A Guide to Governance, part II
Part II: What happens when governance fails and why we need non-executive directors
The future: Trends and Developments
The lessons of Ahold, an international supermarkets group, (see case study below) and some of the other corporate failures since it failed in 2003 has led to European companies coming under scrutiny like never before when it comes to how they run themselves.
The Ahold scandal was swiftly followed by the discovery of a multi-billion euro fraud at Parmalat, the Italian food group, in 2003/04. As a result, greater co-operation developed between competing regulatory bodies both in Brussels and in individual countries to develop a stringent and effective code of corporate governance.
In the UK, the latest consultation from the FRC points the way to the key areas which it believes companies must focus on:
• The chairman’s responsibility for leading the board
• The need for directors to devote sufficient time
• The requirement for non-executive directors (NEDs) to challenge constructively and,
• The need for boards to have a balance of skills and experience.
There is a clear recognition that the recent meltdown in the world’s financial markets has shaken confidence in the corporate governance structures and procedures at some of the biggest corporates in the UK.
Banks in particular cannot escape scrutiny from shareholders and regulators as to why the collective expertise of the finest minds in UK banking failed to spot the looming crisis. That others, regulators and investors in particular, also failed to spot it has in some ways deflected criticism away from boards.
But the future direction of corporate governance procedures and guidelines has to take into account the recent failures at board level. In the same way that Enron led to a sea change in how corporate boards in the US are constituted and run, the banking crisis may represent a chance to examine and strengthen the codes covering this area. Board remuneration and incentive schemes, especially in financial services, have become a cause celebre.
Institutional investors have in turn been stung by the accusation that they failed to engage with their investee companies and failed to question management decisions. As a result the FRC drew up the UK’s first voluntary Stewardship Code, which outlines the responsibilities of institutional shareholders. To date, 68 organisations have signed up to the code. Non-executive directors, supposedly the voice of constructive challenge, have also had their role examined.
CASE STUDY: When corporate governance fails
Little known in the UK, Royal Ahold is a retail giant in the Netherlands. At its peak in 2001, Ahold’s had profits of €1.1 billion on sales of €66.6 billion. Headquartered in the Netherlands, it operated 5,155 stores in 27 countries and employed 250,000 people. It was hugely successful and had enjoyed enormous exponential growth in the years leading up to 2002.
However in 2003 it emerged that the company was in complete disarray – its stock tanked, the management resigned and shareholder valued was wiped out overnight. While the failure of Ahold had many explanations, fundamental failings in corporate governance were at the heart of its collapse. It was so bad, the Economist dubbed Ahold ‘Europe’s Enron’.
Ahold was for a long time owned and run by the Heijn Family. By the 1990s the family’s stake had dwindled to just 7%. Professional managers had been brought in with the express aim to grow the group. This need for constant and exponential growth put intolerable pressure on the company’s controls and ultimately led to its failure. The inability to spot this pressure and act to reverse the direction of the company was the single biggest failure in Ahold’s corporate governance.
The roots of the mistake lay in the family’s decision to retain a supervisory role over management. By using Dutch law they were able to ensure that shareholders and other stakeholders had no way of challenging the board or blocking appointments. Unconstrained, management pursued unsustainable growth strategies that led to its downfall. Simply put, by maintaining unfettered control over the board, Ahold’s management ran it off the road.
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