The crisis in the financial sector is often portrayed as one of regulatory failure. And so the cry goes out for more regulation. The sector is more regulated than ever but it still got into trouble – so why would it need even more regulation, ever more rigorously enforced?

Let’s not kid ourselves. It wasn’t the regulators’ fault that banks overreached themselves. It was managements’. And the people who have the responsibility for overseeing management are the directors. Do – can – boards of directors have anything more than ornamental value?

This is serious stuff. No one has yet come up with any better way of dealing with the fact that the owners of businesses – the shareholders – have to hand control over to professional managers. If corporate governance fails, capitalism fails.

So we need to make corporate governance work. Patently, it didn’t prevent recent events. But what lessons can be learnt from this?

First, we do not need a completely new model. The Combined Code on Corporate Governance, which sets out standards of good practice in relation to issues such as board composition, remuneration, accountability and relations with shareholders, is seen in much of the world as the best model of governance, and rightly so. The problem was not with the code but with the way it was applied.

Too often, people who should know better treat corporate governance as a matter of compliance with rules – but it isn’t. The banks that have run into trouble complied and got ticks in all the boxes, but so what?

Good governance is a complex mix, but, in simple terms, it is dependent on two main things. The first is boardroom behaviour. Are the difficult questions being asked? Is there effective challenge or is there overdependence on the management view? Is there too much group-think?

The second is making sure that the board has a clear line of sight. If the directors cannot see what’s happening inside the business and are not getting good information, they won’t know what questions to ask. If the risk-management processes are not organised in a clear and methodical way, then a handful of part-time nonexecutives don’t stand much of chance of overseeing them. These two things – boardroom behaviour and connectedness to the organisation – are interdependent.

You will not get real challenge in the boardroom unless the company makes it possible, which means that the management needs to want it to happen. Yet sometimes a manager doesn’t really want to be challenged, or to spend good money on structures and processes merely so the board can see that he was right in the first place. This is a management approach that can work fine – until it doesn’t. And then it often turns out to have been very unsuccessful, indeed.

Governance is not merely about structure, process or even the quality of the people. Boardroom behaviour and the management’s commitment to making it work do not lend themselves to checklists for completion by shareholder voting agencies, but we ignore them at our peril.

— Richard Sheath is a director and co-founder of Independent Audit, a corporate governance consultancy

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