The future of corporate governance

Dr Linda Yeuh

Welcome. I’m Linda Yeuh, Associate Fellow at Chatham House, and an Academic Economist, as well as a Board Director. It is my pleasure to serve as Chair today and thank you all for joining this Chatham House webinar in partnership with EY on The Future of Corporate Governance. This webinar will be held on the record and is being recorded. Participants are encouraged to ask questions during the event using the ‘Q&A’ function at the bottom of your screens. The Technical Team will unmute those who want to ask a question. However, if you’d like to stay off microphone, then please indicate this in your question submission and I, as Chair, will read it out on your behalf. So now, it’s time to introduce the speakers.

We’re joined by Sir Jon Thompson, CEO of the Financial Reporting Council, and he will be its successor as well. Mala Shah-Coulson, Associate Partner, Corporate Governance, at EY UK, and Professor Robert Eccles, the Visiting Professor of Management Practice at the Saïd Business School at the University of Oxford. So, in the next hour, we will cover the below topics, what does the future of corporate governance look like? How can effective corporate governance deliver improved accountability, integrity and traceability? What are the trends driving corporate governance reforms at a global level, and what are the implications, at a regulatory and business level, and how will the UK’s proposed reforms to corporate governance affect the role of Directors and Auditors? Now, each of the speakers will spend about three minutes giving you their view of the future of corporate governance, and we will start with Jon.

Sir Jon Thompson

Well, good afternoon, and can I, first of all, say it’s really nice to be with you. Hopefully you can hear me. So, I was asked if I would talk a bit about gaps, as I saw them, and just to start by being transparent about the fact that the Financial Reporting Council is the organisation, which sets the UK corporate governance code, and I think it should be – I’ll define it in terms of saying that there is some angst from Politicians, some policymakers and others who are interested in external audit and corporate governance in the UK. So it isn’t exactly gaps, but it is, kind of, I’m going to talk a bit about concerns that there are with policymakers.

Now, policymakers have concerns in three areas. Firstly, because of corporate collapse where commentators raise concerns about the role of the relevant board, the transparency of the annual report and the role of the Auditor and their report. Secondly, there’s angst about the quality of external audits. So, our annual report on audit quality states about 75% of audits meet the quality standard, from about 150 or so reviews that we do a year, and this is an international challenge, it’s reflective of the work of our international regulator colleagues too. There aren’t really very many countries in the world that have higher standards or higher performance than we do. And, thirdly, there’s some angst about what might be called aggressive accounting.

Now, accounting standards provide for judgements to be made by a board about the financial results, and this isn’t a criticism of the standards, but rather there is quite a lot of concern about how transparent a company is about it making those big adjustments, those big judgement calls in its accounts, whether they’re being prudent at one end of a sort of fictitious scale, or aggressive at the other end.

So, the UK here, as a reminder, commissioned three independent reviews. The first was by Sir John Kingman, the Chairman of Legal & General, and he did a review of the FRC, and he made 83 recommendations for change, mostly about the FRC, which is the regulator, but he did make some very big recommendations, which impact on companies and corporate governance.

Secondly, the review by the Competition and Markets Authority of competition in the UK, audit marker, which made five recommendations. And, lastly, the review by Sir Donald Brydon, the Chairman of Sage, into the quality and effectiveness of audit, which made another 67 recommendations for change. So, altogether, there were 155 recommendations for change to the government, and that led to the publication of the White Paper.

Now, the change impacts on a wide range of organisations, but mostly investors, companies, external Auditors and the regulators, so those are the four main parties where there is significant reform. But for companies, several of the recommendations go directly to the heart of the responsibilities of the board, and the clear policy thinking for Ministers here is that the board is already responsible in law for the running of the company, and the White Paper reemphasises this, and then the White Paper goes further with three significant additions and those revolve around, first of all, increased transparency. So, there’s a set of new reports, like the Resilience Statement, or a new statement on the legality of the reports. Secondly, increased assurance, through a UK version of Sarbanes-Oxley or extending the audit into elements of the annual report and so on, and then, thirdly, increased accountability. In most the Audit Committee Chair and the role of the Audit Committee Chair and the responsibilities and the work of the Audit Committee, there’s definitely increased accountability there.

So, those are some of the changes to corporate governance arising from the government’s White Paper, but, as the regulator, we’re interested in four other things. Very briefly, one, how do we promote excellence in corporate governance, because actually many companies are already well-run, and they’re really quite transparent about reporting, but not everyone is, there’s a real inconsistency in the market, as we see it. Secondly, how do we avoid a standardised, or sort of boiler plate approach to reporting, and sort of how do we reflect the standards of best companies in providing a tailored approach to reporting each company?

Thirdly, how do we promote wider accountability, that is – that companies have, not just to shareholders, but also to others in relation to environmental and social goals to build long-term value? And, lastly, and from my own personal perspective, how do we continue to build purpose-driven organisations? A lot of debate about what does purpose mean and how does that drive a business plan and a long-term sustainable business, because we know that there’s plenty of evidence that purpose-driven organisations have higher productivity, higher staff engagement and so on. So, those are some – that’s some of the landscape, some of the gaps, as we see it, some of the concerns, but it’s great to be with you, looking forward to the questions and the debate.

Dr Linda Yeuh

Thank you very much. Mala.

Mala Shah-Coulson

Yeah, so my comments are beyond – looking beyond even this White Paper that the government has issued. A couple of points from me, I think we ought to look at the flaws of capital when we’re talking about the future of corporate governance, because if you think about how our capital markets have evolved, just in the UK, ten years ago there were 2,600 companies on the main market. That’s now just under 2,000, so I think governance – the focus of governance in the future perhaps needs to move away from just regulating public markets to thinking about private markets, or large private markets at least. And I realise that’s quite a conundrum because there’s a reason why companies want to stay private, but if you take the stakeholder-centric view of governance, I think the footprint these companies have on employees, on the supply chain, on the environment is huge. So I think it’s only natural that the future of governance looks beyond public markets.

