FRC criticises tick box mentality to Corporate Governance Code

The largest companies in the UK need to improve their standards of governance and focus on improving corporate culture rather than taking a box ticking approach to compliance, warns the Financial Reporting Council (FRC)

The latest FRC analysis of annual reports and compliance with the Corporate Governance Code, particularly early adopters of the 2018 Code, showed the prevalence of a box ticking approach pervaded many annual reports, with limited insight on sustainability, corporate culture or their long term non-financial strategy.

The string of corporate failures including Thomas Cook, Carillion and Patisserie Valerie, also raise concerns about board effectiveness and their ability to report risks to their long-term sustainability.

The FRC reviewed reporting against the 2016 UK Corporate Governance Code and assessed FTSE 100 early adopters of the revised 2018 Code. The 2018 Code came into force in 2019 and all premium listed companies report against it this year for the first time.

The new Code was published in July 2018 and applies to premium listed companies for accounting years beginning on or after 1 January 2019. Annual reports published in 2020 will be the first complete set of accounts to comply with the Code, but so far 82 companies have adopted early.

The FRC review of the early adopters found that there was a tick box mentality to compliance, with reporters failing to explain the reasons behind compliance with the various requirements of the Code, with limited detail on decision making processes.

Corporate culture and workforce engagement were the most frequently discussed areas, albeit in a peremptory manner, while there was acknowledgement that in future, justification and explanation of remuneration policies would be an important part of compliance with the Code.

FRC’s chief executive, Sir Jon Thompson said: ‘While there are examples of high quality governance reporting from early adopters, looking ahead we expect to see much greater insight into governance practices and outcomes reporting on a range of key issues from diversity to climate change.

‘Concentrating on achieving box-ticking compliance, at the expense of effective governance and reporting, is paying lip service to the spirit of the Code and does a disservice to the interests of shareholders and wider stakeholders, including the public.’

Around half of the sampled FTSE 100 companies provided purpose statements. However, the quality of these ‘varied greatly’, the FRC said.

‘There was a tendency to conflate mission and vision with purpose; normally, mission and vision rely on a company’s purpose to provide the reasons behind their goals,’ FRC stated.

‘Too many companies substituted what appeared to be a slogan or marketing line for their purpose or restricted it to achieving shareholder returns and profit. This approach is not acceptable for the 2018 Code. Reporting in these ways suggests that many companies have not fully considered purpose and its importance in relation to culture and strategy, nor have they sufficiently considered the views of stakeholders in their purpose statements.’

The best examples of reporting described purpose by considering it alongside culture and strategy rather than in isolation.

Another change to the 2018 Code was the emphasis on the importance of corporate culture and the role of boards. But this has not really filtered down to companies.

Although some early adopters seemed to be taking the issue more seriously, others noted that they planned to increase the focus on this area, admitting it was an area which required long-term commitment. However, the FRC report was critical of many of the reporters, who even three years after the corporate culture issue was first raised, were sidelining it.

‘It was disappointing that only a small number of boards disclosed that they already receive reports on culture to aid discussions, especially as the importance of corporate culture was raised by the FRC more than three years ago,’ the FRC said. ‘Moreover, only a few reported that it had a specific agenda item on alignment of culture with values and strategy. The lack of this level of discussion at board level perhaps links back to some of the poorer articulations on company purpose’.

This includes setting the tone from the top and achieving buy-in from management and employees.   

While some chair statements mentioned the importance of culture and explained that was part of their considerations of the 2018 Code, they admitted that additional work was required to achieve improvements in this area.

Overall, there was limited discussion of assessing and monitoring culture. Of those that did, the main tool used appeared to be employee engagement surveys, with the main metric being completion rates of such surveys. While these are beneficial, they only provide a snapshot of information and should not be used in isolation.

Only one company reported on some of the less positive feedback received as a result of a survey and explained how the board had dealt with the concerns raised. This approach demonstrated company commitment to its survey and values and that it acts on the views expressed, the FRC said. Others tended to focus on the positive responses of any survey and failed to demonstrate any consideration of concerns raised.

The FRC has also confirmed that it will be reviewing the guidance on risk management, internal controls and related financial and business reporting, to address the inherent risk issues related to large listed companies, exacerbated by the collapse of big name listed entities like Carillion, BHS and Thomas Cook.

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