Never far from the headlines in recent weeks, Theresa May's promised corporate governance reform has taken another step with the publication of a green paper seeking views and discussion on three key areas:
- Executive pay
- Employee and wider stakeholder voice
- Large privately-held businesses.
The overarching message is that strengthening what is already "a world-leading corporate governance framework" is as much about ensuring continuing international competitiveness and creating the right conditions for investment as it is about fairness.
For each of the three focus areas the paper sets out the context, the perceived problem (or issue to be considered for reform) and a number of broad options on what form change could take.
The lion's share of the paper is given to a discussion of the executive pay framework in quoted companies and "the widespread perception that it has become increasingly disconnected from both the pay of ordinary working people and the underlying long-term performance of companies". The government says its objective with any reforms is to achieve executive pay "which is long term, fair and transparent, and related to performance" whilst ensuring companies retain flexibility to set pay policy and actual pay appropriate to their needs. Five specific areas relating to executive pay are picked out and various non-exclusive options for reform are considered for each of them.
Shareholder voting and other rights. Options include:
- A binding AGM vote on all or some elements of the executive pay package, either for all companies annually or only for those companies that encountered significant shareholder opposition to their annual remuneration report. The paper acknowledges that a binding vote on pay could have practical difficulties, for example, service agreements would need to make clear that pay was conditional on shareholder approval and thought would need to be given to how a vote against pay would be resolved.
- Stronger consequences for losing the annual advisory vote on the remuneration policy, for example, requiring the company to win the backing of a 'supermajority' of shareholders to approve the next pay policy.
- Pay policies to set an upper threshold for total annual remuneration (including all elements, from basic salary to bonus to Long-Term Incentive Plan) with a binding shareholder vote required where actual pay exceeds it.
- Binding votes on pay policy to be held more frequently than the current three year regime, or allowing shareholders to bring forward a vote on a new pay policy to an earlier date. The paper acknowledges that this would risk incentivising short-term strategies.
Shareholder engagement on pay: options include mandatory disclosure of fund managers' AGM voting records; establishing a senior "shareholder" committee to scrutinise and engage with executive pay arrangements; and considering ways to increase retail shareholder engagement.
The role of remuneration committees: suggestions revolve around encouraging a more universal and pro-active approach to consulting with shareholders and the workforce. Options include requiring the committee to consult with shareholders and the workforce in preparing its executive pay policy and requiring the chair of the committee to have served on the committee for at least 12 months before taking up the role.
Pay disclosure. Suggestions include:
- The controversial issue of pay ratio reporting, comparing CEO pay to pay in the wider workforce. The detail of how pay ratios would be calculated is not fleshed out but the government stresses that it would need to be designed in a way which "genuinely improves the ability of shareholders to understand company pay policies" in order to take informed decisions. The green paper highlights a potential issue with ratio reporting – that it might have the unintended effect of encouraging outsourcing and offshoring to exclude the lowest paid workers from the calculation.
- The reinforcing of disclosure of bonus targets. The paper asks whether the existing, qualified requirements to disclose the performance targets that trigger annual bonus payments should be strengthened and how this could be done without compromising commercial confidentiality. Also, assuming the case for strengthening, for views on whether to increase pressure on companies through institutional investor pressure or to make retrospective disclosure a mandatory reporting requirement.
Long-term pay incentives: discussion is sought on how such plans could be better aligned with the long term interests of quoted companies and shareholders and whether executive share option holding periods under the UK Corporate Governance Code should be increased from a minimum of three years to five years.
Employee and stakeholder voice
The press has made much of the fact that Theresa May's message on workers in boardrooms has lost the strength of her original leadership bid pledge. The green paper reaffirms the Prime Minister's comments at the recent CBI conference - the government is not seeking the mandatory direct appointment of workers to company boards. The paper looks at a number of other options which could work in combination to increase the voice that employees and other interested parties have at boardroom level.
Creating stakeholder advisory panels: amplifying the voice of groups with different perspectives to those typically found in the boardroom. For example, advisory panel members could be invited to board meetings to offer views on relevant agenda items or panels could initiate discussions by asking specific directors to attend their meetings to address questions.
Strengthening reporting requirements: requiring stronger reporting so that employees and other interested groups can better assess how directors are fulfilling their duty to the company to have regard to wider interests when making decisions. For example, by requiring companies to disclose how often, and by what mechanism, boards are considering the interests of employees and other stakeholders.
Designated NEDs: providing a clear, independent voice for employees or other interested groups. For example, a designated NED could be supported by stakeholder advisory panels, and transparency for this aspect of the NED's role could be achieved through enhanced reporting obligations in the annual report.
When looking at how any reforms would be implemented, the government considers different approaches: a flexible principle/high expectation approach supported through changes to the UK Corporate Governance Code and/or legislation; or an industry-led voluntary approach (citing the improvements in gender equality on boards in recent years as how effective voluntary codes of practice can be). It also considers whether an employee-based size threshold or other criteria should be set for reform in this area – which is a theme picked up in the final area looked at in the green paper.
Large privately-held businesses
The high profile failure of BHS has been hugely relevant to the question of private business corporate governance reform (and discussions around reform of corporate governance generally). The green paper notes that there are approximately 2,600 private companies in the UK with more than 1000 employees and that although these companies are not expected or required to meet the same formal corporate governance standards as listed companies, the consequences when things go wrong are equally severe for stakeholders. The green paper considers whether and how privately-held businesses should meet higher minimum corporate governance and reporting standards.
Enhanced standards of corporate governance: various options are considered including requiring compliance with the UK Corporate Governance Code or, perhaps more likely, a separate governance code developed specifically with privately-owned businesses in mind, either following the familiar "comply or explain" approach or on an entirely voluntary basis (backed up by best practice principles which companies sign up to). Whilst the specifics are not clear, the government's view is that it would be proportionate to consider applying formal standards "only to the very largest privately-held firms".
Many of the replies to the consultation are likely to suggest that the government should focus on how private companies are implementing the existing governance regime. If shareholders in private companies are comfortable with the status quo why should a company adopt any enhanced standards? Previous voluntary codes for private companies have not seen widespread acceptance – an example being the Corporate Governance Guidance and Principles for Unlisted Companies in the UK published in November 2010. Will it be any different this time round? We expect not unless there is a business reason which drives change.
Consistent reporting standards: many non-financial reporting standards currently only apply to quoted companies. The government asks whether non-financial reporting standards should, in future, be consistently applied on the basis of a size threshold rather than the type of company.