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Making corporate governance universal

Wednesday, 23 January 2019   (0 Comments)
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By Parmi Natesan and Prieur du Plessis

Proportionality lies at the heart of King IV’s attempt to make corporate governance flexible enough to be useful to all types

One of the many ways in which the King IV Report on Corporate Governance is redefining corporate governance is its focus on outcomes. It strongly delivers the message that corporate governance is not a good in and of itself, but rather a process that will help organisations achieve certain desirable goals. One corollary is that any and all organisations should be eager to adopt the principles and recommended practices to achieve these goals.

The question then becomes: How does one make a code like King IV relevant and practical for a smaller, less complex company, as well as for other types of organisations such as state-owned enterprises, municipal entities or non-profits? These organisations have widely divergent structures, criteria for success and resources, and yet they all have important roles to play in the economy and society. They need, and would benefit from, effective corporate governance.

In fact, this required flexibility results in King IV drawing a clear distinction between its principles or aims and the practices it recommends for achieving those aims. The Code explicitly notes that the recommended practices are to be seen as leading practices and “may therefore not be suitable and appropriate for all organisations”.

The “apply and explain” regime is also critical because it means the end goal is always in the forefront. Practices are not to be seen as something to be implemented; rather they should act as guides for how governing bodies can achieve the underlying principles  ̶  they simply have to be willing and able to explain how their practices promoted this.

In theory, then, governing bodies are free to adapt, or even jettison, practices that they do not consider necessary or appropriate for their organisaion  ̶  provided they disclose how they have achieved the principles. This drives home another key message of King IV: application should be mindful of and oriented towards results.

King IV introduces the concept of proportionality to guide governing bodies through this process.

Unpacking proportionality

For governing bodies, it is obviously critical to understand how to use proportionality in a way that will justify their ultimate course of action. King IV identifies three considerations that would influence proportionality: the organisation’s size (turnover and work force); its resources; and the extent and complexity of its activities. The last-mentioned would include the organisation’s impact on the triple context of the economy, society and environment in which the organisation operates.

Thus a small organisation with few employees, a low turnover and scant resources would implement a given practice differently from a large company, even though both are pursuing the same goal.

For example, King IV recommends the establishment of certain functions such as internal audit or compliance. Motivated by considerations of proportionality, a small non-profit might achieve the goal of these functions not by employing a dedicated team of people (which it could not justify or even afford) but by appointing a senior employee to take on the responsibility. Or it might outsource the function, or share resources with a similar organisation.

A similar thought process might play out when King IV recommends a board committee be formed to achieve a certain set of goals. A resource-scarce organisation might find it preferable to have the governing body itself carry out the committee’s functions, or it could formally assign an individual member to do so.

It is thus very important that governing bodies discuss which proportionality considerations affect the organisation, and what the implications thereof are. Once they have established that, they can begin to make decisions about how best to adapt the recommended practices to achieve the goals expressed in the principles. More importantly, a highly granular understanding of proportionality will ensure that the governing body will be able to explain its reasoning convincingly when it comes to disclosing its actions in the integrated (and/or other) reports.

King IV’s supplements provide guidance for how proportionality considerations can be used to adapt the Code to the circumstances of various types of organisation. But, again, it’s worth emphasising that they are not intended to be binding, but illustrations of how governing bodies can use this concept to create a corporate governance strategy that advances their organisation towards the achievement of King IV’s goals, without having to don a straitjacket. 

Parmi Natesan Dr Prieur du Plessis

Parmi Natesan and Dr Prieur du Plessis are Executive Director: Centre for Corporate Governance and Chairman of the Institute of Directors (IoDSA) respectively. 

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