As recently as 15 years ago, the study of corporate governance mostly was confined to academia and a relatively small group of institutional investors concerned with scrutinizing systems of control in the larger listed companies.
Over the past decade or so, the governance landscape has changed beyond recognition. Every major economy has been through a period of self-examination, resulting in either new legislation or the publication of a best practice code. Some countries have been set on a steady course of reform, whereas others essentially have reacted to events. Wherever you look, corporate governance is a moveable feast — that is partly its fascination.
A single model of good corporate governance clearly is out of the question, nor will there ever be one type of universally acceptable board structure. Nevertheless, much has been written about the convergence of governance models around the world, and there is plenty of evidence that many best practice codes have developed along overlapping lines.
However, the differences in governance from one country to the next remain substantial enough to perplex all but the most diligent observer. Prospective non-executives contemplating a directorship on a foreign board need to understand the often subtle differences in governance from one country to the next. The same is true of directors serving on the board of a company subject to the rules of a foreign stock exchange, and for directors of companies with significant international revenue or M&A interests.
Legislation versus “comply or explain”
The semantics of corporate governance would make an interesting study. A surprising number of terms are employed to describe the officially sanctioned line on governance behaviour from country to country: they are referred to variously as codes, guidelines, principles, recommendations, policies, regulations and rules. Each implies subtly different things and it is not unusual to find several terms used in a single document. This can lead to confusion over what exactly is the precise nature or enforceability of each code or set of guidelines, etc.
On the whole, corporate governance behaviour is governed by one of two approaches: legislation, where governance behaviours are defined by statute and action can be taken through the courts to penalize non-compliance; and the principle of “comply or explain,” in which companies are obliged to disclose the extent of their compliance with a voluntary code of practice and account for any deviations, leaving the market to decide.
Whereas the US has adopted a mainly legislative approach to corporate governance, most other countries take a generally less prescriptive approach. There is no specific code of governance in the US. As the Sarbanes-Oxley Act demonstrates, when the bar is raised, it is not in small measures.
By contrast, the 2003 Combined Code in the UK is the culmination of no fewer than seven reports/codes issued by government-sponsored committees over an 11-year period, which have resulted in steady, incremental changes to governance practice and boardroom behaviour.
The truth is that outside the US many of the fundamental governance imperatives, particularly in the area of disclosure, are neither voluntary nor a matter of “comply or explain” — they are covered by stock exchange listing requirements and are, therefore, mandatory. This effectively amounts to legislation by the back door. For example, in Australia, there is no law requiring a company to have an audit committee, yet the ASX listing rules make one compulsory. A more extreme example can be found in non-US companies listed on the New York Stock Exchange (NYSE) that find themselves subject to the law of another country (Sarbanes-Oxley), which de facto takes precedence over any domestic governance code or best practice recommendations.
Board structure
Variations in board structure from country to country account for many differences in governance practice. The unitary board structure prevails in most countries — that is to say, a single board comprising non-executive directors with some executive representation. Within these countries there are many variations. For example, in the UK, the roles of chairman and CEO typically are separated, whereas in the US they normally are combined. In Italy, where a pyramidal group structure means that the separation between ownership and control often is ambiguous, the main board (consiglio di amministrazione) is supplemented by a board of auditors (collegio sindacale), which is elected by shareholders.
In France, a company may choose between three different board structures, depending on which one enables it “to carry out its mission in the best possible manner.” The single-tier board (conseil d’administration) is the most common and has two manifestations: one with a combined chairman/chief executive and one where the roles are separated. In addition, some companies adopt a two-tier structure with a supervisory board (conseil de surveillance) and a management board (directoire).
In Germany, the two-tier (or dual) board system is prescribed by law. A separate management board (Vorstand) and supervisory board (Aufsichtsrat) are mandatory for all companies that issue shares and for large limited liability companies. The supervisory board is made up exclusively of non-executive directors, of which a percentage must be employee representatives (50% in companies with more than 2,000 employees).
Non-executive directors
Different codes of governance treat non-executive directors in different ways, for example, in terms of the role and composition of the board and its committees, expectations of independence, the nominations process and compensation.
In the case of committee membership, there is clear evidence of convergence among codes. The trend is for most committees to be composed entirely of non-executive directors, and in the case of audit committees, the majority (if not all) should be independent directors.
The importance of the nominating committee has grown around the world as the spotlight falls on board composition and director independence. Many codes now explicitly state that the committee will preside over a formal, rigorous and transparent procedure for the recruitment of new directors. In most countries, the committee’s role also has broadened to include responsibility for succession planning and, in the case of the US and Canada, the supervision of governance issues.
One of the most interesting aspects of the rise of the numerous national governance codes is the myriad interpretations given to the notion of “independence.” Generally considered to be the sine qua non of good governance, independence has become the subject of intense debate. Those on the side of prescription argue that the only really effective way to ensure independent, objective thinking in the boardroom is to outlaw a detailed list of relationships and activities for non-executive directors. Others emphasize that independence ultimately is an intellectual state of mind, and the tendency towards box ticking is not only futile but also counterproductive.
What is certain is that there are as many definitions of independence as there are countries. There are many common threads, such as not having been employed by the company in an executive capacity or as a professional adviser for a given period of time (usually between three and five years); not having close family ties with company advisers or senior employees; and not having an important business relationship with the company, such as being a significant supplier, customer or shareholder. However, most country definitions include unique elements which can, in part, be explained by local circumstances.
So, for example, in Canada the proposed listing rules on independent audit committee members are extremely detailed; by contrast in Switzerland, where the pool of non-executive directors is considered limited, “reasonable application” of the independence criteria is left to companies themselves. In the US, directors receiving more than $100,000 per year in direct compensation cannot be considered independent until three years after such compensation ended; in France, a director loses independent status after serving 12 years on the board. For directors serving on boards in different countries, navigating all the definitions of independence is not a simple task.
Corporate governance is set to remain at the top of the agenda for boards, investors and the media for some time to come. As Spencer Stuart continues to place independent directors into board roles around the world and be involved in board assessments, we will be maintaining a close eye on developments in governance theory and practice, particularly as these developments affect individual directors.
About the authors
David Kimbell has been a consultant with Spencer Stuart since 1979 and co-leads the European Board Services Practice with Henri de Pitray, who focuses on board-level searches across a large variety of sectors for major French and international groups.
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