The second point I would make is the future has to consider how share ownership has changed, how its globalised. So, if you, again, just speaking of the UK, 55% of our shares are in foreign hands now, and that ten years ago it was 40%. So, I think there’s something about thinking, well, how, in line with thinking about the future of governance, how does the future stewardship feature in that? Because I think stewardship is the other side of the governance coin, and without one the other doesn’t work. So, I know Sir Jon, sort of, said, you know, move away from standardisation, or standardised reporting, but I think maybe for – from the stewardship side, there needs to be some thought to international standardisation.

The third thing I’ll, sort of, see in the future of governance is the role of data and given how much boards are having to do already now, and it’s only going in one direction, given all the proposals the government has set out, I think there has to be a role for how data is used by those charged with governance to discharge their governance roles. And I would expect perhaps more automated data insight from things like dashboards or portals to give Directors the ability to monitor regularly, if not instantly.

And then, I think, the future for me is very tainted by what’s happened through the pandemic. I think it’s been a huge accelerator, on many fronts, you know, I mean, we all talk about the negative effects of the pandemic, but there are a few positives, or at least I like to remind myself from time-to-time, you know, home working, the use of collaborative tools, even how fast companies changed gear and switched their business models to make PPE and sanitiser for the frontline. And I think what companies have achieved, which ordinarily would have achieved in a decade, I think has been done in the last 18 months. So, with that in mind, I think the lag between technological changes and these disruptive changes and ways of working, and the corresponding speed of regulatory intervention, or initiatives, needs to be re-examined. I don’t think we can have such a big gap in the future, and I think our governance and our legislative and regulatory frameworks must be nimble enough and adaptable enough to keep up with the pace of change.

And the last point I want to make is, I think it’s very easy to look at corporate governance as a burden and, you know, there is some burden to it, let’s not lie to ourselves, but I also would like to think the future needs to focus on opportunity. It’s not just about risk management and mitigation, and if you – actually yesterday in preparing for this, I went back to the 1992 definition of governance in the Cadbury Report, which is about the system by which companies are directed and controlled, and the word ‘directed’, I was thinking, well, companies have actually emerged strongly from this pandemic as a force for good, and they’re helping solve social problems and, in fact, employees, you know, say that we want our companies to take a strong stance in helping us solve – the public solve social problems. So, how do we craft a governance framework in the future that directs and channels this behaviour? And obviously it is also managing risk at the same time, I mean, you can’t do one without the other.

And the reason I want to emphasise the focus on opportunities, if we all think about what our end outcome is and the end outcome of what the government’s White Paper aims for, is enhanced trust in business. And, in fact, trust in business has risen through the pandemic, if you look at the latest Edelman Barometer, in the UK, just two weeks ago, their spring update said trust in business is 53% compared to 47 pre-pandemic. So, how does our regulatory and corporate governance framework act as an enabler to keep it on that upward trajectory? So, I think those are my, kind of, wider observations on where I see the future going. Thank you.

Dr Linda Yeuh

Thank you very much. Robert. You’re on mute, which is the term of 2020/2021.

Professor Robert G. Eccles

And I promised myself I wouldn’t do that and I did. So, I’ll start again, it’s a pleasure and surprise to be here. When I got Sam’s email, I said, “You made a mistake, I’m an American, just because I’m at Saïd doesn’t mean I’m British. I think you’ve got the wrong guy, you should talk to Colin Mayer.” He said, “No, listen, we’d like to have a token American, provide a little comic relief,” I said, “Fine, I don’t know much about, you know, Section 172, but happy to join.” So, when you talk about the future, Linda, I have a very expansive view of the future.

I read an article the other day that over two million years there were 2.5 Tyrannosaurus Rexs that lived, so if we look at the corporate form we have today, in the West, it’s 100/120 years old, what we call a C corporation in the United States. To cut to the chase, I think the future of corporate governance is to replace, I can’t say how yet, I think is to replace the C corp with what, in the United States, we would call a public benefit corporation. My colleague, Colin Mayer, wrote a wonderful book called Prosperity: Better Business Makes the Greater Good. He wrote an article with Judge Leo Strine, the Former Chief Justice of the Delaware Supreme Court, everything I know about PBCs I’ve learned from Judge Strine, making a very strong case that if you’re serious about stakeholder capitalism, the term that Mala used, then I think you need to go to a public benefit corporation where the big difference is that in the C corp, as we have it in the United States, is still largely, I think Jon can correct me in Section 172, Directors may take account of other stakeholders. They do so from the perspective of a long-term shareholder interest in a public benefit corporation, Directors shall take account of other stakeholders, there will be a positive duty, in a US context, and shareholders will hold them to account.

So, when you look at how the world has changed, you see the growth in the size of companies, you see what Mala talked about, companies going into private hands, a lot in private equity, when you, sort of, look at the concentration in the asset management industry, I think we really have to question if we’re serious about, you know, the SDGs, if we’re serious about science-based targets. I am not convinced at all that anything that we’re doing with a traditional C corp, well-intended as it is, is going to deal with the problems we have today and we need to have a massive shift to a different corporate form, based in company law.

Dr Linda Yeuh

Thank you very much, and a reminder to participants, if you’d like to ask a question of the panel, we will be turning to that after our initial discussion, you can pop that into the ‘Q&A’ box for me and I will bring you onscreen to ask your question. If you’d rather have me ask the question, that’s absolutely fine, just indicate in the question box, when you put it into the ‘Q&A’. But before we open up for questions, I want to ask, I think the panel’s views on the other questions that we flagged, we would certainly cover in this session and perhaps follow up with it on what’s already been said. So, I’m going to turn to you first, Mala, which is, you know, what are you hearing from companies as the biggest concerns about corporate governance? Of course, you’ve also outlined the opportunities, but I think the concerns, including with the upcoming audit reform.

