A radical approach to #corpgov?

John Kay’s submission to the BEIS inquiry made the very important point that businesses are financed differently from the way that they were when our legislative and regulatory regime was first constructed. We are locked into a nineteenth century framework of accountability that bears little resemblance to twenty first century business reality.

In the past the accountancy profession has led the way in radical thinking. The profession has struggled for many years with the idea that financial reports are not useful.  “The Corporate Report” was published by ICAEW in 1975, before the accounting standard setting behemoth had submerged corporate reporting and developed into a huge constraint on any form of constructive rethinking.

The new forms of report proposed by this discussion paper were largely ignored, apart from the value added statement, although the statement of future prospects and the statement of corporate objectives have been revisited, with little acknowledgement of their history, in the integrated accounting project. The list of users and the description of their information needs has become received wisdom, repeated in financial accounting textbooks and firmly set in stone.

Thirteen years later ICAS published the discussion paper “Making Corporate Reports Valuable”.

This is much more radical in its approach, starting with a clean sheet and  thinking through accountability issues and how to address them. (It is notable that chapter 2 provides a corporate governance perspective: Scottish accountants had been reflecting on corporate governance for some time and were central to the establishment of the Cadbury Committee.)

MCRV reframed the list of users and directly addressed problematic areas of reporting. A detailed analysis of information needs led to precise suggestions for different reporting forms. This paper was followed in 1990 by a specimen set of accounts for a fictitious company, Melody plc, showing how the ideas could be applied in practice and in 1993 by a further feasibility study.

The two discussion papers bear rereading. While they were very much of their time, prompted by specific concerns such as the problem of accounting at a time of high levels of inflation, they represent a depth of thinking about reporting and accountability that has not been seen during the past twenty five years since the publication of the Cadbury Code. Corporate governance, financial reporting and audit are inextricably linked (yet surprisingly few corporate accounting textbooks – even those written by accountants – fully address this) as they form the framework within which accountability is expressed and achieved.  It would be encouraging to see the accountancy bodies once again grappling with these issues from a radical perspective, rather than offering further ideas for tinkering at the edges.

But the only recent instance of radical thinking on corporate governance that I have found is in this paper by a US legal scholar which argues that boards of directors are no longer essential.

It’s worth a read.

This week the FRC has announced a fundamental review of the UK Corporate Governance Code.

It remains to be seen how fundamental it will really be, in terms of addressing how corporate governance arrangements relate to modern business models and different funding patterns. And whether it will go back to first principles and pose unasked questions – for example, the unintended consequences of mandating board composition, which have not been widely discussed. Since Cadbury, board independence has been viewed as desirable but US evidence questioning this existed even before Cadbury*. Many large companies now have a hybrid form of two tier board: the board and the executive group do not sit around the table together and the link between the two is principally in the hands of the CEO. Which is ironic, given that corporate governance arrangements were largely intended to curb the power of the CEO.

Another useful set of questions might be: how do governance mechanisms operate within the public sector, where accountability structures are very different? Have boards of central government departments and of NHS Trusts simply replicated arrangements from within the private sector or have such arrangements been adapted? Is there anything that the private sector can learn from this?

The discussion paper published this week by ICSA is an interesting attempt to extend the debate, arguing that restoration of trust in business is not only the responsibility of listed companies and they cannot be expected to shoulder alone the task of achieving broad public policy objectives.  ICSA promises further papers and a radical approach. My breath is bated...

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* Baysinger, B.D and  and Butler, H.N (1985) Corporate Governance and the Board of Directors: Performance Effects of Changes in Board Composition Journal of Law, Economics, & Organization, Vol. 1, No. 1 pp. 101-124;  see also Bhagat, S and Bernard Black, B (1999) The Uncertain Relationship Between Board Composition and Firm Performance The Business Lawyer Vol. 54, No. 3 pp. 921-963

Econocracy

I have yet to read "The Econocracy: The Perils of Leaving Economics to the Experts" by Joe Earle, Cahal Moran and Zach Ward-Perkins but I have been reading this review of the book by Aditya Chakrabortty and it has caused me to reflect further on my own experience of studying economics.

Like Earle, Moran and Ward-Perkins, I studied for an undergraduate economics degree at the University of Manchester. To me, in 1965, the course structure seemed fragmented: I had assumed that I would study mostly economics (although I had no idea what that involved and had chosen it for rebellious reasons).  I was puzzled by the requirement to study social anthropology (what did witchcraft among the Azande have to do with anything?) and politics, although I enjoyed both and found them much easier than my choice of option, accounting.

