Margareta Pagano: Dear Sir David … the only code our boardrooms need is a code of honour

Each time there is a corporate crisis, the government of the day appoints a
distinguished industrialist or financier to clean up the mess and come up
with clever new ways of doing business. Thus, over the past decade or so, we
have had codes from Hempel, Greenbury, Cadbury and Higgs; all very
thoughtful people in their own right but who, once they get snared by
government, suddenly believe that they have to reform the universe.

In this way we have had a raft of fancy new rules, many of which have been
quietly dropped or ignored; and even sillier concepts such as the “comply
or explain” box-ticking devised by the late Sir Derek Higgs, which is
now unravelling as the governance row at Marks & Spencer and the board
succession at HSBC have shown. In the case of HSBC, the board ignored the
advice of Higgs, which stated that a chief executive should not step up to
being the chair, and HSBC now has a hugely successful chairman in Stephen
Green, the former chief executive.

But the real danger from these new codes is that the more we have, the more
the norm by which people operate is lowered; codes rarely allow for
honourable people to behave honourably.

This is why I am nervous about much of what Sir David Walker has to say in his
review, published last week, into improving the corporate governance of our

Some of his ideas are excellent: a new risk committee, strengthening the
chairman’s role, suggesting that non-executive directors spend more time
with their company and that remuneration committees look at the pay
structure throughout a financial institution ? are all to be highly
commended. Other bits are too prescriptive ? in particular, the notion that
NEDs should have more qualifications ? while his proposals to strengthen
shareholder engagement with the boards of the companies in which they invest
could become too bureaucratic and, I fear, unworkable. More of that later.

What I wanted to know the most from Sir David himself is whether he thinks
Britain’s banking disasters would have been prevented if his 39 steps had
been in force. Rather bravely, I thought, Sir David tells me that he hopes
so, mainly because of the three key weapons he proposes ? the new risk
committee, changes to boardroom culture, and the new levers for shareholders
to be more active. It’s easy with hindsight to hope, but would these new
teeth really have given the board the courage to stand up to RBS’s Sir Fred
Goodwin, who ran his fiefdom like the Kremlin, and question the ABN Amro
deal? Or, put another way, if the proposals had been in force, would they
have made NEDs so terrified about doing deals that they would have stopped
him from taking over NatWest, which was generally considered a good deal?
Would a tougher risk committee really have stopped Lord Stevenson and Andy
Hornby, chairman and chief executive of HBOS, from expanding market share at
any price? In fact, their actions were questioned by the risk officer ? and
he was sacked.

Although the public and the Government have chosen to concentrate on sky-high
City pay as the reason for the crash, pay and bonuses are the red herrings
in this drama. The real cause was over-arching ambition, bad management,
appalling risk assessment on the part of the executives, combined with
laziness on the part of the NEDs. As for many of the UK’s biggest investors,
they abrogated their responsibility to challenge the boards either on
strategy ? in the case of RBS, why was it buying ABN? ? or to question pay
levels because, so long as the share price was rising, they were happy to
sit by and watch. How do you dream up a code to change that?

Let’s be frank about Sir David’s remit: this was a political exercise and last
week he delivered the political response that the politicians wanted;
headlines which screamed “Pay of top City bankers to be made public”,
and “Dramatic overhaul of how banks are run”.

By implication, these headlines seemed to say that by making pay transparent
and public, huge bonuses will no longer be an issue, indeed, may even fall.
His idea that those staff earning more than the median level of the
executive directors should also be published is good ? but doesn’t go far
enough. If the point of this is to show the outside world and shareholders
which traders or originators are running the biggest risk, then to be
effective the pay levels of a much larger number of people within that firm
need to be provided ? at least the top 20 earners. This will give
shareholders and regulators a far better picture of where big leverage is
being built up in the bank. However, you can bet that pay won’t come down.
Just take a look at what RBS or any of the other banks are paying their
bankers right now.

I’m not suggesting that pay should come down ? that’s up to the shareholders
to decide, as they are the ultimate owners. So the big question to ask is
whether Walker’s proposals will force the UK’s big shareholders ? and
particularly the new breed of long-only funds, such as the sovereign wealth
funds ? to start behaving like responsible owners. His proposal that
investors should register with the Financial Reporting Council to explain
whether they are long-term holders or short-term “switchers” is
fine in theory, but could be difficult to enforce.

We should be looking to Sweden for a few lessons on how a much healthier
relationship has developed between boards and owners than the one we have in
this country. Instead of the usual bun-fight of an annual meeting, boards
meet with their four or five core, long-term shareholders regularly to talk
about what the company is doing. These are lively and informative forums,
giving investors the chance to evaluate the executives and the NEDs, as well
as question them over strategy and performance.

Shareholders are also involved in choosing the NEDs, thus creating a much
closer relationship between investors and the directors who are spending
their money. For a supposed social-democratic, capitalist society, we do
seem to be scared in the UK of letting shareholders behave as if they real
do own the capital. Sir David tells me he looked at the Swedish model, one
he admires, but says that our insider trading rules and other regulations
would make it difficult to operate. But it would be a pity if the Swedish
experience couldn’t be looked at more closely over the next two months of
the consultation process before Walker’s final report in November.

If we really want to stop the sort of appalling strategic errors made by
Britain’s top bankers, then we have to have a punishment to fit the crime.
We need teeth so draconian that the executives, and the NEDs, lose their
jobs and, possibly, face criminal judgment if they muck up on the scale we
have witnessed. We also need boards to stop being in thrall to the
remuneration consultants who are so good at persuading the bankers ? and
companies ? into paying more than they need. This doesn’t need new
legislation, just enforcing the existing laws.

Before Walker is set in stone, it’s worth asking whether corporate Britain is
run any better today than it was before the last crop of codes. There needs
to be far more debate about this, particularly how to improve the
relationships between companies and their owners; only then will we know
whether Walker’s report is a worthwhile exercise, or more sticking plaster.
What boardrooms really want from Walker is a new code of honour rather than
another code to be cracked in a few years time.

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