Corporate governance is often presented as an issue of compliance - compliance with Codes and Standards, with regulators and of course with the law. Compliance is, of course, an important component of governance but it isn’t the whole story. The real way to think about governance is that it’s a relationship. It’s the relationship between the people who run the organisation and the people on whose behalf the organisation is run.

At its simplest, it’s the relationship between the directors of a company and the company’s shareholders. So the evolution of corporate governance codes started with stock exchange rules for listed companies. The stock exchange governance rules where largely drafted as a response to various corporate scandals to protect the interests of investors and potential investors. Many of the scandals involved the directors benefitting themselves at the expense of the shareholders. This is called an “agency cost” and its part of one of the theories of the organisation called “agency theory”.

The original stock exchange rules gradually developed into the “Combined Code of Corporate Governance” and later into the UK Corporate Governance Code. These codes spelt out good practice for boards of directors and gradually helped inform the discussion of good practice for the boards of other kinds organisation. So other codes evolved. These include, for example, the Governance Framework (Charity Commission) Good Governance (NVCO), the Code of Governance for Housing Co-Operatives, NHS Foundation Code of Governance, the work of the Committee on Standards in Public Life and many others.

These organisations mostly don’t have shareholders, so the wider way of thinking about the governance relationship is that its relationship between the people who run the organisation (and who might be directors, governors or trustees) and the organisations’ stakeholders. Agency theory doesn’t work for these kinds of organisations, so in order to think about the theoretical basis of governance we have to use stakeholder theory! (We’re going to look at the theoretical basis of governance in a future Student Note!).

We looked at the meaning of “stakeholders” in the last edition of Governance Now. Ultimately, the relationship with stakeholders lead to thinking about corporate social responsibility. So governance is really about decisions that are made about how the organisation is run.

Like any other relationship there has to be jurisdiction within which the relationship can work. So there’s always a jurisdiction within which both the directors (or governors or trustees) and owners (or stakeholders) work. This gives us a framework to think about the governance of organisations. All organisations have to be run so any framework for governance must be an inclusive one.

For the people running the organization (directors governors or trustee), there are up to four parts to the framework:

1. The Organisation’s Constitution
For a UK company this would be the Memorandum and Articles. In other countries there are the same documents but they are called the Byelaws, the company charter or the foundation document. For a trust, the constitution is the trust deed. Some organisations (like NHS trust or some universities), have their own piece of legislation. All of these documents spell out what kind of company or organisation it is and what powers the directors have.

2. The Law
This could be the Companies Act, the Charities Act, Health and Social Care Act, the Housing Act, the Police Reform and Social Responsibility Act and many others – each dealing with a specific sector of activity. Amongst many other things these pieces of legislation set out the directors duties.

3. The Regulators
Regulators oversee specific areas of activity and all of the major sector have a regulator. Typical regulators include the Financial Conduct Authority (FCA) or the Homes and Communities Agency (HCA) and many other each appropriate to a particular sector. Regulators set often set out minimum standards of performance.  

4. The Corporate Governance Codes
As we have already seen, each sector has evolved it own corporate governance code. These are often overseen by the regulator for each sector and set out good practice and conduct for the directors. The principle of these codes is usually “comply or explain”.

For the owners or stakeholders there is also a framework for governance – a body of rules within which they have to operate.

A. Shareholder Agreements / Client Charters
For companies, the shareholder agreement is the document that sets out how the shareholder will exercise their various rights. In the public and third sector, charters (e.g. patients / tenants charters) also set out their various rights and how they will work together.

B. Stewardship Codes
The UK Stewardship Code sets out the good practice for investors in their relationship with the companies that they invest in. Major investors (e.g. Hermes) also have stewardship codes. The development of stewardship codes (and stakeholder charters) is likely to be a hot topic in governance in the years ahead as further thinking is done about the governance relationship.