The course had in fact provided a very broad base of social science study, although the links between the different parts of the programme were not emphasised and it was not until I started my doctoral studies many years later that the links dawned on me. It was also many years before I realised that I had been taught by very distinguished scholars in politics (W.J.M.Mackenzie) and social anthropology (Max Gluckman).

But what about the economics courses? I remember that the main textbook was the first edition of An Introduction to Positive Economics by Richard Lipsey. I remember breathing in the smell of my brand new copy. I also remember reading the first chapter time after time in the hope that eventually I would understand it... We also used Samuelson's Economics (a book which gets its own Wikipedia entry) which I found much easier to understand. Or perhaps the diagrams were prettier. I remember that our classes were taught by two young men called David, Colman and Metcalf, who both went on to have very distinguished academic careers, although I didn't understand what they talked about.

My main problem with economics was the models. They required so many assumptions that I couldn't see how the abstractions helped with understanding the complexity of real life problems. I could - eventually - grasp the idea behind the trade-off between guns and butter but how exactly did this explain how decisions about national resources were actually made? What did the Phillips curve actually mean? This puzzlement extended into aspects of accounting: I shed tears over double entry bookkeeping for the whole of the first term until the penny dropped and I managed to produce a balance sheet that balanced.. but what exactly was the point? I hit this problem again when I began my PhD work and found that the corporate governance literature was largely predicated on principal-agent theory, the assumptions of which, to me, led to a very narrow analysis of my area of interest, board behaviour.* 

According to the book review, the Manchester students had a similar problem with abstract models and prompted by this review I look forward to reading their account. But Chakrabortty, as he makes clear, was closely involved with the students and the developments subsequent to their challenge to the Manchester curriculum and I'd like to hear other views - I'd particularly like to know how the Manchester lecturers dealt with the challenge.  Chakrabortty also states: "The authors analysed 174 economics modules for seven Russell Group universities, making this the most comprehensive curriculum review I know of." One could, of course, argue that Russell Group graduates are more likely to have significant future influence as economists than graduates from other universities but my former colleagues were certainly teaching heterodox economics long before the financial crisis which precipitated the story behind this book.

I like the idea of students challenging the curriculum, not because it's too challenging for them (not unusual among my accounting students over the years) but because it doesn't address real world problems. More power to their elbows!

*the late Sumantra Ghoshal, Professor of Strategic and International Management at the London business School, argued persuasively that the teaching of agency theory in business schools had very negative consequences on actual behaviour. The theory has been broadened more recently with scholars developing behavioural agency theory models.

Ghoshal, S (2005)  Bad Management Theories Are Destroying Good Management Practices Academy of Management Learning & Education, Vol. 4, No. 1, 75–91.

Random thoughts on the scope of corporate governance

I've been following tweets about the HBOS fraud from well-informed people and, not for the first time, I wonder how it is possible to distinguish between corporate governance failure, audit failure, poor business decisions and outright fraud. This distinction matters in placing blame - which may, of course, be shared - and in considering regulatory responses.

If corporate governance is about how companies are directed and controlled, any failure of direction or control could be deemed corporate governance failure. But businesses do fail, for all sorts of reasons, not all of which could be anticipated or managed.

Corporate governance failure implicates the board of directors. Audit failure implicates not only the auditor but also the wider profession. Poor business decisions may lie with the board and/or senior management: they could be the result of poor business strategy (the fault of the board?), poor operational implementation (the fault of management?) or lack of proper oversight by the board.

Experienced NEDs have told me anecdotes about feeling powerless in board situations where it was clear to them that decisions made would set the company on a downward path: the challenge for a NED is then whether to stay and continue to try to mitigate the negative outcome or to resign and possibly accentuate the difficulties, as the signal of company problems affects the share price. Would subsequent company failure in such circumstances be viewed as a corporate governance failure?

Fraud is surely a failure at an individual level. Does anyone ever explore the motivations of those convicted of fraud? The detection of fraud is not, as we know from the famous canine analogy (bloodhound not watchdog), necessarily down to the auditor.  But a recent shift in thinking seems to view the occurrence of fraud as a failure of company culture and thus a further area of board culpability.

And where do the regulators stand in all this? The FRC has been remarkably quiet on the HBOS scandal and a recent call for a new corporate governance regulator suggests that the present regime is inadequate.

Some radical thinking is needed. This paper by a US legal scholar deserves wider consideration.

It argues that "the board of directors in a large, public corporation is ineffective to perform the functions assigned to it and so should be eliminated in favor of a governance system that more accurately reflects corporate decision making."