Britain’s Non-Executive Club Needs New Members

(Bloomberg Opinion) -- Britain's accounting watchdog is in the strange position of updating the country's corporate governance code while simultaneously fighting for its life.

The Financial Reporting Council is reeling from the collapse of Carillion Plc earlier this year. The construction firm's demise exposed a host of governance failings: auditors missed red flags in the accounts, the board failed to challenge management, and investors waved through fat pay packets and juicy dividends. As the FRC sifts through the wreckage, critics are attacking it for being toothless, and the government is reviewing its future.

This year's new code won't win the watchdog many new fans. It's still made up of non-binding recommendations, rather than hard and fast rules. Its changes are more incremental than radical.

But by nudging companies towards casting their net wider when appointing board directors -- by bringing in employees, for example, or by engaging more directly with shareholders -- there's hope that board group-think might be reduced. That should be just as important a goal as keeping tabs on pay or audit quality.

Carillion’s collapse exposed the weaknesses of boards with plenty of experience but little desire to rock the boat. Directors failed to challenge executives as debt levels swelled and finances became stretched. They took fright at the idea of scrapping dividends to conserve cash. They resisted the idea of raising equity until it was too late.

Some of this is probably down to the way in which board appointments are made. Of the top 150 publicly traded U.K. firms’ non-executive directors, two-thirds are men, and most have sat on a board before, according to recruiter Spencer Stuart. Almost three-quarters of chairmen sit on boards elsewhere. It looks like a cozy club.

Formal and independent nominations committees may be widespread, but the talent pool hasn't been widened. Decision-making power remains in the hands of one or two people, such as the chairman, according to a 2012 Cranfield School of Management paper. Nobody wants a board that is perpetually unable to come to agreement, but group-think is a clear danger.

One option would be getting investors more involved in the appointment process, as happens in Sweden. There, nominations committees include representatives of top shareholders.

Another is getting workers onto boards, a common sight in the German supervisory board model and one that has found support from Prime Minister Theresa May. It may seem strange to take inspiration from a country that has been rocked by the diesel-emissions scandal, but there would surely be benefits from more feedback from staff. An employee might have an alternative perspective on executives’ behavior and their value for money.

Seeing as external advisors are being scrutinized, it might also make sense to look at who’s doing the recruiting. Some 73 percent of FTSE 100 firms have used recruiting firms to appoint board members in the past. These search firms have their own code of conduct, but the Cranfield School of Management’s paper identifies lingering risk aversion and bias towards “the usual suspects.”

Britain has wrestled with corporate governance for more than a quarter of a century. If boards are to provide proper oversight of management, the well-trodden path to the non-executive club needs to become a little steeper. If it did, we could hope to have fewer corporate failures in future.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Lionel Laurent is a Bloomberg Opinion columnist covering finance and markets. He previously worked at Reuters and Forbes.

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