Principles of Corporate Governance : Guidance Note 2
Corporate governance concerns the strategic direction and effective stewardship of the organisation. A number of concerns have been raised about corporate governance in the private and public sectors in recent years, mainly relating to the perceived lack of control at the top of some organisations and inadequately designed systems that failed to prevent fraudulent, inefficient or inappropriate behaviour.
A number of initiatives have addressed these concerns and strengthened the approach to corporate governance in both the private and public sectors. This section explains the main developments that have led to the principles of corporate governance and how these translate into the conduct and management of public business.
An important aspect of corporate governance is the undertaking of appropriate due diligence measures to mitigate financial or reputational risk. Due diligence involves the detailed examination of a company and its financial or project delivery record before becoming involved in a business arrangement.
Scottish public bodies should also assess the human rights record of any individual or company before entering into an investment relationship with them. A link is provided in the Key Messages section.
Key References and Contacts
- Corporate governance is concerned with the strategic direction and effective stewardship of the organisation.
- There have been a number of reviews in the private sector which together led to the development and publication of a UK Corporate Governance Code
- There are similarities between the public and private sectors in terms of corporate governance principles – but board members should recognise that it is not always possible to draw a direct parallel between the two.
- The Ethical Standards in Public Life etc. (Scotland) Act 2000 introduced the ethical standards framework, which includes Codes of Conduct for board members, a Chief Investigating Officer and a Standards Commission.
- The Guidance on Due Diligence: Human Rights sets out recommendations on how the Scottish Government, executive agencies and non-departmental public bodies (NDPBs) should undertake appropriate due diligence on companies, including their human rights record, before entering into an investment.
- Non-executive board members should be familiar with the nine key principles that underpin public life in Scotland which are set out in the Model Code of Conduct for Board Members of Devolved Public Bodies
Corporate governance is the way in which organisations are directed, controlled and led. It defines relationships and the distribution of rights and responsibilities among those who work with, and in, the public body, determines the rules and procedures through which objectives are set, and provides the means of attaining those objectives and monitoring performance. Importantly, it defines where accountability lies throughout the public body.
Corporate governance has been a high-profile topic in recent years, principally because of concern about ensuring control at the top of, and within, organisations. There is a perception that, in certain cases, senior managers appear to have been able to act without restraint and that inadequately designed systems have failed to prevent fraudulent, inefficient or inappropriate behaviour. The results of poor corporate governance cannot be underestimated. The international financial crisis was partially attributed to failures in governance within the Boards of major financial institutions.
A number of key corporate governance reports in the private sector have contributed to the development of the UK Corporate Governance Code:
The UK Corporate Code – Impact on the Public Sector
The first version of the UK Corporate Governance Code was published in 1992 by the Cadbury Committee. It defined corporate governance as "the system by which companies are directed and controlled".
Over the years, the Code has been revised and expanded to take account of the increasing demands on the UK's corporate governance framework. The current UK Corporate Governance Code was published by the Financial Reporting Council in July 2018.
The UK Corporate Governance Code does not set out a rigid set of rules but instead offers flexibility through the application of Principles in five key areas and through "comply or explain" Provisions and supporting guidance.
The five key areas are:
- Board leadership and company purpose;
- division of responsibilities;
- composition, succession and evaluation;
- audit, risk and internal control, and;
Although the UK Corporate Code applies primarily to companies listed on the London Stock Exchange, these principles are still relevant for public bodies.
While there are a number of similarities between the public and private sectors in terms of corporate governance principles, Board members should be aware that there are significant differences between the two. For example:
- there is a higher level of accountability for public bodies in that they are spending public (taxpayers') monies;
- there is a greater sensitivity over the handling of issues such as conflicts of interest and the public perception of any hint of impropriety;
- it is the Scottish Ministers that take many of the key strategic policy decisions and not the Board (of Directors) as would be the case in a private company or charity;
- the relationships between a public body and its sponsor Directorate within Scottish Government (and the relationship with the Minister) are not replicated in the private or voluntary sectors.
Key Developments in the Public Sector
There have been a number of high-profile reports and inquiries in Scotland highlighting inadequacies in the governance of public bodies. In one report, a Parliamentary Committee concluded that the governance arrangements in a public body did not identify or prevent a crisis which it should have done. Although not the primary factor, the Committee believed that the Board failed sufficiently to challenge the Chief Executive over a significant operational development that ultimately failed.
In another report, the Scottish Parliament's Public Audit Committee concluded that, on the evidence received, members of the Board of a public body had acted with probity throughout a very difficult period but could not escape criticism for not being aware of problems of which they should have been aware.
As in the private sector, there have been a number of developments aimed at improving corporate governance in the public sector:
International Framework: Good Governance in the Public Sector
In 2014 the Chartered Institute of Public Finance and Accountancy and the International Federation of Accountants produced an updated International Framework: Good Governance in the Public Sector.
The 2014 Framework defines and describes one interpretation of the principles that should underpin good governance.
Good Governance in the Public Sector
- behave with integrity, demonstrating strong commitment to ethical values, and respect the rule of law;
- ensure openness and comprehensive stakeholder engagement;
- define outcomes in terms of sustainable economic, social and environmental benefits;
- determine the interventions necessary to optimise the achievement of the intended outcomes;
- develop the entity's capacity, including the capability of its leadership and the individuals within it;
- manage risks and performance through robust internal control and strong public financial management, and;
- implement good practices in transparency, reporting and audit to deliver effective accountability.
Translating Principles into Action
The remaining sections of this guidance provide the practical advice that is needed to enable public bodies and board members to apply the concepts of good corporate governance to their own organisations. They pull together good practice from the private and public sectors to provide guidance to board members across the three main dimensions of corporate governance:
- Roles, Responsibilities and Relationships (Guidance Note 3)
- Effective Financial Management (Guidance Note 4)
- Ethics and Standards of Behaviour (Guidance Note 5)
These guidance notes explain the meaning of these dimensions of corporate governance more fully and their relevance to you as a board member of a public body in Scotland.
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