Lessons from FTSE governance reports

The quality of corporate governance reporting in the UK’s leading companies is not improving as well as most investors would like, according to corporate governance specialists Independent Audit.

In its latest publication, Board Reporting in 2006: A survey of FTSE-100 annual reports, the consultancy finds that:

- Audit committees are divided more or less evenly into those that want investors to know what they have been up to and those that still do not get this across.

- Board reporting is far less differentiated and boards remain generally shy of giving much away.

- Most nomination and remuneration committees have little to say about anything except their terms of reference.

- Nearly all boards are now assessing their effectiveness annually. Rotation between external review and self-assessment is becoming evident. Most give fuller explanations of what they are doing, but then spoil the effect by implying that their rigorous exercises in continuous improvement failed to find anything that could be improved.

There are a lot more good examples of reporting on specific features of board and committee work. The survey found more than 50 companies whose reports contain particular sections, which might help other companies think through how to improve their own reporting.

Audit committees

According to the survey, audit committees appear to be setting the trend in improved reporting disclosure. Many of them have become much better at saying what they actually did during the year. Nearly half have made a successful effort to give the reader something of a feel for the nature of their work.

There are many useful descriptions of activity, with BAA, BT, Old Mutual and Wolseley being particularly well thought through examples. Morrisons gets this year’s ‘most improved’ prize; its report suggests it now has in place not just an audit committee, but a serious one.

Nearly all companies include assessing the independence of their external auditors as part of their work, but only half describe how they do it (Aviva, BHP Billiton, Morrisons, Old Mutual and SAB Miller providing useful descriptions).

Most committees (77%) now confirm that they assessed the effectiveness of the external auditors (up from 58%). However, only one-third of these explain how they did it, with Associated British Foods, Aviva, Gallaher, Hanson and Rexam standing out.

The board

Board reporting, by contrast, remains generally uninspiring and uninformative, says Independent Audit. Many annual reports mention the importance of their company values or ethics, but hardly any board says anything about how it reinforces values and ethics from the top. Presumably, most feel they do this, but hardly any discuss how.

Working together

The latest survey found that few companies do much in the way of meeting the Combined Code on Corporate Governance’s requirement to explain how the board adopts a balanced approach to decision-making.

They do, however, respond to that part of it which relates to non-executive independence. Nearly all companies (97%) make the requisite statement on independence and 82% report having a majority of independent directors – down on last year (88%).

Around 90% of non-executive directors are classified as independent – the same as last year. Nearly half of the boards surveyed still have one or more non-executive directors who have served in excess of nine years, of whom two-thirds are said to remain independent. Allowing for the timing of board changes, the number of long-serving directors across all FTSE-100 companies (65 on 43 boards) is broadly in line with last year. Few of them are due to retire in the next year, which means the situation is likely to persist.

According to Independent Audit, this absence of any significant reduction, despite the large number of companies with long-serving directors, suggests that companies are taking less of a box-ticking approach to this issue and are not shedding directors just because of the passage of time. This could be a good thing – after all, the code’s principle is that independent directors should be independent in mindset and approach, with the nine-year rule being a suggested indicator of declining independence and not a rule at all.

Dialogue with shareholders

Although their efforts are generally unimaginative, most boards say something about how they talk to investors. However, they say much less about how they listened to what investors had to say. Even though BAE Systems, BT, HBOS, Reckitt Benckiser, Royal Bank of Scotland and Vodafone show how it can be done, three-quarters of companies said nothing about how their boards get investor and other stakeholder feedback.

Board effectiveness

Nearly all boards (94%) conducted a review of their effectiveness. Four-fifths of them explained their approaches, with half of these using a questionnaire approach, around 20% relying on interviews, 10% using a combination of the two and the rest working through a self-assessment discussion.

Around 40% of boards have now opted for some form of external review since the revised Combined Code came into force in 2003, nine companies for the first time this year. As in previous years, boards remain very shy of giving any indication of the outcomes. Of the half who say anything about the result of their evaluation, most simply state that they are effective, very effective or fully effective.

Most companies (83%) reviewed individual director performance. Less than half (35 companies) give any indication that such reviews were distinct from the assessment of the board; the others presumably wrap them in with the board review. The lack of information makes it difficult to judge how boards are tackling this.

Similarly, while around 70% of boards reviewed the effectiveness of their committees, only half of these distinguish the committee reviews from the board review. However, reporting on remuneration and nomination, committee effectiveness remains entirely uninformative.