By Joe Truelove From Carey Group, Guernsey

Purpose of the article

This article has been written to consider the nature of corporate governance and the impact that has on board selection and behaviour. Fundamentally, is corporate governance an art or a science?

Declaration of author’s interests

The author holds a Master of Arts degree but is also a Fellow of the Institute of Chartered Accountants in England and Wales. He serves as a Director on the boards of ten companies both regulated and unregulated and has been made the Chair of the audit committee of one of them.

Why does it matter?

Building the right team is the key to success in many competitive activities, from a cricket team to an infantry platoon. The management team of a company and the board of Directors in particular are vital to the success of any business. If the role of the board is to govern the company then without any sense of whether the act of corporate governance itself is an art or a science, how can a board be successfully composed? Should the board be composed of artists or scientists? What happens if inappropriate members are selected?

The scientific approach

It is possible to gain either a Master of Science or a Master of Arts degree in Corporate Governance, so academia seems to be divided on how to categorise corporate governance. When examining the typical syllabus it would appear that the content is predominantly company law and accounting, with some economics, risk management and ethics. No mention of biology, physics or chemistry there at all!

Perhaps even more importantly regulators are attempting to observe and understand the behaviours of boards. They normally do this after a negative event has occurred in a particular company and by reference only to the minutes of the meetings. This is why Directors pay detailed attention to the contents of minutes and compliance with all laws and regulations.

Various codes of corporate governance have been created as responses to various crises and some are required to be adopted by legislation. The UK has a Code of Corporate Governance; the Association of Investment Companies (AIC) has the AIC Code (designed for listed investment companies); the Quoted Companies Alliance has a code especially for small and medium listed companies. Even Guernsey has its very own Code of Corporate Governance, which is a requirement for regulated companies which have not adopted one of the other aforementioned codes. On becoming the member of a board you may feel that you will simply be able to read the applicable code and then be fully able to function as a board member.

Those who believe that the primary function of corporate governance is about understanding the relevant laws and regulations and establishing processes to ensure compliance with them would have us believe that being a company Director is a profession that can be learned and examined like accountancy and law. However this theory doesn’t take into account the intangible nature of the qualities required for the role of Director. Few have the mixture of experience, professional education and wisdom to become a Director. Many of the best Directors have not taken exams in Corporate Governance so it appears that there is something more to corporate governance that cannot be easily quantified and measured in a scientific fashion.

The dark art?

Much of what happens in board rooms takes place behind closed doors and will never become public, so there is an element of mystery associated with the decision making process. Is corporate governance therefore a dark art? There is an unquantifiable element missing from the codes of corporate governance that is subjective rather than objective and which therefore cannot be converted into a tick box procedure, in fact the codes themselves leave plenty of scope for judgement and discretion to be applied, and these cannot be performed in a purely scientific fashion.

If we consider that the study of a language (an arts subject) is divided into reading, writing, speaking and listening then it is fair to note that the role of a Director includes performing all of these acts. The content of most board meetings revolves around the spoken interaction of the members of the board who need to listen to one another. One hopes that they will have all read a series of board papers in advance of the meeting and the summary of what was discussed and conclusions reached at the meeting will be written down during the meeting and a formal record agreed. A large part of corporate governance appears to include understanding company law and that is definitely an arts subject too along with most other essay writing subjects.

Isn’t chemistry an important element of corporate governance? Very few reactive substances are utilised in the practice of corporate governance. The days of boards consuming large quantities of fine wine over lunch under the supervision of a sober company secretary are long gone. The chemistry between the board members however is of key interest. It is possible for a board which to split into two cliques, maybe one backing the fund manager and the other siding with some activist investors. There are situations where the Chairman has lost the confidence of other board members. An overbearing chairman can occasionally dominate a board. Sometimes conflicted individuals will protect their own interests rather than act in the interests of the company. All of these are scenarios evolving from human interaction which cannot be avoided by implementing procedures. A key to understanding board composition is to understand the motivations, potential for conflicts and underlying integrity levels of board members.

Is there an element of social anthropology required to understand the world of corporate governance? Well, observing the behaviours of a board of Directors and attempting to understand them could be compared to David Attenborough observing a group of gorillas and the dominant behaviour of the silverback (or on a fund board the silver haired Chairman keeping the meeting on track). But in this analogy it is David Attenborough who is the scientist. Neither gorillas nor Directors need to be anthropologists to perform their roles. And of course the behaviours of Directors bear almost no resemblance to those of gorillas.

Integrity, honesty and openness in dealings cannot readily be tested in a scientific manner nor can moral courage. We cannot legislate for those forming boards to select those Directors who at first glance appear the most like themselves or the most likely to be compliant and easily led.

Or the social science?

Of course there are a number of subjects which some Universities consider to be arts subjects and others consider a science. Subjects like psychology, economics and geography are often referred to as social sciences. Perhaps therefore corporate governance is a social science.

Psychology and sociology may help to understand why it was long considered desirable to have a peer of the realm as the Chairman of every board and why there so few female board members. Economists may add value at board level to explain the market conditions, but remuneration committee members need not be economists.

Although Corporate Governance is not an exact science, a questioning mind and an ability to apply logic are great attributes for a Director to have. An understanding of company law and financial reporting are very valuable too and they can easily be verified by reference to professional qualifications. Experience of audit is considered desirable for the Chair of the audit committee but does she need to be a retired audit partner? Learning by rote one of the various codes and being able to recall parrot fashion the reference numbers may be helpful, but copies of the rules can be referred to in the meetings.

Corporate Governance is concerned with the human interaction between the board members with management, with shareholders, with advisors and with each other. Yes, there are sociocultural norms to be observed and an element of ritual and ceremony have developed over many years (a bit like Japanese tea drinking!) An ability to get on with other people is taken for granted but mustn’t be overlooked. Emotional intelligence is as important as intelligence quotient and qualifications.

It is much easier to focus on the detail of compliance than to consider the tough subjects which need to be broached. Should the company be wound up? Why doesn’t the Chairman retire? Which one of us will make way for younger blood and new ideas? The ability to navigate these difficult conversations is like the work of a diplomat involved in The Great Game in the 19th century. An art form if ever there was one.

Resolution

Sun Tzu wrote his famous treatise on the Art of War when few people believed that war was an art form. To govern a company is to be human, to interact as part of a team, there will be a leader appointed and you are competing with other similar groups of people. Like war it’s a fight for life and death or, in the world of investment funds a constant battle to generate superior returns and attract more investors.

To win that battle boards need to be able to think outside the box not tick a series of boxes. Whilst scientific application of processes may help to satisfy the regulator and social sciences may assist with an understanding of how boards function; corporate governance is above all an art form, like war and diplomacy, requiring the application of judgement, wisdom and experience to the strategic decision making process of a company. Understanding this is the first step to being able to consider what sorts of individuals and skills are required to create a formidable team.

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