International trends point to employee representation on boards and growing influence from giant index funds, says global governance expert.
Roger Barker believes the global governance community faces a “watershed moment” as boards serve a broader range of stakeholders in response to changing community expectations – a change so profound it could influence governance models and the role of directors.
Dr Barker is Head of Corporate Governance at the Institute of Directors (IOD), the UK equivalent of the Australian Institute of Company Directors (AICD), and a noted global governance expert. His insights on trends in the UK and Europe are useful for Australian boards that want to understand the future of governance.
He believes governance has had two main phases this century. The first responded to perceived governance shortcomings after the 2008-09 GFC. Extra regulations and a view that boards should be more immersed in their role led to greater professionalisation of directorship.
The second phase is starting. Here, the role of listed company boards is changing from being an agent of shareholders, where profit maximisation is the focus, to representing a broader group of stakeholders and governing the pursuit of financial and non-financial goals.
This transition is well underway in Australia. The rise of Environmental, Social and Governance (ESG) reporting – and the market’s focus on ESG performance – is a defining characteristic of governance this decade. Investors are showing greater interest in an organisation’s approach to climate change, safety, diversity, human rights and other ESG issues.
Fundamentally, the notion of company success worldwide is being challenged… It is not enough for listed companies to report strong profit growth; communities want to know that performance is sustainable and is making the world a better place.
Barker believes this ESG focus will intensify. He expects boards in more countries to have employee-appointed directors – a model favoured in Germany and some Nordic countries. And a larger debate on who directors serve and how organisation performance is reported and measured – and how boards are judged against that.
“Fundamentally, the notion of company success worldwide is being challenged,” he says. “It is not enough for listed companies to report strong profit growth; communities want to know that performance is sustainable and is making the world a better place.”
Barkers adds: “As a result, communities expect boards to serve not only the interests of shareholders. They want directors to consider the needs of employees, customers, suppliers and other stakeholders, most of whom do not have equity in the organisation or voting rights. This approach challenges the traditional model of boards as agents of shareholders.”
Not all boards are moving in this direction. As some broaden their focus on ESG and stakeholder needs, others, particularly in the US, are adopting governance models that support a more aggressive focus on profit growth. Increasing privatisation of listed companies worldwide and different voting rights for shareholders, particularly in the tech sector, is part of that trend.
“We’re seeing a watering down of governance guidelines and listing rules in some markets as stock exchanges compete aggressively for the largest IPOs,” says Barker. “And more listed companies converting to private ownership through mergers and acquisitions, which in turn reduces governance transparency and creates different governance models.”
At the risk of simplification, governance models risk becoming polarised, not unlike politics where the gap between the left and right is widening. As some commercial boards focus on ESG and community outcomes, others are adopting governance models that have greater flexibility to pursue profit imperatives with less regard to ESG.
Here is an edited extract of Dr Barker’s interview with the Governance Leadership Centre:
GLC: Roger, the Australian Prudential Regulation Authority (APRA) in its report this year on the Commonwealth Bank implied that directors should dig deeper in their organisation. Do you expect boards to move towards a quasi-management role in coming years?
RB: No. The broader trend of directors spending extra time on their role has been underway since the GFC. After the crisis there was a view that not enough directors sufficiently understood their organisation or its financial accounts. But a non-executive director spending extra time on their role is not the same as becoming an executive director.
I would be very concerned if directorship morphs into a pseudo-management role. Directors who become too immersed in the day-to-day operations of their company can lose their objectivity and independence. Also, if they are paid higher fees because the role involves more work, they might be less willing to step away from that role, or challenge management, if required.
GLC: You mention the rise of ESG as one of the great governance trends. What is driving growth in ESG and where is this trend headed?
