Bob Garratt: Prudence saps performance

Corporate governance has become an increasingly fashionable phrase in the last five years, capturing the public's imagination as "business process re-engineering", "strategy" and "outsourcing" did before it.

Now it is similarly used and abused by many as a nostrum for current ills. It is not. And neither is it a fashion item.

The concept of corporate governance has been around for some 5000 years. The phrase derives from the Greek kubernetes (the steersman) through the Latin and Old French to reach Middle English in Chaucer's "Nun's Priest's Tale".

Although the first book in English called Corporate Governance was written by Bob Tricker in 1984, public interest developed only after the Maxwell pension fund scandal.

As corporate scandals have multiplied so has public alarm. This is made manifest by the developed world's growing concern over where pension and investment money has gone and what wealth they may still have in future.

This puts pressure on the politicians. And there's the rub.

As corporate governance has opened up, many consultants and lawyers have positioned themselves as experts on ensuring corporate governance, without being aware that they were offering only one aspect of it - compliance. This is worrying because a consequence of the rapid growth of codes and acts has been to create an industry off over-engineering and gold-plating the compliance product to the point where many boards believe that "corporate governance" is only about compliance.

Even more worrying, these products are being sold on to governments and not-for-profits as immediately applicable to them. This fixation with compliance has two major consequences; higher costs for the client (and good fees for the consultants) and, through the notion of "single point of accountability", a very human wish to avoid risk and pass it as high up the chain of responsibilities as possible.

Are we seeing a significant erosion in the very basis of risk-taking capitalism here through over-zealousness by the regulators and supine regulatees?

I argue that we are, and that until we bring a balancing concept of "board performance" into the corporate governance equation we will not progress. Compliance is necessary but not sufficient. Sufficiency comes from a board balancing the continuous directoral dilemma of board compliance (prudent control) with board performance (driving the enterprise forward).

The United States has taken a "rules based approach" - once you have ticked all of the compliance boxes, you can do anything else you wish.

It is worth remembering that Enron was 100 per cent compliant under the then US legislation.

The UK's attitude is much more a self-regulatory "comply or explain" approach. That is, if a board feels it has good reasons for not complying with the code, but not company law, it can go to its owners and explain why. They then have the right to object and vote against the board.

The UK also takes the position that once the compliance position is correct a board must still rise above that and ask "is this a true and accurate position?"

In the UK and US it is also noticeable that the politicians want to bring more company law more into the criminal realm. This is worrying as one of the differentiators between directors and managers is the large amount of civil and criminal law that binds directoral decisions.

If this political punishment by criminalisation process continues who will wish to be a director?

On the other hand, who is now an "owner"? Much of corporate governance development is based on the concept of "Agency Theory", which developed because mass ownership of corporations meant that they had not the time nor capacity to oversee the work of their employed managers, but neither did they trust them.

Therefore external directors were appointed to police the managers. This confrontational approach to corporate governance persists in many countries and can be fuelled by compliance-based codes.

But some boards espouse an alternative "Stewardship Theory" approach which focuses in developing mutual trust around the boardroom table, and with the managers, especially through the induction, development and regular appraisal of all concerned. As yet little research has been done in this area. Why? Possibly because the whole area of "ownership" needs drastic review.

Bob Monks, founder of investment fund LENS, states that in UK-listed companies the annual churn rate of shareholders can be as high as 90 per cent and in the US, 60 per cent.

Who then is an "owner", especially one that can and will exercise their voting rights? It is interesting to speculate that Agency Theory may now begin to be applied to the fund managers and the way they exercise their rights as "owners" as they are obviously not well trusted by the ultimate owners of the pension funds.

There is also the issue of directoral competence and, ultimately, director accreditation.

Voluntary director accreditation is laudable, but we must fight governmental moves towards mandatory director accreditation.

However, the significant rising number of people passing voluntarily the Institute of Directors' Diploma exam and later the oral exam to become a chartered director is worth noting. At present there are 350 in the UK and the number will rise sharply towards 1200 by 2007.

It is being developed also in Japan and other parts of Asia and Africa are looking at it seriously. Will we see a strong profession of directors emerging based on the fundamental values of Accountability, Probity and Transparency? I hope so.

As the boundaries of corporate governance become more understood, directing will become increasingly differentiated from managing.

But it is not just directors about whom we should concern ourselves, but the induction, re-education and competence building of shareholders, investor relations, investment bankers, venture capitalists, pension fund trustees and fund managers which are a corporate governance necessity.

* Professor Bob Garratt is a management consultant and visiting fellow at the Management School of Imperial College, London. He is also author of the bestselling Fish Rots from the Head.