Mala Shah-Coulson

Sure. So, I think if I split that into two, in terms of gaps and concerns, more broadly, beyond the White Paper, I think, for me, this information or misinformation is a huge area to deal with and through the pandemic we’ve seen a lot of it and some of it has had really tragic consequences, you know, things like even vaccine take-up are impacted by disinformation, you know, mobile phone masts were destroyed in the UK because there was some theory that they were responsible for spreading the virus. And I think guarding information quality is a huge impact – has a huge impact and it’s not one company’s problem, it’s not some companies’ problem, it’s – it requires concerted effort from regulators, companies and government. And the reason I place so much emphasis on good information quality is because the impact of information quality on trust in business, which is, as I said before, it’s the ultimate aim of any reform to our systems, I think again, I’m going to quote the Edelman Barometer, but, you know, 76% of informed public trust the business and that falls to 48%, if you look at the mass public. So, I think reforms need to address that information trust gap. So, I think that’s my first point.

And then, I think in terms of the gaps and what I’ve been hearing from companies about the government’s current proposals, related to a point I made, you know, some of this is rooted in reviews that Sir Jon outlined that date back to 2018. And time has passed and I think there is a little bit of – things have moved on, especially with the pandemic, so perhaps some proposals aren’t hitting home as they perhaps would have a few years ago, when those reviews were undertaken. So I think that that gap between the speed of change in business versus the speed of change in regulation is really something key. I think the other things I’m hearing from business is actually recognising there is a cost to all of this, you know, many are actually positive about quite a few aspects of the change, but everything comes with some regulatory burden and cost, and I think it’s, sort of, the recognition that investors will need to pick up some of these costs and it’s about choices investors and other stakeholders make.

And the third thing I would say is, I think there is a risk that the proposals are still – you know, they’re very wide-ranging, don’t get me wrong, but I think they’re still quite focused on the financial aspects of governance and yet, when you look at things like the World Bank’s Global Risk Reports, if you look at the transition of risks between 2015 and now, financial risks have actually fallen. It’s all the ESG risks, that Professor Robert was talking about, you know, climate change, water scarcity, and I just think, you know, are we missing something about how governance actually is going to solve the problems of today, and also post-pandemic the social problems, you know, things like employee mental health and the burnout. So, whilst I agree the reforms are, you know, huge and wide-ranging, I also think have we, kind of, because of the pandemic, missed something because we are focused quite narrowly on financial aspects of governance?

Dr Linda Yeuh

Thank you very much, Mala. Jon, I’m going to come to you next. In your opening comments, you’ve already discussed the gaps that need addressing, but I think it’d be useful for you perhaps to say a few words about how you see, and you know this as a regulator, it often is the case that you regulate the stables after the horses have bolted and there’s always this sense that regulation needs to match trends. So, it’d be good to just get your views on how you see business trends changing and the ways in which corporate governance ought to shift with that, so that we don’t end up just shutting the barn doors or whatever that metaphor is.

Sir Jon Thompson

Yeah, you’re right. Well, look, there is always a time lag, isn’t there, between failures in a system and regulators taking action, and it’s a criticism of regulators in any domain, in any country in the world, and, you know, Kingman was right, in terms of pointing out the FRC was somewhat backward-looking and needed to be more in the now and more about the future. And I think we have significantly increased our capacity to do future-facing work, in terms of identifying what’s best in the market, pulling that out, in terms of corporate reporting or corporate governance or transparency or accountability and so on and then promoting that through what’s called the FRC Lab, which does this kind of best practice promotion, innovation work, and we’ve significantly increased the resources there and we will continue to do that.

But there is always a tension, I think, when you’re a regulator between are you trying to police a system, and – or are you trying to promote innovation and experimentation and so on? And there is this kind of inherent tension between it because everyone, if there’s a failure, everyone says, you know, “You should have been a Policeman and you should have stopped that from happening,” but they also want you to be, kind of, forward-facing, and it’s just an inherent tension. And I’ll be upfront about it, we haven’t really reconciled ourselves to that because Kingman wanted us to do both and he wanted us to increase our capacity in both of those disciplines, and we are doing that, I think.

How do we match trends? Well, I think some of the propositions in the White Paper, in the government’s propositions, do try to be more forward-facing. I mean, I think Donald Brydon’s recommendation about the resilience statement I think is actually really quite an innovative step forward, in terms of trying to get companies to be more transparent in their analysis of the risks they face, short, medium and long-term. And, secondly, trying to make them more accountable to a wider range of stakeholders.

Now, it seems to me that we would support both of those as steps forward, particularly in terms of what Robert said in his opening remarks, you know, are companies responsible to other stakeholders other than shareholders? We believe they are, that is quite forward-leaning, some of the best companies already do some tremendous work in this area, and there is now a majority of Directors in the company, according to our recent survey, now do actually acknowledge that they have responsibility over and above that of shareholders. So, I think we’re moving in the right direction, but I don’t pretend that we’re anything like the finished regulator that Kingman envisaged and there’s more for us to do, post the legislation and continuing to build what are we here for. What do we do? How does that manifest itself, and how do you get the right balance between the various tensions in the system?

Dr Linda Yeuh

Thank you. Robert, I want to ask you next about a similar question, but globally, what are some of the global trends in corporate governance? And if you had any advice on positioning the UK as an attractive place for leading multinationals, that would be welcome too.