RB: Ultimately, it is being driven by institutional investors, particularly index funds (such as exchange traded funds that aim to replicate the performance of sharemarket indices). BlackRock, Vanguard, State Street and other large index funds have become more focused on governance, and holding boards to account, in recent years, because their clients expect it. As more money flows into index funds, BlackRock and other funds are increasing their ownership of individual companies globally, giving them greater influence on governance issues through their voting power.
GLC: How much governance influence do index funds really have if they are, in effect, required to hold companies in an index, unlike active managers that can buy and sell?
RB: That’s a good question. In some respects, large index funds are uniquely positioned to drive governance initiatives because they must hold a stock, to replicate a sharemarket index. As long-term investors, they can push for long-term governance change, which is something active managers that have a shorter-term focus may be less interested in.
GLC: Could listed companies in the West move to a Nordic governance model, where large shareholders have much more say in the company’s strategy and governance?
RB: It would be difficult. Listed companies in Nordic countries tend to have fewer and larger shareholders compared to, say, United States companies that have a higher proportion of retail investors. The Nordic governance model works for many Scandinavian companies because it is easier for a handful of large shareholders to serve on the board. That’s not the case in the US, UK or Europe where fund managers typically do not join the board of a company in which they invest, because they makes them an ‘insider’ and limits their investment activity.
GLC: Do you expect the influence of shareholder activism on boards to grow?
RB: Yes. Shareholder activism in the UK and Europe continues to affect more companies and boards. For example, the large German industrial company, Thyssenkrupp, was targeted this year by shareholder activists who wanted the company broken up, so that there would be better focus on its successful elevator division. The chairman and CEO resigned. I suspect we will see a bigger push for activists in coming years to force strategic change in companies they believe are underperforming. That will have implications for boards.
GLC: Will the Germany Supervisory Board model, which allows workers to elect representatives for almost half of companies in that market, influence governance models in other markets?
RB: The employee-elected director aspect of that model will. German and Scandinavian countries have long had some employee-elected directors on their boards and France moved to that model earlier this decade. (French companies with 5,000 employees worldwide or 1,000 in France, by law must have one employee representative on the board where there are up to 12 board member, and two on the board where there are 12 or more directors.)
The revised UK Corporate Governance Code (effective January 1, 2019) has a stronger focus on boards understanding the interests of employees. UK companies can choose one of three options (in the comply-or-explain code) on how they give employees more ‘voice’ in the boardroom. This could include an employee-elected board member, workforce advisory board or the designation of a non-executive director to engage with employees.
It will be interesting to see which option UK companies favour. Regardless, it seems inevitable that boards in other markets will be expected to have input from the organisation’s employees on governance decisions, as part of the push to govern for a wider group of stakeholders.
GLC: You are concerned about an emerging global trend of stock exchanges adapting their listing rules or governance guidelines to attract companies. What is the significance of this trend?
RB: I’m worried that the world could be entering a race to the bottom in governance standards in listed companies because of a global decline in Initial Public Offerings (IPO) and exchange listings. Also, many companies are choosing to stay private than list on exchanges, and listed companies are increasingly being privatised and taken off exchanges.
Hong Kong, for example, is allowing deviations to the traditional model of one share, one vote, possibly because it lost the Alibaba Group Holding IPO to the New York Stock Exchange in 2014. As global stock exchanges compete more aggressively for new listings and IPOs, my fear is they will water down governance standards too far, to accommodate them.
At the same time, companies remaining private has governance implications because there is less transparency and accountability, and likely to be smaller boards with less independence. The UK is introducing a Corporate Governance Code for private companies from next year, to lift private-sector governance standards. (Larger private companies will have to include a corporate governance statement in their annual report.)
We are also seeing more tech companies introduce dual-class voting shares that enhance their founder’s voting power. The rise of these so-called ‘tech unicorns’ is challenging traditional governance models and the one share, one vote, concept that is fundamental to governance.
These issues go the heart of the same debate: who will appoint directors in the future, who will those directors serve and what is the board’s purpose? Those questions are yet to be resolved.
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