Governance focus and accountability extending to private sector

New UK initiative could provide a model for Australia to follow.

Directors of Australia’s largest private companies should watch developments in the United Kingdom on the looming introduction of a corporate governance code for private companies.

Consultations on the code concluded in September and a final version is expected to be published next month. Known as the Wates Corporate Governance Principles for Large Private Companies, the code is part of reforms to the UK Corporate Governance regime.

The Wates Principles has six key Principles and guidance notes on: board purpose, composition, responsibility, opportunities and risk, remuneration and stakeholders.

The Principles are considered more flexible than those in the UK Corporate Governance Code, are voluntary, and based on an “apply and explain” approach, whereby the private company explains how its governance practices achieved the Principles.

The new reporting requirement applies to companies in the UK that have either 2,000 employees or a turnover of more than £200 million and a balance sheet of more than £2 billion. Private companies that meet this criteria must publish a corporate governance statement in the annual report and website.

Australia’s largest 170 private companies (using IBISWorld data on revenue, and accounting for currency differences) would be subject to the Principles if a similar code applied here. Visy, Hancock Prospecting, 7-Eleven, Meriton and several large accounting and law firms would meet the employees or turnover requirement in the Wates Principles.

James Wates CBE, chair of the coalition group that developed the Principles, said: “Private companies are a significant contributor to the UK economy, providing tax revenue and employing millions of people. They have a significant impact on people’s lives, and it is important they are well-governed and transparent about how they operate.

“These Principles will provide a flexible tool for companies of all sizes, not just those captured by the new legislative reporting requirement, to understand good practice in corporate governance and, crucially, adopt that good practice widely. The Principles are about fundamental aspects of business leadership and performance.”

The Principles are an important governance development for six reasons.

1. Governance focus extending to private sector

Major governance efforts in the UK, Australia and other developed markets typically focus on listed companies. The ASX Corporate Governance Principles and Recommendations, for example, outlines recommended governance practice for ASX-listed entities.

Some large not-for-profit enterprises and private companies in Australia follow the ASX Principles and Recommendations, and others choose to report on governance voluntarily because that is good business. But far less is known about governance in the private sector compared to listed public companies, and private companies generally are not subject to the same governance expectations.

2. Importance of private sector to economy

Private companies are a large and growing part of the UK economy. The same is true in Australia. Our largest 500 private companies generated $220 billion in revenue in 2017-18 or 4.3 per cent of the nation’s revenue, found the 2018 IBISWorld Top 500 Private Companies list.

Our top 500 private companies are growing their revenue faster than the national average: 6.9 per cent versus 5.8 per cent, says IBISWorld. They employ almost one in 20 Australian workers.

As Australia’s leading private companies grow, and have greater impact in industry and the community, the introduction of corporate governance principles, tailored for the private sector, is worthy of debate. In time, such a code could lead to more private companies forming boards, recruiting independent non-executive directors and increasing their governance reporting and disclosure.

3. Restoring public trust

The next significant aspect of the Wates Principles is its response to growing scandals in the UK private sector. Several large-scale failures in UK private companies, notably the collapse of retailer BHS in 2016, hurt customers, employees, suppliers and the community.

Australia has also had scandals in the private sector in recent years, particularly around staff underpayment in large franchises. Public trust in Australian institutions, as in other developed markets, continues to fall as a community backlash towards business scandals builds. A governance code for large private companies would be a step to improving public confidence in this part of the economy.

4. Decline in listed entities

UK Principles are timely as more companies choose to remain privately owned than list on the stock exchange. The number of companies listed on the US stock exchange has declined by almost 50 per cent from its 1996 peak, according to the Center for Research in Security Prices at the University of Chicago’s Booth School of Business.

Several explanations have been offered for this global phenomenon of fewer listed companies. The market’s largest listed companies are getting bigger as they acquire small competitors. And many start-up ventures in technology and other emerging sectors are able to stay privately owned for longer because there are now more funding options available through venture capital, private equity and equity crowdfunding.

It is also possible that more companies are choosing to remain privately owned, or are delisting from stock exchanges and being privatised, to avoid the extra cost, compliance, governance and accountability of being a listed entity. Tesla founder, Elon Musk, sparked controversy (and a Federal lawsuit) this year when he tweeted that he wanted to take the US$70-billion company private.

A governance code for the private sector will be important if more companies choose to remain private and some listed companies choose to delist from the stock exchange after being acquired by private equity or other new owners. Although the Wates Principles is initially a basic governance approach, it could become more rigorous over time as the private sector adopts it.

5. ESG focus extending to private sector

The Wates Principles’ focus on stakeholders (Principle six) says the board of a large private company should have meaningful engagement with the organisation’s material stakeholders, including the workforce, and foster good stakeholder relationships.

The focus of environmental, social and governance (ESG) reporting has been a key governance development this decade for listed entities, as investors seek greater disclosure of non-financial metrics and incorporate the data into investment decisions. There is far less disclosure of ESG or discussion of it in the private sector compared to the listed-company arena.

Listed-company boards in Australia have, generally, increased their engagement with shareholders and other stakeholders in response to the market’s interest in ESG. But there is no formal mechanism to encourage private companies to engage with stakeholders on ESG.