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Why King IV’s “apply and explain” is so important

Wednesday, 20 February 2019   (2 Comments)
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By Parmi Natesan and Prieur du Plessis

It’s not what you do, but why that counts in corporate governance. King IV’s disclosure regime forces governing bodies to take actions that have the right results.

In poker, as in so much of life, bluff can take you very far but sooner or later you have to show your hand. Disclosure is the ultimate litmus test: are you doing what you said you would do, and are you getting the desired results? For that reason, disclosure has become a very significant element of corporate governance.

One of the most significant developments in the King IV Report on Corporate Governance for South Africa is thus the move from King III’s disclosure regime of “apply or explain” to “apply and explain”. It’s important to unpack what this means.

Mervyn King, the former chair of the King Committee, says he was somewhat alarmed to discover that although compliance with King III had become a condition of listing on the JSE, it was apparent that many companies simply saw it as a cost of doing business. With greater or lesser degrees of cynicism, they would simply follow as many of the recommended practices as they could, with no further explanations necessary. This kind of tick-box approach strikes at the heart of corporate governance because it reduces governance to a set of mechanical actions, with little regard for what the goal was and whether it was achieved.

Professor King says King IV’s new approach was, in part at least, inspired by the desire to encourage companies to take a more proactive approach to corporate governance  ̶  and to reap the rewards for doing so. The “apply and explain” disclosure regime was instituted because it forces governing bodies to come to grips with how the actions they took were intended to help the organisation achieve its goals.

Moving away from compliance

Apply and explain thus decisively moves away from a compliance-based approach in which companies can fail to engage with the spirit of the code. To make this practical, King IV provides a framework of a limited number of principles (16 plus one extra for institutional investors) with recommended practices linked to the achievement of each principle. The principle of proportionality comes into play here, because it gives governing bodies the latitude to adapt these practices (as outlined in this column on 23 January 2019).

But by insisting that governing bodies explain why they took the actions they did, King IV is in effect forcing them to ensure they have applied their minds to the challenge of achieving the goal set by the principle  ̶  they cannot hide behind the mindless compliance of simply taking the recommended actions. They have to explain what their thinking was and, even better, how their actions moved the organisation forward in its journey to achieving each goal.

King IV encourages organisations to move beyond compliance to crafting actions that are appropriate to the organisation’s context, and which will move them closer to achieving the goals enshrined in its 17 principles. In so doing, King IV is helping organisations realise the benefits of corporate governance.

In conclusion, perhaps it would be good to remind ourselves of what exactly those benefits are  ̶  the tick-box approach to governance has often tended to mask them. Corporate governance would not exist, or be worth implementing, if it did not have positive outcomes for organisations and their bottom lines.

The list is a long one, but some of the key benefits are:

  • Enhanced credibility and reputation. A well-governed company is better positioned to access capital at good rates, and to attract investors/ shareholders. It is also much more likely to enjoy customer support and loyalty, and to be seen as a desirable employer by talented people.
  • Stronger resistance to fraud. White-collar crime is one of the great risks for businesses, even though it’s often underreported. Good governance means good controls, an overall tendency to transparency and, crucially, an ethical ethos  ̶  all anathema to fraud and fraudsters.
  • A more resilient organisation. By making business continuity a governing body responsibility, organisations are much more likely to mitigate risk successfully, and to recover from a disaster should one occur.
  • Leadership continuity. Governance codes require governing bodies to put succession plans in place for top leaders, so a damaging leadership interregnum is avoided.

These are all benefits worth having!

Parmi Natesan Dr Prieur du Plessis

Parmi Natesan and Dr Prieur du Plessis are respectively CEO Elect and Chairman of the Institute of Directors (IoDSA). 

Enquiries: info@iodsa.co.za
Better Directors. Better Boards. Better Business

 

Comments...

Christelle Marais (Faul) Ms says...
Posted Tuesday, 05 March 2019
Perhaps an additional benefit of the "apply and explain"-requirement, is that it forces independent non-executive directors, executive directors and shareholder representative directors to work closer together. In driving outputs and outcomes as opposed to compliance inputs, the gap between independent directors (who are sometimes seen as to "have no skin in the game") and representative/ executive directors becomes smaller, as all should (theoretically, at least) work towards the same outcomes.
Lomalanga V. Matsebula (Dlamini) says...
Posted Friday, 22 February 2019
This is such a relevant article. I am saying this in relation to today's presentation before the Zondo commission by ESKOM's governing body chairperson. The importance of the subject matter in the article is being played out as one listens to the aforementioned chairperson. One could not agree more with the benefit that can realised by companies, from the 'apply and explain' disclosure regime that was introduced by King IV. It does change governing bodies mindsets. With this new regime, governing bodies are persuaded to naturally apply their minds on all issues they debate on before a resolution is taken. It also help governing bodies to appreciate the impact of board room decisions on Strategy, Risk and Sustainability of the company they direct. Beautiful article indeed!!!!!!!!!!!!!