Corporate Governance in Europe – update on key issues

The political landscape is dramatically different from just few years back. Social and economic upheaval is pulling threads in the fabric of the European community.

Brexit will have huge impact not only in politics, but also on the European corporate community. For business and industry are of course not unaffected by political change.

And in the midst of this, over the past couple of years, we have seen some of our most respected companies add fuel to the fire: For neither is a company “entire of itself”. Corporate scandals erode trust not only in the brands and companies and individuals involved, but in entire industries.

As board directors, does this concern us – and are we concerned? Yes, it does, and yes, we are.

Does this concern us – are we concerned? Yes, it does, and yes, we are.

The role of the board is being redefined

As board directors, we hire and fire executives. We are responsible for the company’s major strategic choices. And we monitor the company’s operation.

Over the past decade, boards of directors around the world have seen their roles redefined in terms of both the scope of their responsibilities, their actual workload, and the speed with which they are required to respond.

Today’s boards of directors navigate rapidly changing waters, where storms are frequent and where safe harbors are few and far between. To fulfil their mission – not only keeping the company boat afloat, but actually sailing it, actually thriving through the voyage – requires a broad skill set and strong judgement on the part of the board of directors.

Regulators; Police or Pilots?

In that context, it would sometimes be helpful if regulators saw their role perhaps a little more as pilots, and a little less as police. Because ongoing adjustments to the regulation of corporate governance in Europe affect not only boards’ flexibility – they actually rock the very cornerstones of European corporate governance.

The expressed goal of the European Commission is not to regulate more, but to regulate better. It would not be fair to say that the European Commission legislates corporate governance extensively. But in politics, the imperative to “do something” sometimes overrides concerns of practicality, or unintended consequences.

In fact, the EU legislators seem to favor patchwork over quiltmaking – they are adding new pieces of legislation, without necessarily taking the overall regulative architecture into consideration. Their basic assumptions change over time, and their regulations reflect it. And while building new additions in different styles may make your house bigger, it rarely results in stunning architecture.

In the first EU action plan on Corporate Governance in 2003, that is – over a decade ago – the Commission expressed itself quite clearly:

• There was no need for a European Code on Corporate Governance,
• Corporate Governance disclosure could be improved through an annual corporate governance statement,
• Shareholders’ rights should be strengthened by improving access to information and by reinforcing shareholders’ democracy,

In 2003, the EU Commission wanted to modernise boards of directors;

• First, by looking at boards’ composition and at executive remuneration,
• Secondly, they considered independent directors as a necessary counterbalance to the company’s executive management, and
• Thirdly, they relied on the collective responsibility of boards.

A paradigm shift

Fast forward from 2003, to the 2012 action plan and the legislation that has emerged from it, and it appears a paradigm shift has occurred – as though the Commission’s basic assumptions have changed:

• We are not yet quite at the point of one single European Governance Code, but it is obvious that the European Commission has attempted to harmonize governance across Europe, modelled on British corporate governance.
• Transparency has become the main driver, and compliance its enabler – without anyone really questioning the value of the information produced.
• Whereas in 2003 the European Commission talked about the board as a collegium, and stressed its independent judgement, they tend now to request more board committees, and to require external scrutiny from shareholders.

Let’s look at two important pieces of legislation that are under discussion by the EU right now.

Audit Reform blurring the clear-cut division of duties and liabilities

The implementation of the Audit Reform places audit committees at the heart of audit quality. The new legislation allocates specific legal responsibilities to the audit committee, rather than to the board as a whole. These include approval of non-audit services, and approval of the statutory auditor. At ecoDa, we fear that this may create an information gap between board directors who sit on audit committees, and board directors who do not. Ultimately, this may result in a situation where some board members carry heavier legal responsibilities than others.

The regulation also requests that Audit Committees’ performance be monitored by the competent national authorities. In ecoDa’s view, an audit committee is a board subcommittee, and the board remains the ultimate responsible body. If certain decision powers are delegated to a subcommittee, the board should still be accountable for the consequences of its decisions.

In ecoDa’s view, placing specific legal responsibilities on the audit committee, blurs the governance system’s otherwise clear-cut division of duties and responsibilities.

The European Commission now seems to be taking more interest in shareholders’ duties, than in their rights.

Shareholders RIGHTS or Shareholders DUTIES?

Next, let us turn to the revised Shareholders’ Rights Directive, which is currently under negotiation between the European Commission, the Council, and the Parliament. While the title still focuses on shareholders’ rights, the European Commission now seems to be taking more interest in shareholders’ duties, than in their rights. The directive is about:

• Shareholders’ identification, and facilitating the exercise of shareholders’ rights,
• Transparency obligations for institutional investors, asset managers and proxy advisors,
• Directors’ pay, and
• Related party transactions.

In terms of remuneration, the text requests:

• A binding or advisory vote on the remuneration policy,
• That shareholders be granted the right to vote on the company’s remuneration report (though with a possible exemption for smaller companies),
• And that the total amount, as well as every element of remuneration paid to each director, be disclosed.

EcoDa does not believe that we can turn inactive shareholders into micro-managers. We think it is risky to shift key decision-making powers away from the board, and into the hands of shareholders – or more specifically, to the fund managers or proxy advisory firms to which they often delegate many of their key governance decisions.

These two examples – the Audit Reform and the revised Shareholders’ Rights Directive – both illustrate two fundamental points:

• The collegiality of the board and its independent judgement are the cornerstones of corporate governance, and should not be jeopardized. And…
• …Legislators cannot with one hand place more and more responsibility on boards of directors, while with the other hand, take away its powers to fulfill these responsibilities.

The power of trust

I’ve made it my business as chair of ecoDa to talk about trust. For today, business is society, and society is business, and neither can make without the other. Companies need to understand that if they compromise their bond of trust with society, today’s regulators will find out, and today’s customers and shareholders are freemen-of-the-land, and will migrate elsewhere.

Whether you choose to see increased regulations as an expression of mistrust or not, the fact remains: Trust is earned, and cannot be bought. If you want to be trusted, you need to build trust. Doing so is not a matter of proclamations, but of steady work, in every company, in every national institute of directors, and in ecoDa, ever mindful of the fact that in today’s global society, trust built over decades can be destroyed in a minute, and that what affects one, affects us all.

If you think that sounds gloomy, think again: For the flip side of that coin is that, when you do good work, build trust, and succeed, your success will be more sustainable, and also a great deal more satisfactory. Your people will be happier too: for where trust is robust, people are comfortable, more efficient, more confident in their decisions, and work better together.

At the end of the day, people like to do business with people and companies they trust. As the volatility we are seeing in the world increases – in terms of technology, business models, markets, political and economic unrest – the value of that trust will multiply. Yes, indeed, people like to do business with people and companies they trust. That is why building trust is also building your company’s future!

Teema-artikkeleita julkaistaan liittyen Directors’ Institute of Finlandin ajankohtaisiin teemoihin. Kolmannen vuosineljänneksen teema on Hallitustyönkehittäminen. Neljännen vuosineljänneksen teema on Hallitus ja kasvu. Teema-artikkelit julkaistaan kokonaisuudessaan Boardview-lehdessä joulukuussa. Kirjoittajat ovat DIF:n valitsemia asiantuntijoita.