Professor Robert G. Eccles

So, when we had our little prep session, you said we could go with the flow, so I’m going to go with the flow. I’m going to ignore the question that you asked me, if you don’t mind, and I’m going to kind of go to the second for the UK. I think Sir Jon is right, you know, innovation is important. I think, you know, the UK is moving in the right direction faster than the US. I mean, the US is like a whole other set of problems. We don’t even have a corporate governance code, but there was a comment sent in by Caroline Emmet about a book that I hadn’t heard of, by the Labour Shadow Secretary, so I multitasked and I read about this in the FT, Go Big: How to Fix Our World, so the basic proposal Mr Miliband is making is what I was talking about, kind of, following on the B corp. There’s a B Corp UK. My colleague at Oxford, you know, Mary Johnstone-Louis, is the Chair, and so I know that there’s at least some discussion in the UK about having a public benefit corporation legal form, which you don’t have, you know, you don’t have it in France, you do the [inaudible – 55:54] enterprise. So, I have a question actually for Jon, so let’s say that company law is being considered to change in the UK, so that at least there’s an option to have a public benefit corporation, what is the role that the FRC plays in this? Would it study it? Would it make a recommendation? Would it just wait to see the legislation happen and then, sort of, issue guidance around, kind of, what does corporate governance mean in a public benefit corporation? Like, how does that work in the UK between the role of the FRC, legislation and how you’d get the UK to move in the direction of at least having the option of a public benefit corporation?

Dr Linda Yeuh

Go ahead, Jon.

Sir Jon Thompson

Thanks, Linda. Well, I don’t necessarily follow that you need to change the corporate form to drive the higher levels of accountability by a corporation. So, under the current Company’s Act, there is some accountability beyond the shareholders. There is a general move now, as I said, I think the recent Director’s Survey said 61% of Directors felt that they had accountability beyond the shareholders, so there’s definitely some momentum there. If what we now begin to say is there are some minimum non-financial reporting standards that you have to apply, particularly in relation to environmental and social impact of your company, then that drives more accountability into that sector. You don’t necessarily have to change the underpinning corporate form, in order to drive that level of accountability.

The big question, which arises from that is, unlike international financial reporting standards, there is currently really no international agreement on non-financial reporting standards, and can you – can we drive that? And so, we’ve been promoting the Sustainable Accountability Standards Board’s standards as being the – a set of internationally comparable measures for how you can measure the impact of your company on the environment, and that then drives some consistent accountability. But there is an option in UK law to do what you suggested, but I would strongly recommend that we would probably go down a different route of here are some standards, all public interest entities, as they’re called in the UK, have to comply with these standards. That delivers us a consistent set of metrics, that drives wider accountability, and then we go from there. I think that is – would probably be my recommendations to Politicians.

Dr Linda Yeuh

Thank you very much. As Robert’s pointed out, we’re getting some fantastically good questions coming through, but please do put it in the ‘Q&A’, so I can pick them up in just a few moments. But before we do that, I do want to cover off the last part of the four topics that we told the audience that we would cover, which is the question, and really this is for you, Jon, “How will the UK’s proposed reforms to corporate governance affect the role of Directors and Auditors?” And I believe you have four big things to share.

Sir Jon Thompson

Thanks, I like numbers and lists, sorry about that. So, for me, for Directors, there are probably four big things for Directors. So, first of all, it reemphasises the existing legislation on the role of Directors, you know, it’s the company results. All Directors are responsible for the running of a company, that’s already in UK law and the government is very strongly reemphasising that. I think there is somewhat of a debate about that, and occasionally, I’ve been in forums where Non-Executive Directors will say, “No, no, no, I’m not responsible actually for the company, it’s the Executive.” Well, in law, it’s not, it’s all the Directors of a company.

There are three thing – three significant changes in the consultation document. One is driving up transparency, so there are a range of new reports, with an aim of driving additional transparency, in terms of corporate reporting. Although to Mala’s rather brilliant point about information and so on, we are looking at other also reductions we could make in the annual report, so we could change the nature of transparency.

Secondly, it’s trying to drive high levels of accountability, in particular in relation to the work of the Audit Committee Chair, because we know, from talking to companies, that investors want to engage with the Remuneration Committee Chair, but they don’t necessarily want to talk to the Audit Committee Chair, and we think, well, that’s not – that doesn’t seem like the right balance, we need to get more balance into that accountability. And then, thirdly, it’s trying to drive high levels of assurance, the third new thing is high levels of assurance, so, for example, asking for the UK version of Sarbanes-Oxley, although it’s much narrower, in terms of its definition. So, that’s really it for Directors, reemphasising higher transparency, higher accountability and assurance.

For Auditors, well, they require quite a lot of changes for Auditors, there’s probably eight, I won’t try and do eight ‘cause it’s just too many, but the big things for Auditors, I think, are, first of all, much clearer reporting, because if you read an audit report it can be really rather dense and somewhat opaque about what the Auditors are really trying to say. And if you’re really going to drive accountability, then you need clarity about what are they saying in a way that everyone can engage with, ‘cause if we’re trying to encourage investors into the space of engaging more, they need to understand what the Auditors are saying, so that’s one.

The rather controversial topic about how do you builds a resilience of the audit market through what was originally something called joint audit, and then we put in managed shared audit, and then the government’s come forward with market capping, the big four, and, you know, there’s a very healthy debate in there about how do you get competition and resilience and what does that mean? And then, I suppose, for the Auditors, it’s the audit being extended well beyond the financials into things like alternative performance measures, or key performance indicators, or frankly anything that the Audit Committee wanted further assurance about, either from the external Auditor or from other assurance providers. That is potentially quite a significant change. There are others too, but I picked those three as a sort of illustration of some of the biggest changes for Auditors.

Dr Linda Yeuh

If I go to Mala on a follow-up, Jon, you mentioned there the kind of UK SOX as a lighter form of US SOX, is that a change from a principles-based to a more prescriptive way of regulating?

