This blog post will be on the dynamics between the theoretical rules of a Corporate Governance Code and their practical application in the real-world business environment. The contrast between what’s on paper and what actually happens can be striking. Why this blog? There has been a lot of Governance training these last few months. I have been to a few, as Corporate Governance is one of the topics of interest to me. What strikes me is the theoretical nature of most of these governance trainings. And practical examples being given, if any, don’t have the flavor of actual practice. I have tasted the flavor of failed governance repeatedly, unfortunately, and the practical examples being given in these courses don’t even come close to the experience.
WHAT IS CORPORATE GOVERNANCE?
Let’s start with what Corporate Governance is. Corporate governance encompasses the system of rules, practices, and processes by which a company is directed and controlled. It involves a blend of laws, regulations, procedures, practices, and implicit rules that determine a company’s ability to make decisions, accountability, control mechanisms, and how it deals with various stakeholders, including shareholders, employees, customers, and the broader community. While corporate governance codes provide a theoretical blueprint for best practices, the reality of implementing these principles can vary significantly. Understanding both aspects is crucial for effective corporate governance. This blog delves into the differences between the textbook version of corporate governance and its application within the real-world corporate scene.
Corporate Governance Codes serve as a framework to guide the behavior of corporate entities. They encapsulate best practices and principles designed to ensure accountability, fairness, and transparency in a company’s operations and relations with its stakeholders. Key principles typically include the roles and responsibilities of the board, rights and equitable treatment of shareholders, interests of other stakeholders, integrity and ethical behavior, and disclosure and transparency. On paper, these rules seem straightforward and effective. However, the real-world application of these principles can be far more nuanced.
EXPERIENCING GOVERNANCE IN PRACTICE
In practice, governance is influenced by a myriad of factors including corporate culture, leadership styles, and market pressures. Companies may find themselves in situations where strict adherence to the governance code is challenging or not entirely practical. For example, the principle of board independence can be difficult to maintain in closely held firms where directors are often selected from within the existing network of major shareholders or executives.
DIFFERENCES BETWEEN THEORY AND PRACTICE
In practice, the implementation of corporate governance principles is influenced by a myriad of factors, including corporate culture, leadership personality, market pressures, and the socio-political context. Companies may interpret and apply the same set of rules differently, leading to a diversity of governance practices.
Challenges Include:
- Navigating board dynamics and conflicts of interest. Not all board members may be on the “good governance same page”. Especially if there are political nominations of board members, you should expect governance issues.
- Balancing short-term pressures with long-term strategic goals. This is a common challenge, as “short term results” often determine bonuses, public image, effective leadership, etc. Short term achievements communicate better than a long wait.
- Managing stakeholder expectations and engagement.
- Adapting to legal and regulatory changes.
These real-world complexities can lead to deviations from the idealized models presented by governance codes, requiring a more nuanced understanding and flexible application of these principles.
There are several differences between theory and practice which I can highlight. Important ones are:
- Compliance vs. Culture: Remember the quote from Drucker: “Culture eats Strategy for breakfast”. The message being that Culture is often underestimated. While a company might comply with governance codes on paper, its culture could significantly deviate from these standards. A culture of transparency and accountability is much harder to cultivate and requires more than just ticking boxes on a compliance checklist. This is what I call the difference between “installation” and “implementation”. The first one is just for “show”, the second one is a way of doing. While corporate governance codes can mandate compliance, they cannot dictate corporate culture. A company might tick all the boxes for compliance yet harbor a culture that is at odds with the spirit of these regulations. This disconnect between compliance and culture is a striking difference, where the letter of the law is followed but not its spirit.
- The Role of Informal Practices and Unwritten Rules: Informal practices often shape the actual governance landscape within corporations. These unwritten rules can sometimes contradict formal governance codes, leading to a gap between policy and practice.
- The Impact of Individual Leadership Styles: The leadership style of top executives and board members can greatly influence governance practices. Charismatic leaders may sway decision-making processes, overshadowing the collective decision-making advocated by governance codes. There are several examples of this on the Islands (former -Netherlands Antilles).
- Board Dynamics and Decision Making: Corporate governance codes advocate for balanced, independent boards capable of making objective decisions. However, reality often involves complex dynamics, with power plays, personal relationships, and internal politics influencing decisions more than the objective criteria outlined in governance frameworks.
- Shareholder Engagement: Theoretical models stress the importance of active and equitable shareholder engagement. Practically, however, the extent and nature of this engagement can vary greatly, with large institutional shareholders wielding disproportionate influence over corporate decisions, sometimes at the expense of smaller shareholders and other stakeholders. I have seen majority shareholders ignoring minority shareholders in all decision making.
- Ethical Considerations and Reality: Corporate governance codes promote ethical conduct and decision-making. Yet, companies may encounter situations where adhering strictly to ethical guidelines conflicts with competitive pressures or operational realities, leading to ethical dilemmas not easily resolved by adherence to governance codes alone. It’s not unthinkable that sometimes management uses “the end justifies the means” attitude to get something done, including bending, or breaking the rules.
- Crisis Management: Corporate governance codes provide frameworks for risk management but often lack detailed guidance for crisis management. The real test of governance comes in times of crisis, where quick, decisive action is required, sometimes necessitating deviation from standard procedures to protect the interests of the company and its stakeholders. When the “Sh**” hits the fan, it’s then when “Sh**” get real.
BRIDGING THE GAP
To bridge the gap between theoretical governance codes and their practical application, companies can adopt several strategies. Embedding governance principles into corporate culture, enhancing board training and development, and fostering open dialogue between all stakeholders are pivotal. It’s also vital to recognize the dynamic nature of governance and the need for codes and practices to evolve together.
Companies must foster a culture that values ethical behavior and transparency. This involves more than just written codes; it requires continuous effort to instill these values in every aspect of the business. Leadership plays a crucial role in setting the tone for the company’s culture.
Effective oversight mechanisms, including independent audits and robust internal controls, are essential to ensure that governance principles are being followed in practice. Regular reviews and updates to these mechanisms can help in identifying and addressing gaps.
Continuous training and education programs for employees at all levels can reinforce the importance of adhering to governance codes and ethical standards. These programs can also help in understanding the practical implications of these standards.
Encouraging transparency and holding individuals accountable for their actions are critical. This includes clear reporting of both successes and failures, and a willingness to address issues openly and constructively.
Regular engagement with stakeholders can provide valuable feedback on the company’s governance practices. This engagement can also help in building trust and ensuring that the company’s practices align with stakeholder expectations.
The difference between learning the rules of a Corporate Governance Code and experiencing governance in practice is profound. While codes provide a necessary framework for ethical and effective management, the real-world application of these principles is fraught with challenges and complexities. By learning from past failures and implementing robust strategies to bridge the gap between theory and practice, companies can foster a culture of transparency, accountability, and ethical behavior that supports long-term success and sustainability.
Dieudonne (Neetje) van der Veen is a financial and management business consultant. His work and experience are mainly financial management and structuring of businesses in distress and Governance on Planning & Control cycles. Mr. van der Veen has a master’s degree in business economics (Erasmus Universiteit Rotterdam), is a Registered Accountant (Koninklijke Nederlandse Beroepsorganisatie van Accountants), a CFE (Certified Fraud Examiner) and a CICA (Certified Internal Control Auditor).
