workforce?
- What behaviours are being driven when setting strategy and financial targets?
- Is management using root cause analysis when things go wrong? (Examining not just what went wrong but why.) For example, were incentives/rewards, social or power dynamics a contributing factor?
- Is the company holding exit interviews with leavers and are we considering how the feedback reflects on the company’s culture?
- What evidence do we have that the chief executive is willing to listen, take criticism and let others make decisions?
- How does the ‘tone in the middle’ resonate with the workforce?
- What action do we take against senior people or star performers who do not uphold the company’s values?
- "Silo thinking
- Dominant chief executive
- Leadership arrogance
- Pressure to meet the numbers/overambitious targets
- Lack of access to information
- Low levels of engagement between leadership and employees
- Lack of openness to challenge
- Poor succession planning
- Misaligned incentives and flawed executive remuneration practices
- Tolerance of regulatory or code of ethics breaches, e.g. by star employees
- A lack of diversity
- Hierarchical attitudes"
Regular readers will have at least a general understanding of the issues the FRC is tackling. For readers who wish to gain a deeper understanding of the issues, we recommend two influential publications. 'Roads to Ruin" is the seminal (2011) Cass Business School report for Airmic. Based on twenty case studies it lays the ground for the field A further six years' research made it possible for our book “Rethinking Reputational Risk” to take a more systematic approach and address the needs of both leaders and risk professionals. They provide complementary perspectives on the insights that inform the FRC's approach.
We have also written a more detailed analysis of the FRC proposals which you will find here.
Anthony Fitzsimmons is Chairman of Reputability LLP and, with the late Derek Atkins, author of “Rethinking Reputational Risk: How to Manage the Risks that can Ruin Your Business, Your Reputation and You”