Mala Shah-Coulson

Yes, I think our current frameworks, regulatory frameworks, have a lot of requirements around internal controls, you know, they are set out in the code. In fact, Directors already have to do an annual review of the effectiveness of internal controls. They are set out in the disclosure guidance and transparency rules at the FCA. I think what is different is the granularity by which they make statements, as required under the code today, isn’t there. So there is therefore not like a common method of a Director saying, “Yes, we’ve reviewed the effectiveness of internal controls by doing X, Y and Z.” So, I think, for me, I think that granularity is necessary to create a level playing field, otherwise you get different standards and you get some gaps in how companies do things. As to whether you make it completely prescriptive, question mark. I think it has to be a balance. If I think back to when US SOX was introduced, the actual SOX legislation for companies was about two or three paragraphs in the, you know, the Sarbanes-Oxley Act. What drove the whole granularity was the Audit Standard in the US, at that time Audit Standard 5, and I think that put so much onus on companies to document various processes and controls because the Auditors asked for it, not because they were required to.

So, I think, again, when the UK is thinking about the system it brings in, whether it’s internal financial controls or broader, or whether it’s subject to Auditor at a station or not, there needs – the requirements for the Directors need to be mirrored and matched by what the Auditor is supposed to be doing. As soon as you have an imbalance and there’s a gap, then I think you get different – you know, you get purpose and unintended consequences of that regulation.

Dr Linda Yeuh

I think I should hear Jon.

Sir Jon Thompson

Well, Mala’s right, it…

Professor Robert G. Eccles

I think Jon froze.

Dr Linda Yeuh

I think Jon you’re going to have to exit and re-enter, I think. He’s back. You were frozen there for a second, but you’re back now, no worries.

Sir Jon Thompson

Okay, my apologies. We think there’s a lot to be learnt from what happened in the US in, what, 2003/4 and in the first few years and if you look at what happened there, and there’s various academic analysis of this, there was a significant cost and then it dropped down and many of the controls are then automated and so on. So, there’s a lot to be learnt from what happened in the US, and we do have to also recognise there are 50 dualistic companies here and in the US.

I think the other relevant area here that we’re going to have to do some work on is the Financial Conduct Authority Senior Manager’s regime has many similarities to Sarbanes-Oxley. There’s definitely some sort of overlapping, so whatever system we need to define needs to reconcile with that. And to your original question, does that mean it’s moving away from the code being in principle? Yes, to be blunt about it, it is. To Mala’s point, it may or may not be driven by Audit Standards, because the government has given some options in relation to our testation, one of which is that it should be audited, the other two are not, so there’s some choice to be played into that space. So I think we’re expecting quite a strong response to this, because it is one of the three areas where there are significant additional costs for companies. So, yes, we’re moving away from that and in several other areas I think we are moving away from the 18 principles of the current corporate governance code, are being specified more in detail as a result of the White Paper, yes.

Dr Linda Yeuh

That’s interesting. I suspect we’ll probably come back to it in the ‘Q&A’, because the principles-based approach is quite a characteristic of the UK system, but it sounds like obviously you’re looking at it. Final question to Robert, before we bring in the audience, which is around stewardship and sustainability. Robert, just talk us through how these issues should be done, should it be done as it were in-house, international bodies and standards, should it be going to proxy agencies, how do you see, sort of, a good system for looking after stewardship, broadly defined, whether that’s sustainability, or social, or governance, or even remuneration ought to be looked at? So a really small question for you.

Professor Robert G. Eccles

Thank you. So, let me address that and then touch on a couple of other points and we’ll open it up. I think in terms of stewardship, I mean, the United States doesn’t have a stewardship code, I don’t see it happening any time soon. I’m not quite convinced that you need to have any kind of code at a global level, an international level, because you’ve got this huge concentration, I mentioned before, in the asset management industry. So there’s a handful of big asset managers and asset owners, and they are collectively finding ways to exercise stewardship by acting in packs, and I mentioned Climate Action 100 would be a good example of that, and they all invest globally. And so, what I see happening that’s very important in the past four or five years has basically been a flip between the corporate community probably being ahead on sustainability and then it’s really switched over to the investment community, where corporate governance and financial performance and all of that is sort of rolled into it and you’ve got a very kind of dramatic example and that Engine No. 1 campaign against Exxon Mobile, and I was involved in a bit. So, I’m pretty encouraged by what I see.

The investors I talk to and in my research over the past couple of years, I’ve probably talked to 100, I can tell you they’re pretty sceptical about all the company talk around purpose and governance. It’s better in the UK than it is in the US, and so I think even today there is a lot of catch-up that companies have to do to just meet investor expectations the way they are. To Jon’s point about standards for external reporting rather than changing the corporate form, I’m a big fan of the International Sustainability Standards Board. We’ll see what happens, the EU’s got its taxonomy, the SUC has issued its guidance, hopefully we’ll have at least a baseline.

And then just one quick thing on audits, and so this is something that my colleague, David Pitt-Watson at the Judge School of Cambridge, first turned my attention to, and it’s really important, I think. Right now, there’s a big question about whether the financial audits, as they’re being done today, take account of climate change and, kind of, down in the weeds here, beyond my pay grade, but it’s called Key Audit Matters and under IFRS, it’s called Critical Audit Matters, under US GAP, and so one thing maybe Mala could talk about is where she sees the audit community going, the big four, ‘cause, you know, they basically audit most of the world’s market cap, in terms of before we get standards for climate disclosure, which I hope we’re going to have by the end of the year, just are the audits that are being done today, are they taking proper account when they put the financial accounts together, the income statement and the balance sheet, are they taking account of climate change or not?

Dr Linda Yeuh

Mala, please.

