The measure of Wates
The publication of a new corporate governance code for private companies has potential implications for private equity-backed companies. But how relevant is it to most UK companies?
The codification of corporate governance in the UK has, until recently, focused on publicly listed companies. Following the collapse of BCCI and the Maxwell empire, the UK’s first foray into setting out principles for good corporate governance was the 1992 Cadbury Report. There have been revised versions of corporate governance codes for public companies almost every year since. Last year, in the wake of the failure of BHS, among others, there was the publication of a new code, the Wates Principles (see ‘Latest Thinking’, overleaf for details). Designed primarily for large private companies, the framework is targeted at companies with 2,000-plus employees. This clearly has implications for private equity firms completing mega-deals in the UK, which will be required to make statements about corporate governance arrangements in the big companies they back. But what about lower down the deal-size spectrum where, arguably, the majority of private equity firms in the UK target their money?
James Wates, chairman of the group that put together the principles (as well as chairman of family-owned construction company The Wates Group), makes clear in his introduction that he’d like more widespread adoption. He writes: “My hope is that a wide range of companies – and not just those included in the new legislative requirement to report on their corporate governance arrangements – will use the Wates Principles.”
But private equity executives targeting smaller businesses do not seem keen – it certainly seems unlikely that the Wates Principles will be seen as much of a guide.
Alistair Brew, head of investment operations at the Business Growth Fund (BGF), says the principles are sensible and that BGF largely follows the spirit of them already. “But we don’t go into a business saying that we will institute these six items,” he says. “For us, it’s more about behaviour and substance than complying with a code. We speak to the businesses that we back at least on a weekly basis, and codifying that relationship would be too bureaucratic in an entrepreneurially run organisation.”
Jon Moulton, chairman and founder of Better Capital – who is also on the Corporate Finance Faculty’s board and a regular columnist for Corporate Financier – is involved in the All Party Parliamentary Corporate Governance Group.
He is characterisically forthright: “There is an assumption that lots of corporate governance is a good thing, but I’d have to ask whether it’s worth the cost. No one has done an impact assessment on the Wates recommendations, or on any other corporate governance code. In public companies, you now have board packs running to hundreds of pages – they have increased in FTSE 350 companies on average by 28,000 words over the past 10 years. Who has time to read that? One of the great advantages of private equity is that there is a much more direct relationship between the investing shareholders and the board. Codification isn’t necessary.”
Given the closer relationship between investor and company, the purpose of corporate governance in private equity is different than in a public company. Not all agree on the precise nature of that purpose. That possibly reflects a variation in strategies. For Moulton, who is most closely associated with turnarounds, it’s about protecting the investment. He says: “Corporate governance in general used to be about having a policeman on board to ensure that the company didn’t rip off the shareholders, although it has extended into all sorts of directions. In companies that I back, that original aim still stands – you have to focus on the integrity of the numbers you are getting and have a firm grasp on how the business is run.”
For Bernard Dale, Connection Capital’s managing partner, a well-functioning board should create shareholder value. “Clearly corporate governance is vital, but it’s not a factor that makes a difference to returns,” he explains. “Good corporate governance is about making sure that processes are followed and things are done correctly so that shareholders, the company and its creditors are protected. What drives value is commitment and hard work. Clearly, the two coincide when something isn’t working, and that’s where good non-executive directors come into play. They should have a low tolerance for poor performance.”
Some see creating value and robust corporate governance as far more intertwined. David Atkinson, senior investment manager at Panoramic Growth Equity, explains: “Corporate governance sets the tone of how a business is run. It provides the guidelines and structure within which the company and its employees operate, offering the opportunity for self-review, instilling discipline, giving the board the right framework within which to set the company strategy. It’s essentially a vehicle for keeping things on track. There’s clearly a monitoring element to corporate governance for us, but it’s also about how we can help the business grow and improve.”
The varying needs of the business backed by private equity, particularly at the smaller deal-size level, usually dictates what actions investors take to improve corporate governance in the businesses
they back. In many situations companies don’t have full boards or hold regular board meetings. “Some companies we invest in don’t have well-defined structures in place,” admits Atkinson. “Making improvements often means ensuring the right balance of people and skill sets, along with enhancing the quality of monthly reporting, which forms the basis for effective decision-making.”
Developments can include constituting regular formal board meetings, bringing in an independent chairman to act as a bridge between investors and the executive team, or simply a greater clarification of roles. In larger companies, there can also be a place for committees, such as those responsible for setting remuneration, and for audit. However, for the most part, private equity firms adopt a lean and flexible approach to board composition.
“In public companies, you see a whole variety of committees covering a wide range of responsibilities,” explains Atkinson. “Working with SMEs, by nature you don’t need lots of committees, but there is probably extra emphasis on being highly conscious of every pound that is spent. We carefully consider any potential external board appointments on a cost-benefit basis.” There is clearly little appetite – and many would argue little need – for codification of corporate governance below the large private business level. Some will question how effective it can be in big businesses.
“No matter how prescriptive you are, there will always be people who work around these codes,” says Atkinson. “Post-Enron and again after the financial crisis, you’ve seen the development of tiered boards, and the proliferation of independent directors. But you still see businesses fail as a result of fraud or other misdemeanours. Logically, codifying best practice should help, but it doesn’t always, as we’ve seen.”
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