Corporate governance failures were at the heart of the financial crisis. From Northern Rock to RBS to HBoS and Co-op, a series of authoritative reports have set out how Boards… failed to question their firms’ business models sufficiently, and didn’t properly scrutinise ambitious acquisitions, challenge dominant CEOs, or foresee potential system integration problems.
Aside from the Walker Review, the regulator’s chief response to the problem is SMCR, an individual accountability regime. While this has many virtues, it stems primarily from the regulators’ inability to hold senior managers to account, and so there are risks in expecting it to solve multiple other problems as well. I’ve written elsewhere on various aspects of SMCR, but today I want to focus on the extent to which it potentially encourages Group think and the extreme importance of countering this for Boards and regulators alike.
Group think is widely identified as one of the underlying causes of the corporate governance failures during the crisis and there have been several attempts since to encourage boards to diversify. But these have been largely unsuccessful, not least in the face of the counter-pressure that Boards should be packed by individuals who are qualified and experienced at that level. The absence of these qualities was one of the main criticisms of the Northern Rock and Co-op Boards, with the FSA severely criticised for allowing it to happen.
One of the natural tendencies of SMCR will be to encourage Boards to avoid inexperience or different experience. This tendency is already part of the inertia that inhibits Boards from appointing more women, more people from BAME backgrounds and so on. And regulators too will tend to play safe, wary of being seen to approve people who seem to be less qualified.
This is not about not having Board directors who are expert and experienced in financial services. A long time ago, I argued vehemently, with consultants appointed by the Government, that the core business of UK Sport was elite sport – the fashion of the day was to appoint people with retail business backgrounds to such Non-Departmental Public Bodies (NDPBs) - and that the composition of its Board should better reflect that reality.
But Board debates do need to include genuinely different perspectives. And that’s almost impossible to do reliably if there is too much common ground of experience. Critically, this is true no matter how good the people.
Breadth, Risks & Diversity
This is where the IPPR’s recommendations about broadening the range of stakeholders represented on Boards becomes relevant. And so too does Charles Randell’s implicit plea (see link) for Boards to think more about future risks. They argue persuasively that the core corporate governance weaknesses exposed a decade ago are largely still present. (I'll write about another shared thread - short-termism - another time.)
Both the IPPR and Charles Randell’s speech, at their root, are as much about the importance of diverse – and potentially dissenting – thought as they are about representation or forward looking risks. For that reason alone Board diversity deserves some fresh thought.
The next blog in this series will look at financial crime
The financial statements may be accompanied by disclosures about risks that have not yet crystallised but, generally speaking, they do not try to adjust reported results for risk. Both management and shareholders are sometimes long gone by the time that the potential risks to a firm’s business model become actual threats to its survival.