The UK is extending corporate governance requirements to private companies for the first time, a move set to influence boardroom behaviour and business decision-making. While this may appear to be a burden, getting governance right can prove a huge driver of growth and success
The Financial Reporting Council (FRC) is extending UK corporate governance requirements to private sector firms for the first time. The government first mooted the idea in a green paper in 2016, leading to the creation of an “industry coalition” group including the Confederation of British Industry (CBI), Institute of Directors (IoD) and Trades Union Congress (TUC), chaired by private construction business owner James Wates.
The Wates Corporate Governance Principles, published this June, are the result. These will apply to private businesses with at least 2,000 employees or a turnover of more than £200 million and a balance sheet exceeding £2 billion, from January 2019.
The impetus for change has come from policymakers and regulators concerned at recent corporate failures among both listed and private firms. The demise of Carillion, for example, brought a host of challenges to light – variously affecting partner businesses, suppliers, customers and employees. Even when a brand is rescued, the original business may have gone into administration and problems can arise. House of Fraser customers, for example, were owed money for undelivered goods but must now line up with other creditors. Proper governance could have helped some issues or at least minimised the repercussions and privately owned businesses will now no longer escape scrutiny.
Firms will be expected to apply Wates or another such code, and they must explain how they are applying their chosen code in the directors’ report. To complete the picture, new Companies Reporting legislation will also require private firms with more than 250 employees to report on one governance measure in particular – a requirement to consult with and have regard to the views of employees.
“It is not just that the FRC code, which applies to large listed companies, has been updated to give employees a bigger influence in how decisions are made. It is also that the corporate governance principles are now to be applicable to large private companies, and in time this will trickle down to smaller companies,” says Ross Bryson, partner in the corporate department at City law firm Mishcon de Reya.
The Wates principles cover a wide range of activity. The first four – stipulating an effective independent board, the need to create and preserve value and mitigation of risks – are arguably the least controversial, though they might present a challenge to a dominant chief executive. More controversially, principle five suggests that the board promote executive remuneration structures aligned to the sustainable long-term success of a company, taking into account pay and conditions elsewhere in the organisation. Principle six says the board has a responsibility to oversee meaningful engagement with material stakeholders, including the workforce, and have regard to that discussion when taking decisions.
When the Wates principles were published, Elizabeth Bagger, executive director at the Institute for Family Business, said: “Good governance is an important part of a successful business and we know that families care about having a well-governed business that will be sustainable for the long term. But not all businesses have the structures in place that they need to manage risk and take long-term decisions.”
While the Wates principles will directly concern the largest private firms, many businesses are embracing these ideas in the belief that getting governance right can be a strong driver of profit and growth.
Alex Klein, CEO of computer firm Kano, believes corporate governance has contributed to his company’s success. “We have always had a board of directors that is both supportive and willing to give management space to excel. Together, we have invested heavily in product development, with the principle that long-term engagement is as important as revenue. Both have grown considerably as a result. We ask board members to weigh in and advise on critical topics as well as support us with partners.”
It is also the case that firms with better governance should be able to command a better price with private buyers and private equity firms. Mr Bryson adds: “With buyers, it is becoming a part of the everyday conversation in a way that wasn’t the case before. From a due diligence perspective, lack of a corporate governance structure undermines a buyer’s confidence in the target company’s business history and in the quality of the due diligence responses. This can change the tone of the negotiations and ultimately soften the sale price.”
Some owners may bristle at the increased scrutiny, but they can’t argue that the man responsible for the code doesn’t understand their sector. James Wates’s own construction firm leads by example. As a family-owned business, the purpose of setting out detailed corporate governance policies on its website is not to give comfort to shareholders, but to send a strong message to customers, staff and suppliers, and to the wider communities where it undertakes work, that this is a company they can trust. The question is: will his peers among the privately-owned firms decide to embrace his principles?