The Quiet Revolution – Corporate Governance in the Public Sector, Gary Martin and John Dowdall
Sunday, July 03, 2011
In light of the global financial crisis, much commentary in corporate governance has been concentrated on the activity of organisations deemed ‘systemically’ important to the economy, namely banks. Yet, relatively little discourse has been directed towards corporate governance in organisations that arguably have as much impact on the lives of each member of society – those organisations in the public sector. Government departments and public bodies make choices and take decisions on a daily basis that affect all of us as citizens – understanding how these choices and decisions are made is, therefore, a matter of significant public interest. In an attempt to redress this apparent imbalance in the corporate governance debate, the following article introduces readers to this important topic as part of a three part series on public sector corporate governance, to be completed during the remainder of 2011.
Setting the Scene
As Dr. Nii Sowa[1] points out, governance is the exercise of authority, direction and control of an organisation in order to insure its purpose is achieved, referring specifically to: who is in charge of what; who sets the direction and parameters within which the direction is pursued; who makes decisions about what; who sets performance indicators, monitors progress and evaluates results; and who is accountable to whom for what. This definition succinctly summarises the key characteristics of corporate governance. This is a subject which has become increasingly important for public sector organisations in recent times, despite the relative lack of public debate about its development. Hepworth[2] has observed that, though the origins of corporate governance reform lies in the private sector, where its initial focus was on financial reporting and accountability issues, its influence has impacted on the public sector, in line with expanding areas of focus for private sector corporate governance. Specifically, he further points to the following issues: identifying and managing risk; securing independent elements on boards; and defining the roles of audit committees and the relationship with audit, internal and external.
This widening of the corporate governance focus of public sector bodies has been evidenced in the deliberations and development of recent best practice guidance in the U.K. and Ireland. For example, HM Treasury’s[3] Review of Corporate Governance in Central Government Departments in 2010 notes the following key areas of possible changes to guidance, amongst others: clarification of board function and purpose; clarification of the role of Ministers in relation to corporate governance; emphasis on risk management; and emphasis on the induction, training and development of board members. In Ireland, the Code of Practice for the Governance of State Bodies[4] (Department of Finance, 2009: 1) highlights the widening impact corporate governance can have: it points out that ‘high standards of corporate governance in all State Agencies, whether in the commercial or non-commercial sphere, are critical to ensuring a positive contribution to the State’s overall economic efficiency and competitiveness’.
But before examining the key principles that underpin corporate governance in a public sector context, it is important to first explore the unique aspects of the public sector and how it works, particularly in relation to how it impacts on corporate governance practices and processes.
It is crucial to state at the outset that public money is not the same as private money. There are four principal reasons why this is so. Firstly, it is compulsorily extracted from the taxpayer on the authority of elected representatives. Secondly, public money can only be used for the purposes it was authorised in line with the concept of regularity. Thirdly, public bodies are required to conduct their business in accordance with recognised standards of propriety. And fourthly, public bodies must be able to show that they have sought value for money. They are thus subject to different, but stringent, standards of accountability. This accountability acts as a proxy for the competitive pressures that, in the private sector, drive down costs and ensure resources are utilised efficiently. These important defining characteristics of the public sector contextualise the next section of the article which deals with articulating some of the underlying principles of public sector corporate governance.
The Underpinning Principles of Public Sector Corporate Governance.
Although all public bodies are required to have formal governance structures in place it is evident that there is a wide variation in the effectiveness of these arrangements. In recent years there has been no shortage of examples of serious failures of governance in the public sector. These have contributed to an erosion of public confidence in standards in public life in both Ireland and the United Kingdom. Against this background, it is instructive to ask what exactly constitutes good governance as a concept in the public sector.
The principles of good governance have been set out in the Good Governance Standard for Public Services, produced by an independent commission chaired by Sir Alan Langlands[5]. The Standard is intended to help those involved with the governance of public services to apply common principles of good governance and provides guidance on implementation. It can be regarded as required reading for anyone entering on an executive or non-executive governance role in an organisation which spends public money. There are six core principles in the Standard:
Focusing on the organisation’s purpose and on outcomes for citizens and service users. The function of governance is to ensure that an organisation fulfils its overall purpose, achieves its intended outcomes for citizens and service users and operates in an efficient and ethical manner. The Standard makes the point that this central principle should guide all governance activity.
Performing effectively in clearly defined functions and roles. All concerned with governance need to be clear about their own roles and responsibilities and those of others, and to behave in ways that are consistent with these roles. The public sector can be a challenging environment for non-executives from a private sector background and clarity about their role is particularly important if they are to make an effective contribution.
Promoting values for the whole organisation and demonstrating the values of good governance through behaviour. This is reflected in a shared ethos or culture and builds on the Nolan Committee’s[6] seven principles for the conduct of people in public life: selflessness, integrity, objectivity, accountability, openness, honesty and leadership.
