The Most Difficult Question of All in Corporate Governance
By Sir Adrian Cadbury [In Memoriam]

It is this: What is the relationship between governance and performance?

Editor’s Note: Sir Adrian Cadbury, who died in September 2015, played an influential role in the development of higher standards of corporate governance practices. In the early 1990s he chaired a government-instigated inquiry that devised a Code of Best Practice that has been widely adopted by U.K. companies and has had a major influence on the development of corporate governance codes globally. The 1992 Cadbury Report “is still recognised around the world as the starting point on how companies should be managed,” noted The Guardian newspaper in its obituary of the former chairman of Cadbury Schweppes, the confectionary and beverage products company. Directors & Boards published the following set of observations by Sir Adrian that stands the test of time in an article titled “On Coming Up to Code” [Summer 1997].

Why has corporate governance become such a matter of public interest around the world? And why are boards of directors the primary target for this attention?

The straightforward answer is that they are accountable to shareholders for corporate performance. They are also seen more widely as being responsible for the legal and ethical behavior of the companies they direct.

Across the world there are increasing pressures for institutions of every kind to become more transparent in their activities and more responsive to those they serve. These pressures have been accompanied by demands for higher standards of accountability, behavior, and performance.

Public corporations have always been powerful institutions, but their influence is perceived to have grown, partly because that of politicians has declined. In addition, their increasingly international reach is seen as strengthening their influence and as making them less answerable to a single jurisdiction.

A Lack of Confidence

The fundamental reason, however, why boards of directors have become a focus of attention is lack of confidence in their system of accountability.

The most difficult question of all is the relationship between corporate governance and performance.

It is not readily susceptible to research, because of the complexity of the relationship and because measurable aspects of governance, such as the proportion of outside directors or the extent to which directors are shareholders, are of limited relevance.

What matters is the caliber of the directors concerned. This is an important reason for preferring market regulation, where possible, over statutory legislation.

The law has to deal with form, but what counts is substance, on which investors are in a position to make a judgment. The market answer to the question of whether improved governance translates into improved performance is that many investors believe that it does.

Studies by CalPERS and others support that conclusion. A recent U.K. survey showed that close to two-thirds of the 605 analysts and fund managers who took part considered corporate governance standards important when making investment decisions.

It is equally significant that companies which have been successful over the long term generally meet the kind of code recommendations being put forward, while none of the companies involved in recent corporate disasters have done so. It is not surprising that successful companies meet code recommendations, because these are closely based on best practice. The one certainty is that governance structures which do not measure up to accepted standards increase the risk of fraud, corporate failure or both.

Important to Private Companies, Too

Although the published codes are primarily addressed to directors of quoted companies, they are relevant to private companies.

The private companies of today are the public companies of tomorrow. When they wish to raise outside equity capital, or when they face the difficult transition from family control to formal board control (a transition I have experienced), they will need to have in place the kind of governance structures which these codes recommend. Going through the governance checklist is a reassurance to directors of all types of company in an increasingly litigious world.

If I were to make a heroic generalization as to the direction in which power within the corporate governance system worldwide is shifting, it would be along the lines of the events at General Motors. Institutional shareholders are now readier to bring pressure to bear on the boards of companies whose results are failing to meet their expectations. Boards, and particularly their outside directors, are responding to these pressures and are monitoring the management of their enterprises more closely.

In sum, the voice of shareholders is becoming more powerful, outside directors are playing a more forceful role, and boards themselves are taking a tighter grip on the running of their enterprises. The focus on boards remains. 

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