Mala Shah-Coulson

Yeah, it’s a good question, and if you think about the TCFD, it’s actually the focus, the true focus is on the financial aspects of climate change. And we’ve just recently done some analysis of December reports in the FTSE 350 and we reviewed about 100 accounts of December yearends, and looked at how they’d implemented TCFD. So, I think before moving at how Auditors are looking at it, I think even looking at companies’ disclosures about the financial impacts, so they are increasingly talking about the strategic impact, the governance impact, but I think I – from my memory of the statistics, there were four companies that we found in over 100 referencing the financial impacts of climate change in their financial statements. So, I don’t think we’re there yet, Robert, both from the company perspective and from the Auditor perspective. I mean, we, as a firm, I think we are asked increasingly, even mandating some work to be done on how we incorporate the impact of climate change into, kind of, thinking about our risk assessments and the execution of our audit procedures, but it’s nascent, I will say it’s nascent. So, I think there’s a way to go.

Professor Robert G. Eccles

I mean, David is doing some studies like you talked about, looking at companies down to the level of seeing how the accounts were prepared. So, I mean, I can put you in touch with him, I know him already, I think what he’s doing is really important work, and that 4% number, that’s amazing. I mean, that’s very telling, Mala.

Dr Linda Yeuh

Thank you. We are now going to bring in – there’s some really great questions coming in from the audience. I think the first couple I’m going to group together and, Robert, I think this is really for you. One of the questioners is Sandy Morgan, who says, “I agree with Robert’s comments about the change of corporate mandates. However, what does he think will facilitate this change, shareholders, regulators?” And it’s a related second question that’s been posed, which is, “Shareholder capitalism tends to be quite a divisive term concept, is it in fact the case you don’t need to be brought in – you don’t need to bring in this concept to reap the benefits of audit and corporate governance reform because there are bottom-line benefits to be had by being a good corporation?” And, “How do we bring together critical mass stakeholders together, regardless of where they sit on the stakeholder/shareholder capitalism spectrum?” So, Robert, I think this question is really for you, which is, do you really need the term ‘stakeholder capitalism,’ and how do you do it well?

Professor Robert G. Eccles

Well, that’s a broad set of topics. I mean, I think that the term ‘stakeholder capitalism’ is useful at least rhetorically, you know, to kind of have a counterpoint to so-called shareholder capitalism, and, you know, both of them get, I think, misinterpreted. I’m less concerned about what the terminology is. I mean, I think Jon makes some good points, that there’s a lot that you can do with the corporate form as it is today, if the board is sincere, if management is sincere, if investors are pushing them. For the most part at least, my experience in the US is that the boards still don’t get it, for the most part, I mean, I think that the CEO does, the CFOs are a little bit reluctant.

Again, I think the investor pressure is really important here. Innovation, Veeva Systems became a public benefit corporation in the United States. They got 99% of the shareholder vote, so you can say there’s maybe two ways to get there. One would be that you could have legislation, you know, conceivably you could have legislation. In the United States, Elizabeth Warren was proposing something like that, to say we’re going to change our corporate form. As a practical matter, I don’t think that’s going to happen. I think having the option, and in the United States it would be state-by-state, in the UK it would be for the country, where, you know, if a company wanted to, then the company would have to instigate that the shareholders would support it. And I think it’s a good way to find out whether shareholders are authentic as well, because what you end up with is this stakeholder capitalism, multiple stakeholders, it’s related to financial performance that’s over the long-term.

We’re kind of ducking the impact question a little bit around ESG, empirical evidence, as the ESG contributes, that’s more kind of operations and risk impact, as the externalities of products and services and that’s where, again, I think this other corporate form is important. Jon made the point, I think, around remuneration when we were talking about standards, and I think that could go a long way. I mean, I would agree on that, but you need standards, so if you had standards for sustainability reporting, just like you have for financial reporting, which we didn’t always have, then you would have credible metrics that you would be able to tie compensation to. But then again, the boards would have to rise to the occasion to make sure that the Senior Executives’ compensation was tied to these non-financial measures.

Dr Linda Yeuh

Thank you, Robert. Jon, I think this question is well-positioned for you as well.

Sir Jon Thompson

Thanks. Well, look, we see accountability in a, if you like, a more simplistic way, which is this. So, a company is owned by shareholders, there is definitely some accountability between the board and the shareholders, in terms of reporting financially and non-financially. But companies don’t exist in some void. They impact on a wide range of other parties. They impact on employees and pensioners and communities and suppliers and other capital providers and financial institutions and so on, and therefore there is a level of accountability that goes with that, if you’re significant and large enough in the UK to be on a premium-listed UK market. So, that’s how we see it, and what we are trying to introduce here is some – is to increase that level of accountability through transparency of reporting, ‘cause, you know, if you’re a mineral extractor, it directly impacts on the people that you’re, you know, being where you’re extracting those minerals from, and there is a level of accountability that goes from that. And that’s what we’re trying to facilitate, the debate about trying to facilitate higher standards of transparency and accountability and so on. That’s the angle that we’re coming at it from, just worth being explored.

Dr Linda Yeuh

Thank you. Okay, so we are now going to bring in our audience members who – participants who want to ask their question themselves, I believe. So I’m going to ask Catherine Curl and then Dara Fagan, so what’s going to happen, Catherine, you first, is you are going to get promoted, there you are, so it’s very disconcerting for a sec, as you change status, but you are now with us and so please do ask your question, I should say questions.

Catherine Curl

Thank you very much, I had two. I don’t want to take all of the airtime here though, thank you. Right, my first question really has to do with the notion of being – I guess, of a company being in business to meet the needs of multiple stakeholders, not only shareholders, and my question is, would that change or broadening of purpose potentially lead to a loss of focus on the part of a firm, such as – such that the firm actually accomplishes nothing, particularly if the interests of various stakeholders diverge? So – and my second question is, I’d be very interested in what the committee thinks about how they propose bringing into scope unlisted firms, who may, but are not obligated to adhere to some of these standards?

Dr Linda Yeuh

Great questions, thank you very much. Alright, Mala, do you want to take a stab at them first?