Taking informed, transparent decisions and managing risk. Governors taking decisions need the support of appropriate systems, including an effective risk management system.
Developing the capacity and capability of the governing body to be effective. Governing bodies should consider the skills they need for their particular functions and recognise the value of a diverse membership which reflects the community.
Engaging stakeholders and making accountability real. Governing bodies in the public sector have multiple accountabilities: to the citizen and to those who have the authority to hold them to account including the legislature, ministers and regulators. Real accountability requires a relationship and dialogue.
These principles of good governance have been widely accepted as relevant throughout the public sector. They provide a basis for considering the good practice necessary to put them into effect. They also assist those involved with public bodies as either governors or stakeholders to challenge poor governance and promote improvement. Moreover, they provide the backdrop for the development of the next section of the article: considering how to move from articulating principles to progressing practice.
Principles to Practice: What should a public sector corporate governance framework entail?
On reviewing some of the definitions of corporate governance mentioned at the outset of the article, it could be argued that there is a tendency in best practice guidance to focus too intently on the structural dimensions of corporate governance. Yet structures, important though they are, are not enough on their own. Taking one of the most recent high profile examples where governance went wrong in some institutions with dramatic consequences, the banking sector, those institutions that experienced difficulty had, on paper, what might be argued to be robust structural arrangements in place: despite this, something fundamental was apparently missing – a complementary corporate culture that supported the structures effectively.
Any policymaker who has reflected on the lessons emerging from the banking crisis for corporate governance in the private sector should also have a concern about the implications for public sector governance. The banks have revealed how, even in a sector which appeared to conform to best practice in governance, determined managements could vitiate the structures which were intended to safeguard the integrity and long-term health of their organisations. Public bodies are not, of course, subject to the intense pressures to maximise short-term profits which were characteristic of the financial institutions. However, the public sector has its own vulnerabilities – to political short-termism, to bureaucratic empire building, to conflicts of interest and misuse of public funds. These can be extremely damaging to the public interest and, when judged in the harsh light of public accountability, can jeopardise the continued existence of the organisation concerned. It will be important, therefore, that any lessons for reinforcing the essential principles of corporate governance and rebuilding public confidence are also read across to the public sector.
The Audit Commission[7] in the U.K. presciently pointed to some of these broader aspects of corporate governance, and their importance, as far back as 2003 when it remarked that corporate governance ‘combines the ‘hard’ factors – robust systems and processes – with the ‘softer’ characteristics of effective leadership and high standards of behaviour’.
If the important imperatives of regularity and propriety are to be achieved, and the principles articulated in the Good Governance Standard for Public Services given life, then adopting this multi-dimensional view of corporate governance could, it is argued, be greatly enabling. Running public services is a complex endeavour. Achieving challenging, outcome orientated results for a diverse range of stakeholders is no easy task, whatever the corporate governance framework. This challenge has recently become even more complicated as a result of the fiscal consolidation that has followed unprecedented budgetary cuts.
A focus on good corporate governance can help public bodies deliver the ever more exacting performance imperatives which are expected of them, whilst at the same time meeting demanding standards of accountability. To do this, however, corporate governance must not be simply seen as a narrow compliance obligation. By adopting a more multi-dimensional approach to corporate governance, there is a greater likelihood that it can be seen as a catalyst to achieve even better performance, allowing public bodies adapt to their vastly changed circumstances. In this way, a goal for governors of public bodies should be good corporate governance, an approach combining suitable structures with a complementary corporate culture that supports the ethos and values of public service organisations.
Having introduced the conceptual framework that will inform the next two articles, the second piece in the series will examine in greater detail a variety of best practice guidance frameworks, with a view to exploring how they can be made to work effectively in practice.
[1] Sowa, N. (2005) ‘The Macroeconomic Benefits of Good Corporate Governance’, Round Table Discussion on ‘Corporate Governance and Ethics in Banks’ (14-15 November 2005, Banking College, Accra, Ghana).
[2] Hepworth, N. (2004) ‘Corporate Governance in the Public Sector’, MEDA Programme, Ankara, 22-25 November 2004 (CIPFA, London).
[3] HM Treasury (2010) ‘Review of Corporate Governance in Central Government Departments’ (HM Treasury, London).
[4] Department of Finance (2009) ‘The Code of Practice for the Governance of State Bodies’ (Department of Finance, Dublin).
[5] CIPFA/OPM (2004), ‘The Good Governance Standard for Public Services’ (CIPFA, London).
[6] First Report of the Committee on Standards in Public Life (The Nolan Committee), (1995), HMSO. Cm2850
[7] Audit Commission (2003) ‘Corporate Governance: Improvement and Trust in Local Public Services’ (Audit Commission, London).
Gary Martin is a Senior Lecturer in Accounting at the University of Ulster.
John Dowdall CB, is Visiting Professor at the University of Ulster’s Department of Accounting and a former Comptroller and Auditor General for Northern Ireland.
