Government consultation on audit and governance – risks for family businesses by Sir James Wates CBE, Chairman of Institute for Family Business
27th July 2021
The deadline of a government consultation always seems to focus minds. In the case of the business department’s consultation on audit and governance regulation, the 8 July deadline focused minds on the damaging effects some of the government’s proposals may have.
Among a wide range of proposals floated in March this year by BEIS in its consultation paper “Restoring trust in audit and corporate governance” is an ill-conceived proposal to extend the definition of Public Interest Entities (or simply “PIEs”). These are companies that are subject to extra scrutiny by regulators because of the nature of their business.
Most of the approximately 2,000 companies designated as PIEs are very large listed companies or operate in markets that are considered critical to the public interest.
The government’s proposals to expand the list of PIEs include different options based on size thresholds, with no regard to type of business activity. One proposed option could double the number of companies classified as PIEs.
This expansion would have a significant negative impact on many members of the Institute for Family Business. The extra audit and reporting requirements would entail considerable costs and, perhaps more worryingly, would establish disincentives to innovate and grow for many family-owned companies, a sector that employs 14 million people and represents about a third of UK GDP.
Nonetheless the proposal may have political legs. A small number of high-profile cases of poor governance – the examples of Patisserie Valerie and BHS are frequently cited, though it’s a big stretch to imply they reflect a trend – encourage ministers to be seen to be “doing something” to “clean up big business”. Increased supervision by regulators can become a default political response.
Unfortunately, the proposed sledgehammer is likely to crush quite a few nuts. Which is indeed “doing something”, but without really addressing the problem at hand.
The primary issue here is that the proposals would subject private companies to regulation that was designed for listed companies. Even private companies on the larger end of the spectrum are a diverse group – some family-owned, some private equity, some wholly-owned subsidiaries of foreign groups. Most of them are structured completely differently from listed companies, and their shareholders are well informed on the running of the business. Family businesses in particular tend to have owners that are closely involved in the oversight of the company and are actively involved in shaping its corporate culture.
The diversity of privately-owned companies requires a more flexible approach to promoting good governance, which is exactly what we delivered when a coalition group of business experts and I developed the Wates Corporate Governance Principles for Large Private Companies, published in December 2018. This coalition group was established at the Government’s request, because it was recognised that the UK Corporate Governance Code (for large listed companies) just isn’t appropriate for private companies.
The Wates Principles therefore were developed specifically for private companies, by a coalition that included private companies. They avoided a tick-box approach, challenging companies to develop ever stronger governance. They encourage an “Apply and Explain” approach in which companies must carefully examine their own governance arrangements, in the light of the good practice and guidance provided in the Wates Principles publication, and report at year’s end on how they performed.
This reporting system, brought in when the government enacted the Companies (Miscellaneous Reporting) Regulations 2018, has only recently yielded a full crop of governance reports by large private companies. Signs so far are good that many large private companies are really grasping the spirit of the Wates Principles, using them not just for the purposes of reporting but to guide self-improvement. Many are reporting in clear, transparent fashion that is genuinely understandable to all stakeholders.
Working with the Financial Reporting Council, we hope to publish academic research later this year showing how well the legislation is working to promote good governance, notwithstanding that it is early days still. There are plenty of good examples to name and fame. And we need time for the good practice to spread.
In light of the wonderful achievements of science over the last 16 months, one would have hoped that this government, more than any other, might wait to see how well their first experiment was working before embarking on a second.
Whereas the Wates Principles seek to promote good governance positively, in a way that is appropriate for each individual company, the proposed regulations to expand PIEs would burden private companies with extra audit costs and would create clear incentives for companies to remain just below the established thresholds. Hardly a means to encourage growth (and increase tax revenues) at such a crucial moment: with many large private companies ready to seize the opportunities that the end of restrictions will bring and to push the economy and the public finances forward.
The proposal to expand the list of companies classified as PIEs is the wrong solution at the wrong time. Rather, the government should make the effort to evaluate the impact of recent legislative changes, identify areas where more disclosure is needed (taking into consideration evidence being gathered from the implementation of the Wates Principles), and work with private companies to develop a suitable approach.
The Institute for Family Business, and I’m sure the rest of the private business community, stands ready to work with government in such a thoughtful endeavor.