Understanding King IV and what it is intended to achieve
Tuesday, 06 March 2018
Recent corporate scandals have rightly provoked renewed focus on the role of directors and the importance of good governance. One sometimes hears the view expressed that these governance failures within both the public and private sectors should be laid at the door of King IV.
Such discussions are very necessary and welcome: the more we discuss governance and what it can do, the better it will be understood. The Institute of Directors in Southern Africa (IoDSA) and the King Committee would like to contribute to the discussion.
A number of common themes are raised in conversations and articles, and we give our views on each of them below. We trust that this added perspective will assist our members in their understanding and interpretation of King IV.
To what extent can codes of corporate governance prevent corporate failure? Why has King IV not prevented the recent failures in both the public and private sectors?
The first point to make is the difference between a law and a voluntary code.
A law provides the framework that people must not transgress and provides the sanctions they will face if they do. By contrast, a voluntary code like King seeks to set out the principles and best practices that organisations with a sincere desire to achieve good governance should follow.
Certain parts of a governance code may be formally integrated into legislation/regulation, or may find their way into jurisprudence to become part of the common law. Thus, for example, some elements of King III were incorporated into the new Companies Act.
We need to recognise that no law or code can realistically hope to prevent criminal activity. If somebody wants to do something wrong, he or she will do it either by disregarding the law or finding a loophole within it.
The same general observation could be made about negligence.
Both laws and codes can quite easily be circumvented by people who wish to do so, or who are only concerned with “not being caught”. It is for this reason that King IV places so much emphasis on creating an ethical culture and mindset. When this mindset is present, individuals and companies will seek to act in the right way—even when nobody is looking—because they understand that to do so makes good business sense and reduces risk.
Because it is not trying to be a law, and because it recognises that ethical behaviour is ultimately a matter of choice, King is a voluntary code. King IV’s “apply and explain” approach reflects this ethos, and prompts the governing body to apply its mind to achieving the principles, rather than simply following a set of rules blindly.
Importantly, such an approach also confers a great deal of flexibility. Each organisation operates in its own context; the King Committee’s intention was to make the code flexible enough to be useful to all types of organisation. Hence, King IV focuses on the principles that inform what should be achieved, not on mandating specific actions.
It is crucial to understand that King IV and other voluntary codes are intended as guides to help organisations achieve good governance principles through the adoption of governance practices in a way that does not unduly constrain them, and that is appropriate to their particular circumstances.
Why is tenure of members of the governing body so important, and what is the King IV approach in this regard?
Clearly, it is undesirable that members of a governing body outlive their usefulness, either because they have become settled in a rut or because they have formed relationships with other members of the governing body or with officials of the organisation itself that compromise their independent judgement and make them susceptible to group think. But the King Committee also recognised that to mandate a cap on how many years a governing-body member should serve would impose unnecessary constraints, and might rob governing bodies of members who were experienced, continued to add value and whose independence is not compromised.
In particular, some commentators mention the nine-year rule used in some jurisdictions.
In line with the thinking outlines above, the King Committee’s view is that nine is simply a number, and not a magic formula. Such a magic formula ignores the fact that one group of directors with common backgrounds could become too cosy after a much shorter time, while another group might be continuing to function well after a longer time-period. More importantly, specifying a particular number of years would be to risk focusing on form (and thus a tick-box approach), rather than the substance of the principle.
Rather, the Committee felt, the principle that the governing-body should comprise an appropriate balance to discharge its duties objectively and effectively should be articulated, with governing bodies being encouraged to address the issue of tenure within this context. Simply “rotating” members of the governing body according to some arbitrary schedule would not achieve the desired result, and could have other undesirable consequences such as the loss of high-performing individuals and institutional knowledge.
This focus on the principle underlying board tenure, rather than mandating fixed terms of office, also enables King IV to be applicable to all organisations, regardless of size or purpose.
King IV clearly identifies group think and over-cosy relationships as a challenge for boards, and emphasises the need for truly independent thought. How that principle is made real is up to the board and the shareholders, who ultimately appoint the board. Specific guidance around lead indicators of independence is given in this regard.
The enhancement of the role of the lead independent member of the governing body was also introduced to strengthen this aspect.
Does King IV address cross-directorships and the need to increase the pool of directors in the country?
King IV does emphasise the importance of diversity in recommended practice 10 of Principle 7. Again, how that diversity is achieved is a matter for the board to determine, not the Code to prescribe. On cross directorships, King IV recommends Nomination Committees consider the number of other professional positions intended candidates hold before making appointments, without stipulating a maximum recommended number for similar reasons as discussed above in relation to board tenure.
What is the position with regards to a former CEO becoming chair of the governing body?
King IV recommends a cooling-off period before former CEOs can assume this position. It is up to the shareholders and stakeholders to hold the board to account, or a regulator to embody the recommendation in its regulations. King IV’s view is that the governing body should have the freedom to consider what would work best for it, and then to disclose its reasoning to stakeholders.
The enhanced role of the lead independent noted above is also relevant here. If the Chair is not independent—for example, if he or she is a former CEO—then the lead independent can act as a counterweight to the Chair.
How has King IV brought the necessary levels of transparency and accountability?
Transparency and accountability are cornerstones of King IV. They are explicit in the first Principle, and are two of the six characteristics of ethical and effective leadership.
However, as already noted, King IV is designed to be flexible enough for the governing body to exercise its own judgment in ensuring that all the governance arrangements are appropriate to the organisation’s size, nature, maturity and specific needs.
King IV makes it very clear that transparency and accountability are two sides of the same coin; the need to disclose not only what was done but the thinking behind it promotes both accountability and the flexibility any organisation needs to adapt the code to its particular circumstances. Disclosure of this nature gives stakeholders the opportunity come to their own conclusions.
It is therefore up to the shareholders and other stakeholders, including regulators, to hold boards to account for how they implement good governance. King IV emphasises disclosure as significant way to further greater transparency, and to promote accountability.
Why did the King Committee decide not to recommend a binding vote on remuneration?
Executive remuneration is both highly complex and something of a hot topic, which may make it hard to think clearly and objectively about it.
The whole issue of a binding vote is somewhat of a red herring; in jurisdictions where a binding vote exists, it does so only because it is mandated in law. As a voluntary code, King IV is concerned to articulate the principle and to recommend ways of making it real.
As opposed to being silent on the matter, the King Committee opted for a non-binding vote because it could be used constructively as a way to raise a concern and initiate engagement between the remuneration committee and shareholders. King IV also raised the threshold for passing a remuneration policy from 50 percent to 75 percent. Thus, under King IV, if more than a quarter of the shareholders vote against the remuneration policy, the governing body has to engage with them and disclose the details of that engagement, including its result. By contrast, a binding vote simply rejects a certain policy. This clearly demonstrates how important we feel it is for the remuneration committee to engage properly with stakeholder concerns and input.
We should also point out that “non-binding” should not be confused with “compulsory”. In terms of JSE regulations, companies must take a vote on remuneration, so the vote is compulsory even though it is non-binding. In other words, shareholder unhappiness is indicated and, under King IV, must be dealt with transparently.
Further, the important role of the institutional investors in respect of engagement on remuneration as well as other governance issues and the necessary link to the Code for Responsible investment in South Africa (CRISA) is achieved through principle 17.
In conclusion, it is worth noting that the King Committee received numerous submissions from the public, which substantially influenced the final version of King IV. We believe the result is a code that embodies the latest thinking and provides a flexible, constructive framework that organisations can use to improve their governance. It is not a set of regulations that must be followed, and it is certainly not a guarantee that corporate failure will not occur.
Read the consolidated report of all the submissions and how they were handled.