Corporate governance: Playing politics

It is virtually impossible amid the current market turmoil to turn out a monthly column without finding that, several weeks after writing, you have an enormous quantity of egg all over your face. “Stick all your spare cash into Iceland,” some misguided journalist might urge, imagining the frozen island a haven from events elsewhere. And then, a few days later, find themselves shouting: “Stop the press!” as they strive to insert the word “don’t” into their copy. (Not that I would have done that.) An old contact of mine in the City has been urging everyone to get their cash out of Iceland for almost a year now. And, at any rate, Iceland seemed an odd place to put your money in the first place.

As you will have gathered, these are not good times to make short-term prognostications. Better to look to the long-term. But the recurring thud of failing banks hitting the deck hasn’t helped that approach much.

City bars are full of people starting conversations with: “Who would have thought that…” But there is one issue that will be with us long after the current troubles have quietened down. That old faithful, regulation.

There are two sorts of regulation: the traditional resort of politicians ­ the knee-jerk ­ and the other sort, which is much more rare, and comes from the experience of business. It is the latter which is effective, but no one gets any headlines or much cash out of that.

You can refine the essence of regulation into two further classifications based on the motivations behind their use. There is the type of regulation which enables one sector of society to get its own back on another. And there is the type of regulation which is created to help things run better. Sarbanes-Oxley is a good example of the former; vindictive politicians making business pay for making them look foolish for not understanding what was going on. The idea of the operating and financial review, is an example of the latter with people in business working for years to create a better way of getting useful and relevant business information from companies to stakeholders. Needless to say, the politicians set about sitting on it and then trying to dismantle it for no pressing reason.

You can see in which direction I am heading. Governments around the world are going to feel themselves under pressure to play to the gallery of their electorates and produce measures which are long on headlines.

They are also under another pressure. It has become obvious around the world that politicians have, by and large, not really had much of an understanding of what was going on. They have found this embarrassing.

And an embarrassed politician is a dangerous thing. The over-reaction to prove they really are in control creates immense damage all around them.

If we are to learn from what is happening now, we have the relatively recent efforts at regulation to instruct us. The mention of Sarbanes-Oxley tends to result in eyes closing, followed by a thumping sound as foreheads hit desks. But it is a very good example of what those who create and implement regulation need to learn from. A recent research publication from the Institute of Chartered Accountants of Scotland does a very good job in drawing our attention to what we need to remember and understand.

The first is that, despite much calling for concerted global action on regulation, this route tends to end in disaster. It is all down to different cultures in corporate governance; comparing the Turnbull efforts in the UK and the Sarbanes-Oxley efforts in the US, the study points out that the motivations were totally different. In the US, it was the detection of fraudulent reporting, while in the UK it was on requiring company boards to adopt best practice. No wonder that Sarbanes-Oxley in the US was “a reactive response to perceived limitations in corporate governance and reporting highlighted by financial scandals”, whereas in the UK “internal control disclosure is seen as an important defence against the imposition of more prescriptive regulation.”

The researchers’ final conclusion about these cultural differences should be stuck under the noses of anyone attempting to create new regulations: “If regulators and policy makers do not take account of these differences, regulatory development, whether based on enforced legislative compliance or the adoption of preferred behavioural norms via voluntary codes, may be ineffective.”

And that brings us back to the heart of the matter. We can be sure that any new regulatory initiatives following this economic chaos will not have effectiveness at their core. Creating and implementing effective regulation is not something politicians would waste their time on. They need fireworks, balloons, headlines. Then they move on whenever the next election comes around. The rest of us, and business, are in this for the long haul. Unravelling the coming regulatory binge will be the focus of corporate governance for years to come.

Reporting on Internal Control in the UK and the US: Insights from the Turnbull and Sarbanes-Oxley Consultations, by Laura Spira and Catherine Gowthorpe, published by ICAS, can be downloaded free from the ICAS website.