Time to catch up: corporate governance in private companies

Posted by Aura Toader on 2 October 2019
Aura Toader

When retail giant BHS collapsed in 2016, 11,000 employees lost their jobs and 20,000 people had their pensions cut. One year before, Sir Philip Green had sold the loss-making company, along with its underfunded pension fund, for the sum of £1 to a former race-car driver who had been declared bankrupt three times.

Those disgruntled employees might wonder just what the directors on the BHS board were thinking. They will never know, but now at least the staff of other large private companies will need wonder no more. Under section 172 of the Companies Act 2006, directors must consider the interest of a wide range of stakeholders—but they didn’t have to give an account of how those interests had been weighed up, if at all. Under the reforms pushed through by former Prime Minister Theresa May in 2018, directors of large companies must now describe how they have discharged their section 172 duty. So, for example, directors have to explain how the interests of employees have influenced the key decisions taken by the company.

Unlike the famous UK Corporate Governance Code, the new rule is not limited to public companies, but also applies to private companies such as BHS. And now these companies get their own code too: the Wates Corporate Governance Principles. When they report on 2019, UK companies with more than 2,000 employees or a turnover of more than £200 million and a balance sheet of more than £2 billion will have to explain their governance arrangements in much greater detail than before.

Proponents argue that this makes sense as not only do the section 172 strictures already apply to private businesses as well as public companies but private companies also benefit from such things as limited liability, meaning that many of the key stakeholders – including workers, creditors and pensioners – can be left with only limited protections in the event of a company failure. These changes to the law are about making private companies more accountable. Reporting on the Principles can provide greater transparency into how companies are run. And, importantly, the principles are really a list of things that boards should already be thinking about and acting on, not rules that must be followed.

 

What are the Wates Principles?

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Source: Financial Reporting Council (2018). The Wates Corporate Governance Principles for Large Private Companies

 

The principles came about when the Government asked James Wates CBE, himself the long-standing leader of a successful 100-year old private family business, to lead the creation of a governance code for private companies. Private companies are encouraged to follow six principles to inform and develop their governance practices and adopt them on an “apply and explain” basis. The principles are sufficiently high-level that companies are expected to apply them all (the “apply” bit), but different companies will apply them in different ways, and so are expected to “explain” how they are achieving the desired outcomes.

James Wates described the principles as a tool that will enable companies to “look at themselves in the mirror and evaluate what have they done well and where is there still room for improvement”. 

How will companies benefit from reporting against the Wates Principles?

The principles are a helpful exercise for companies that want to improve their governance. Even when companies don’t intentionally set out to improve their practices, reporting on the principles will challenge boards to consider important issues and ask themselves the question as to whether they are satisfied with the way they have been doing things—in other words, what gets reported gets done. That way, the mere act of reporting can change behaviours and make a positive difference. Ultimately though, these disclosures are foundations for the trust of investors and stakeholders. 

Shortcomings of the Principles

Critics say that the Wates Principles are not ambitious enough, however. Some want the principles to be tougher on executive remuneration, for example. Others complain that they should provide more reassurance to minority shareholders, who enjoy fewer protections than they do in listed companies.

Our view

Some of this criticism seems to stem from a misunderstanding of the role of principles and codes, and how they relate to the law. The law sets out minimum acceptable standards below which companies must not fall. Codes and principles encourage companies to do more than the minimum, and by requiring companies to report on the Wates Principles the hope is that it will incentivise them to adopt best practice.

That is not to say that some of the concerns about remuneration or minority shareholder rights aren’t justified, just that the answer to dealing with them is through strengthening the law. If the rules are deficient, you need to change the rulebook, not add detail to a set of high-level principles.   

The Wates Principles are high-level of necessity. Because of the diversity of private businesses that will be covered by the Principles – these will range from companies owned by private equity investors run for short-term cash and an early exit; to family-owned businesses that intend to persist and prosper for a further few hundred years; to large mutually-owned operations whose profitability is less important than delivering a service for members, to name but a few – only a flexible set of principles can possibly encompass the panoply of approaches that must be right for their governance.

The potential pitfall we see is not so much in the principles, but in their application. The Wates Principles challenge boards to discuss difficult topics, such as defining the firm’s purpose and long-term strategy, taking into account a variety of stakeholders. They are discussion-starter in the boardroom and a useful framework for governance disclosures. 

It is not the Wates Principles that are lacking. If they fail, it will be because boards have failed to rise to the challenge that they set. Those boards that address the questions that underlie the Principles and consider how their company can most effectively be run to deliver long-term value for all stakeholders will be the ones that prosper.

 

 

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Topics: UK, Blog