Regulation  

The unintended consequences of corporate governance changes

Sam Gilpin

Sam Gilpin

Looking back on the past year, one thing the British business sector has not lacked is corporate governance scandals.

Whether related to accounting issues, as was the case with M&C Saatchi, allegations of executive misconduct, or both – Ted Baker comes to mind – these types of high-profile mis-steps have intensified the calls for changes to be made.

As the UK prepares for  regulatory changes, it is important to reflect on how this might impact business more broadly.

Recent noises from the FRC (Financial Reporting Council) suggesting that they are looking to line up changes to the Corporate Governance Code will not come as a shock to many.

Indeed, it lies in the interest of all stakeholders in a business to have checks and balances in place to avoid transgressions that can hurt an organisation’s viability.

Putting the onus of financial controls explicitly on directors, with the possibility of criminal proceedings for those who report misleading statements, may get them to take greater responsibility of their company.

In the best of worlds, it may also lead to the entrenchment of positive corporate norms.

That said, there are three potential unintended consequences to be mindful of.

Implications for followers, leaders, and investors

The first two potential consequences are behavioural.

Firstly, while it is crucial for there to be accountability following breaches of rules, a potential repercussion is an increased reluctance, or even fear, for followers to raise issues when they emerge.

Leaders need to ensure that they are projecting a spirit of openness into their organisation, that they are not “shooting the messenger”, and it is an environment where it is okay to speak truth to power.

Creating a psychologically safe environment also has broader benefits, as was demonstrated by internal research conducted by Google, which found that it was the most common characteristic of high performing teams.

Secondly, fear of consequence can have a paralysing impact on leaders’ willingness to take risks.

This may seem counter-intuitive.

Surely, we think, the aim of strengthened regulation is to stop gung-ho executives from making rash decisions.

But there is a world of difference between boldness and recklessness, and in a fast-moving business context a reluctance to change can also be the death knell of a company (think Kodak).

There are two practical steps that leaders need to make: first, they must master their own anxieties about negative consequences to ensure that they are willing to make calls based on a dispassionate assessment of the available information; second, they must bring their colleagues with them so that they do not settle for the compromise option, which often turns out to be a variant on the horse designed by committee.

The third potential consequence relates to the impact on the wider business environment.