In November 2016, the Government issued a consultation paper on a range of measures aimed at strengthening big business through better corporate governance. The consultation closed in February 2017. The outcome of the consultation has now been published and includes a range of legislative and business-led measures aimed at improving corporate governance, ensuring executive pay is properly aligned to long-term company performance and giving employees a stronger voice in the boardroom.
The package of reforms now being proposed includes three key elements. The first will require all listed companies to publish and justify the pay ratio between their CEO and the wider workforce. The second will see companies with significant (i.e. 20%) shareholder opposition to executive pay packages included on a new public register, and the third introduces new measures to help employees' voices to be heard in the boardroom. We explore these, and other proposed reforms, further below.
Transparency in executive pay
The most controversial proposal under consideration was to require listed companies to publish ratios comparing CEO pay with pay in the wider company workforce (rather than just the median pay as at present). This would enable comparisons to be drawn between companies and sectors, and for changes to be seen in the ratios over time.
Despite some opposition to this, the government has decided to press ahead with its plans for annual pay ratio reporting. Listed companies will also have to put the ratio in the context of pay and conditions across the wider workforce, and explain changes in the ratio from year to year.
The government plans to work out the detail of this and include it in draft new laws to be published later this year. The current proposal is that the ratio should be based on the CEO's total annual remuneration relative to the average total remuneration of the company's UK workforce.
Under the new regime, listed companies would be required to provide a clearer explanation in remuneration policies of the potential remuneration outcomes of long-term incentive plans (LTIPs) under a range of scenarios, including significant share price growth. The government also intends to invite the Financial Reporting Council (FRC) to consult on a proposal to increase from three to five years the minimum holding period for share options.
The government's suggestion that bonus targets could be subject to disclosure has been dropped.
Shareholder voting and other rights
The reforms also include measures designed to encourage companies that face significant shareholder dissent to executive pay to do more to address this. As part of this, the government plans to name premium listed companies with significant shareholder opposition (i.e. 20%) to executive pay packages on a new public register, to be run by the Investment Association, along with a record of what those companies say they are doing to address shareholder concerns.
The government will also invite the FRC to revise the Corporate Governance Code (the Code) to set out the steps that premium listed companies should take when they encounter significant shareholder opposition to executive pay.
Increasing the effectiveness of remuneration committees
The government considers that there is a need to increase the effectiveness of remuneration committees. As a result, it intends to invite the FRC to consult on revising the Code and its supporting guidance to give remuneration committees broader responsibility for overseeing pay and incentives across their company, and require them to explain to the wider workforce each year how executive pay aligns with wider company pay policy.
It also plans to introduce a new requirement that chairs of remuneration committees should have served at least 12 months on such a committee, unless there is a clear and valid reason why this may not be appropriate or possible in a particular case.
Measures to ensure employees' voices are heard in the boardroom
Although the government plans to introduce new measures designed to help ensure employees' voices are heard in the boardroom, it is leaving it to the FRC to work out the best way of achieving this, and a new requirement will be included in the Code.
Currently, directors are required to have regard to the interests of employees, customers and wider stakeholders when carrying out their statutory duty to act in a way that promotes the success of their company (section 172 duty). The government intends to introduce a new requirement for all large public and private companies to disclose how their directors have complied with that duty in relation to employees' and other stakeholders' interests.
The government also suggests that on a "comply or explain" basis, premium listed companies should be required to adopt one of three employee engagement mechanisms: (1) assigning a non-executive director to represent employees (2) creating an employee advisory council, or (3) nominating a director from the workforce.
Corporate governance in large private businesses
The government has also considered the extent to which the largest privately held businesses should meet higher minimum corporate governance and reporting standards. The government intends to invite the FRC, in consultation with the business community, to develop a voluntary set of corporate governance principles for the largest private companies – so these companies can continue to use industry-developed codes, or their own preferred approach, if that is more appropriate.
The government expects the FRC to develop a new principle for the Code establishing the importance of strengthening the voice of employees and other non-shareholder interests at board level for private companies.
New laws are also planned to require companies of a significant size (currently proposed to include companies with more than 2000 employees, unless they are subject to an existing corporate governance requirement) to disclose their corporate governance arrangements in their Directors' Report and on their website, including whether they follow any formal code and an explanation if they follow a code in part, or not at all. A similar requirement may also be applied to limited liability partnerships (LLPs) of an equivalent size. If implemented, this would include many professional services businesses that so far have minimal corporate governance obligations.
Diversity on boards
The consultation paper did not seek views on boardroom diversity but since the issue was raised during the consultation, the government has said that while progress still needs to be made in appointing more women to senior and executive management positions, it doesn't consider that a higher target should be set at this stage (the Davies Review target for 2020 is for women to represent 33% of FTSE board members and 33% of executive committees and their direct reports). It therefore seems that any steps to introduce new legislation to increase gender diversity on boards will not happen for the foreseeable future as the ongoing approach is to set voluntary targets.
The government also confirmed that it intends to take a similar voluntary, business-led approach to increasing ethnic representation on boards, provided sufficient progress is made.
Conclusion and next steps
The reforms have prompted a mixed response with some expressing disappointment that they do not go further, and the business community breathing a collective sigh of relief that some of the tougher proposals, such as a requirement for an employee representative on the board and annual binding votes on executive pay, have been dropped.
A number of the proposed reforms involve incremental changes to existing corporate governance principles and will therefore not involve companies introducing significant changes to their current corporate processes. The package of reforms does however include a few changes which will be significant for some businesses, perhaps most notably the executive pay framework for listed companies and the increased corporate governance reporting for large private companies.
The FRC intends to consult on amendments to the Code in the Autumn. The government currently plans to bring the reforms into effect by June 2018, to apply to company reporting years commencing on or after that date.
The outcome of the consultation is available here