How Does Compliance Affect Corporate Governance?

The relationship between compliance and corporate governance has evolved significantly in recent years. 

Compliance now plays a central role in shaping how companies are managed and overseen; this shift has implications for boards, executives and shareholders alike.

Compliance refers to adhering to laws, regulations and internal policies. 

Corporate governance encompasses the systems and processes by which companies are controlled and directed. 

While distinct, these two areas have become increasingly intertwined, with regulatory pressures driving much of this convergence. 

The convergence of compliance and corporate governance

In the wake of corporate scandals and financial crises, governments have imposed stricter compliance requirements on businesses; this has forced boards to take a more active role in overseeing compliance matters.

Many companies have established dedicated compliance departments. 

These units work to detect and prevent legal and ethical violations. They also help embed a culture of compliance throughout the organisation.

The Financial Conduct Authority (FCA), which regulates financial services firms in the UK, has emphasised the importance of compliance in corporate governance. It requires firms to have robust compliance systems and controls in place.

Similarly, the US Securities and Exchange Commission, which oversees securities markets, has increased its focus on compliance. It regularly brings enforcement actions against companies for compliance failures.

How compliance impacts board responsibilities

Compliance considerations now factor heavily into board decision-making. 

Directors must ensure the company has robust compliance programs in place. They are also expected to monitor compliance risks and issues more closely, which has expanded the scope of board oversight.

Directors now delve into areas such as anti-corruption measures, data privacy practices and environmental compliance. 

They must also stay abreast of evolving regulatory requirements across jurisdictions.

Compliance has become a regular agenda item at board meetings, with many boards having established dedicated compliance committees. These groups focus specifically on compliance matters and report to the full board.

The chief compliance officer now often has a direct reporting line to the board; this gives directors unfiltered access to compliance information. It also elevates the status of the compliance function within the organisation.

Boards are increasingly held accountable for compliance failures. In some jurisdictions, directors can face personal liability for serious breaches, which has heightened board engagement with compliance issues.

Compliance shapes corporate strategy and risk management

Compliance imperatives increasingly influence corporate strategy. 

Boards must consider compliance risks when evaluating new ventures or markets, they may opt to avoid certain high-risk activities altogether.

Risk management processes have also evolved to incorporate compliance concerns. 

Enterprise risk assessments now typically include an analysis of compliance risks; this helps companies allocate resources to mitigate their most pressing compliance challenges.

Many firms have adopted the "three lines of defence" model for risk management. This framework positions compliance as a key second line of defence, alongside other control functions.It reinforces compliance's role in supporting sound governance.

The Basel Committee on Banking Supervision, which sets global standards for bank regulation, has endorsed this model. 

It recommends banks implement strong compliance functions as part of their risk management frameworks.

Compliance considerations also impact mergers and acquisitions. 

Due diligence processes now scrutinise target companies' compliance programs, potential compliance liabilities can affect deal valuations and structures.

Compliance drives changes to corporate culture

Perhaps most significantly, compliance is reshaping corporate culture. 

Boards recognise that a strong ethical culture is crucial for effective compliance, they are pushing executives to foster environments where employees feel empowered to raise concerns.

This cultural shift extends to how performance is measured and rewarded.

Many companies now factor compliance and ethics into executive compensation decisions, which helps align incentives with desired behaviours. Compliance training has also become more robust and frequent. 

Employees at all levels are expected to understand their compliance obligations; this helps embed compliance considerations into day-to-day operations. 

Meanwhile, whistleblowing mechanisms have gained prominence as part of compliance programs.

Companies are establishing confidential channels for reporting concerns, which supports early detection of potential issues.

The compliance function continues to evolve rapidly. As regulatory pressures mount, its influence on corporate governance is likely to grow. 

Boards and executives must adapt to this new reality to ensure their organisations remain both compliant and competitive.

The future of compliance and corporate governance

Technology is playing an increasing role in compliance efforts. 

Data analytics and artificial intelligence are being used to monitor transactions and detect anomalies. Such processes and technology will continue to enhance the effectiveness of compliance programs.

While the cost of compliance has risen significantly for many firms, effective compliance can be worth the cost and provide benefits beyond regulatory adherence.

It can also enhance a company's reputation, improve operational efficiency and reduce the risk of costly enforcement actions.

As the compliance landscape continues to evolve, boards and executives must remain vigilant. They must ensure their governance structures and processes keep pace with changing regulatory expectations and best practices.