Mala Shah-Coulson

Yeah, so on the question of purpose being so wide and therefore the company losing focus, to me a purpose defines why the company exists, and then it’s your strategy that should keep focus because your strategy should be aligning with that purpose. But your strategy can be more granular in saying, okay, so to achieve our purpose and our raison d’etre, how are we going – what are we going to do and how? And so, I think if – where you can really get out of focus is where there’s that misalignment and where there’s lack of clear definition around strategic objectives, and then you can go all the way down. So, you know, you can say, okay, we’ve got our strategic objectives, how do we measure that we’re achieving anything? And I think things like key performance indicators have to be linked back to strategy and every now and then I think when the board is making strategic decisions, whether that’s an acquisition, whether that’s a restructuring, I think the way you keep focus is saying, okay, how does this align with our purpose, you know, that final step back and linking it back to purpose is very key for you to kind of a) remain true to the purpose you set out with, and b) also make sure that, you know, you’re not, like, veering off on a tangent from your stated purpose. So, that’s like my answer to the first question.

Dr Linda Yeuh

Wonderful, thank you, Mala. Jon.

Sir Jon Thompson

Well, look, Catherine, on your second question, we wrestled with this after we had the three independent reviews and of course all three of them say, here’s some more things that you can do, and the natural inclination is to say, okay, we’ll load those onto companies, which are on public markets because they are already publicly accountable. And so we’ll – it increased the amount of transparency and accountability on those companies, and as we were doing that, it struck us that what you’re doing is creating even more of a differential between those companies, which are on our public market and those companies which are attracting capital from sources. And so, Kingman actually made this recommendation which said, well, you might want to think about that, and the manifestation of this is in something called the definition of a public interest entity, that’s the term that’s used, and so we revisited that question with – on the basis of a report by Sir James Wates, the Chair of the Wates Construction Group, which is of course a large private company. And he made some recommendations to the government about standards of corporate governance in large private companies, and on the basis of these various reports, the view was actually, you can’t just drive up higher levels of accountability and transparency on those coming in on a public market, you’ve also got to think about the accountability of those on a – accessing private capital. And so, the recommendation was brought forward that the definition of a public interest entity should be expanded to include a range of these large private companies, on the basis of either their turnover or their number of employees, or their balance sheet value, and Sir James made some recommendations in that regard. And that’s what the government is consulting on, because there are still – if you’d like to go back to my three original reasons why there’s angst from Parliamentarians, one of those is corporate collapse, and some of our most spectacular corporate collapses have come in privately-owned companies. And so, you’re not just increasing the regulatory differential, what you’re actually doing is maintaining it by adding to both sides of the equation, as it were, and I think it’s important that we do, do that, so that we don’t continue to open up this gap between public and private capital.

Dr Linda Yeuh

Thank you. Robert, I’ll come to you before we bring in the next question, perhaps you can answer the first question around – that Catherine had posed, do you start to lose the purpose of the company by focusing on stakeholders?

Professor Robert G. Eccles

So, I mean, I think Mala said it well. I mean, if you’ve got a clear purpose, you know, why do you exist, what is the role of this company in society, and you’ve got some KPIs, you manage to those just like you manage to earnings, and there will be some financial metrics and there will be some non-financial metrics. I’ve never really bought this, you know, kind of lack of focus thing. I mean, companies deal with trade-offs all the time. Shareholders are not a homogenous group, there’s hedge funds and there’s long and there’s shorts, and so it’s like, you know, they’re making those trade-off decisions on alongside, just basically don’t buy that argument.

In terms of, you know, disclosure, private companies, this corporate sustainability reporting directive and the new taxonomy, man, it’s just based on size. It’s 50,000 companies, public, private, it doesn’t make a difference, I think it’s number of employees of 250. The SCC consultation on climate disclosure, one of the questions, should it be private companies? SCC is concerned about capital formation, like Mala talked about, in the UK I think the number of listed companies here has gone down by half. So, I think you need to level the playing field. I think you need to have more disclosures from private companies, not only from a capital formation point of view, but from a system level point of view.

I mean, there’s a lot of assets that are in the private sector and people are concerned about fuel assets going the private equity complicated thing. I think you need to have, if they don’t want to report their financial stuff, that’s okay, but I think some critical sustainability issues, like climate, maybe a couple of social things, like diversity, equity and inclusion, that varies more by country, I see no reason why you can’t have private companies and shouldn’t have private companies reporting on those as well.

Dr Linda Yeuh

Thank you, Robert. Now, let’s bring in Dara Fagan to ask his question.

Dara Fagan

Hello, I hope you can hear me okay.

Dr Linda Yeuh

Yeah, perfectly.

Dara Fagan

Thank you, Linda. So, it was a question, well, two parts, one is a micro one maybe, but I was interested in the comments from Jon around the unitary board and all the Board Directors have similar responsibilities, because the consultation document seemed, in a number of areas, to subdivide the board, or give differential responsibilities or exposure, and I was interested in how that could be reconciled? So, for example, Executive Directors signing off on financial statements, or looking at roles like – such as the audit share differently from other Non-Executives, ‘cause that seemed to drive a slight wedge or a difference between members of the board. And if I can ask a, sort of, second question, around audit and assurance, I see the analogy in the paper between that and remuneration, but I’m interested in the experience of engagement, even in something such as remuneration, which seems a lot simpler to engage on than audit and assurance. It’s incredibly problematic and I wonder how the role of the proxies and shareholders that actually don’t want to engage, or are resistant to engaging, how you can achieve that and not be prone to special interest groups, focusing on one area of audit and assurance at the expense of everything else?

Dr Linda Yeuh

Thank you very much. Jon.

Sir Jon Thompson

Thanks. I’ll let my colleagues have a crack at your second question. Yeah, sorry, so let’s start with the legal responsibilities of a company. So, the issue arises here because of the current regulatory scope of the Financial Reporting Council. So, we can only take regulatory action against those members of a board who happen to be qualified Accountants, and, as Kingman pointed out, this seems a little odd, doesn’t it, that the – that one of the regulators which diagnoses why a company collapses can then only take any regulatory enforcement action against those members of the Board who happen to be qualified Accountants.

