Poor board governance blights UK businesses
by Liad Meidar, Managing Partner and Chief Investment Officer
In late 2016 when we first invested in DX Group, a British logistics provider, we were struck by just how much its chairman had on his plate. As well as DX, he held five other chairmanships and a further three board seats.
Meanwhile, the DX board as a whole was rather underpopulated, comprising four members in total, none of whom, when you looked beneath the bonnet, were truly “independent”. With a small “country club” board and a busy chairman, this did not look like corporate governance that could deliver success.
Sure enough, the company’s shares dropped 95pc from their IPO price a few years earlier. Over the course of eight months, we worked with the company to install an entirely new board, including an executive chairman able to dedicate the majority of his time to the company. DX is now on an entirely better trajectory under its new, more watchful leadership. Meanwhile, DX’s previous chairman is now facing pressure from an activist investor over his time commitments as chairman of Mears Group.
In an attempt to tackle this type of poor corporate governance, the Financial Reporting Council (FRC), which has set the broad rules for boardroom conduct for many years, announced last month a new UK Corporate Governance Code; the FRC claimed the revised rule book is “fit for the future”. It’s closer to “fit for the bin”; while the new code makes some of the right noises, we fear that little will ultimately change.
The improved corporate governance is down to several factors: Ensure that board members, especially chairmen, do not have so many outside commitments that they cannot dedicate the necessary time and effort to fulfil their duties properly; ensure that a majority of these board members are truly independent; create incentive structures that align boards and management to all stakeholders, not just shareholders; and implement an enforcement mechanism that has more teeth than the soft “comply or explain” regime.
Unfortunately, the much-overhyped reboot of the code drops the ball on most of these crucial issues.
There is no explicit limit on the number of boards on which one can serve (concerning in an environment in which nominations committees tend to seek candidates with the most plc board experience).
Secondly, “independence” is deemed to be lost after nine years, an absurd length of time. To alleviate the “country club” board culture of so many smaller UK companies, we would see board members lose their designation of independence after five years. Remuneration recommendations in the new code are littered with too much “should” and not enough “must”. Clawbacks, phased share award grants, stretch goals, and alignment to all stakeholders must be part of any remuneration plan.
Finally, “comply or explain” needs sharper teeth than just the threat of shareholders voting with their feet and disinvesting. Ultimately, by relying on “comply or explain”, companies can continue to flout the rules as long as they claim they are right to do so, which is a licence to maintain the status quo.
We faced this when we invested in French Connection, where the CEO is also the chairman (among the most egregious of corporate governance no-nos). In response to our calls to “comply” and divide the roles, the board has continued to “explain” away his non-compliant dual role year after year with the two same unconvincing sentences in the annual reports about company culture and the “need for speedy reaction times”.
Corporate governance matters. Bad governance can kill a company, which is bad for all stakeholders: not just shareholders, but employees, creditors, and pensioners.
With a long, hard look at the UK Corporate Governance Code, the FRC had a chance to clean up the boardroom. They’ve merely managed to rearrange the mess.