There are, I think, many companies where the CFO is not necessarily a qualified Accountant, and neither is the CEO, you know, so it significantly limits your ability to take regulatory action against the Directors who happen to be in these situations of being on a board when a company collapses. So, it came from, well, let’s put them all on the same plane, in relation to enforcement action and reinforce the current existing law about their legal responsibilities to the company’s results and so on and so forth, so there was that. And then, you’re right, there is some inherent tension in saying – and then somewhat more defining the role of the Audit Committee Chair, there are potentially some options in relation to the Executives, like there are with the US system, although it’s worth me reemphasising the government’s also consulting on – well, it could just be the Board that make the testation, not just the Executive members, so there’s another option in there. But you’re right that it does begin to potentially – it’s been put to me in other places, that potentially might pull apart the CFO and the Audit Committee Chair on one side of the board, and the Chief Executive and the Chairman on another side of the board, coming from slightly different directions, in terms of accountability and results and strategy and so on. And that is something that we are going to have to work our way through, with colleagues, in terms of how do we get the right balance between roles and responsibilities and regulatory remit and actions?

Dr Linda Yeuh

Thank you, Jon. Mala, do you want to take the second question? I think Jon had punted that one into the ether here.

Mala Shah-Coulson

Yeah, I think I’ll give you my view, and, interestingly, I had a conversation with an investor this morning about the – how they see, you know, the issue of engagement, given, you know, Audit Committees I’ve spoken to recognise that it’s difficult to engage now because investors are – may not have the capacity to engage on everything, and a few points stand out to me. I think a good stewardship depends on engaging on the right issues, so you could say, well, do they continue to engage on remuneration because there is still a huge issue? Potentially, I don’t know, I mean, I’m not an investor or in a company to be able to comment, but I think the fact that it’s recurring is something that needs to be thought about and it also brings me to my point on the efficacy of the regulation. So, you know, the remuneration regulations in this country were brought in, well, first, I think, in 2006, then revised in 2013, and if there’s still this recurring issue, then I kind of think are we making strides in the right direction? Compared to something like gender pay gap, which the reporting has actually led to some change, I’m not saying it’s all fixed, but there is some incremental change happening every year.

I also think, you know, investors are honest and they have said there is a capacity shift, but there is also a, sort of, slightly – a knowledge issue, you know, are they able, will they be able to engage at a technical level on what should be audited and assured because, you know, I think investors I’ve spoken to, even in the current system, their understanding of what assurance actually means is lacking. So, I think it’s not just about their willingness to engage, there will have to be some education, and I think the, as Sir Jon said, you know, the FRC would have to double in size, I think investors will have to kind of think about their resourcing and the structures they have in place to kind of engage with companies.

Dr Linda Yeuh

Thank you, Mala. We only have literally a couple of minutes left, so Deborah, if it’s okay, I’m going to ask your question, just so we can – I’ll get one more in, I’m sorry we haven’t been able to get to everybody’s questions, and rather than bringing you in, so this question from Deborah Gilson is, “Please could you comment on where you think more engagement may become potentially futile, for example, in the aftermath of a failed advisory vote on pay, and where the board and company did extensive engagement beforehand, but a majority of shareholders simply disagreed with the board’s decisions?” A nice easy one for you, Jon, as the final question.

Sir Jon Thompson

Thanks, Linda. Do you know what? I think Deborah’s question is one on which I genuinely don’t know the answer. I mean, I don’t know is the straightforward answer to that question. So, I won’t make it up, because, you know, the point of having seminars like this is that people occasionally think – make you really think about it, and that is definitely something where I think it’s worth walking away and having a think about. So, I’m sorry, Deborah, I don’t know the answer to that question. Great question.

Dr Linda Yeuh

Because I’m an Academic, I actually – oh, sorry, Robert, go ahead.

Professor Robert G. Eccles

Just real quick, I mean, she raises a good point, and I think in the US context people will say the problem is, you know, these, you know, proposals say on paper, they’re precatory, you know, until they don’t have any teeth. I mean, what they would say is they just – you don’t have the mechanisms, and so in a US context, you know, you have to start voting against the Chair or the board, or something like that, and you don’t get enough vote there. The direct engagement on the compensation, it usually doesn’t work, although there’s research that Allison Binns of Morgan Stanley has done that it is a leading indicator of problems in financial performance when there’s say on pay issues.

Dr Linda Yeuh

Thank you. Well, you know, as an Academic, I actually think a successful event, seminar, is when there’s lot of great questions, but – and not necessarily all the answers, ‘cause I think this has given us a huge amount of food for thought, and especially for a seminar that was titled The Future of Corporate Governance, and I think we’ve covered quite a lot of these issues, which will shape the way that, you know, companies are governed and all of us, as stakeholders, will be affected. So, an absolutely wonderful discussion, and I think my quick takeaway is that it does seem that this future and these changes, will need to be proportional and flexible to the different kinds of companies to which it applies, and of course I’d be remiss in not just saying the 21st Century world has changed and I think for the UK to take this opportunity to position itself, I think would be quite an important part of this, there’s a macro issue as well as the micro ones.

So, with that, let me thank very much this fantastic panel, Sir Jon Thompson, Mala Shah-Coulson, and Professor Robert Eccles, what an absolutely stimulating discussion, and a huge thanks to all of you for your fantastic questions. I do feel we could have gone on for longer, but we are unfortunately out of time, but thank you for posing those and for watching today. And then, just finally, a huge thanks to Sam Martin, Leslie McKenna, Peter Scarfon, and the rest of the Chatham House and EY teams for putting together this great event. So, thank you all once again and have a brilliant rest of the day.

Professor Robert G. Eccles

Take care. Bye, bye.

Mala Shah-Coulson

Thanks.