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Corporate leadership

i Board structure and practices

The UK system features a unitary board. There is no two-tier structure: executive directors and independent, non-executive directors instead act together as one board. The company's powers are exercised by its board acting collectively, with a small number of decisions requiring shareholder approval. In practice, substantial managerial authority is delegated by the board to the company's executives; the board appoints the executives and exercises an oversight function by approving decisions that do not require shareholder approval and that have not been fully delegated. Standing committees of the board typically include at least a nomination committee, audit committee and remuneration committee, but the creation of other standing committees, or ad hoc committees to exercise delegated powers, is permitted.

There is currently no co-determination principle in the UK requiring seats on the board to be reserved for employee representatives. However, as its most significant new proposal, the Code seeks to amplify the voice of workers in the boardroom. Companies can choose from three options: a director appointed from the workforce, a formal workforce advisory panel or a designated non-executive director with specific responsibility for ensuring that the views of the workforce are represented to the board. A poll undertaken by the Institute of Chartered Secretaries and Administrators (ICSA) suggested that, as of October 2018, 91 per cent of companies surveyed were not considering having workers on their board. Instead, 48 per cent of those surveyed were considering the designated non-executive director approach, while 37 per cent were considering either a combination or an alternative approach to workforce engagement.

The Code recommends that the board and its committees should have an appropriate balance of skills, experience, independence and knowledge of the company to enable them to discharge their respective duties and responsibilities effectively. At least half of the board, excluding the chairperson, is required to comprise individuals determined by the board to be independent. This way, no individual or small group of individuals can dominate the board's decision-making. It is the CEO, however, who is responsible for delivering the agreed strategy and for the day-to-day running of the company's business.

The criteria for determining whether a director may be regarded as independent are set out in the Code. A director will not be regarded as independent if that director:

  1. has been an employee of the company or its group within the past five years;
  2. has, or has had within the past three years, a material business relationship with the company;
  3. has received or receives additional remuneration from the company apart from a director's fee, participates in the company's share option or a performance-related pay scheme, or is a member of the company's pension scheme;
  4. has close family ties with any of the company's advisers, directors or senior employees;
  5. holds cross-directorships or has significant links with other directors through involvement in other companies or bodies;
  6. represents a significant shareholder; or
  7. has served on the board for more than nine years from the date of his or her first election.

The Code requires that the board constitute a nomination committee, an audit committee and a remuneration committee. The strength and independence of these committees – whose particular duties are addressed in the Code and in recommended terms of reference published by ICSA – is a key factor in ensuring effective corporate governance, although ultimate responsibility for areas addressed by these committees remains with the board collectively. Some boards also constitute a risk committee that is separate from the audit committee, and has responsibility for overseeing risk exposure and future risk strategy.

The Code recommends that the audit committee should comprise at least three directors, all of whom are independent and one of whom should have recent and relevant financial experience. The chairperson of the board should not be a member of the audit committee. FTSE 350 companies are required to put their audit engagement out to competitive tender at least every 10 years, and the audit committee oversees this process. In December 2018, the Competition and Markets Authority concluded an investigation in to whether the audit sector is competitive and resilient enough following much public criticism of statutory audits. Among other things, legislation to separate audit from consulting services has been proposed and this has the backing of the majority of the largest four accountancy firms in the UK.

The nomination committee should comprise a majority of independent directors. The chairperson of the board can be a member of (and chair) the nomination committee. The remuneration committee should comprise at least three independent directors. The chairperson of the board may sit on (but not chair) the remuneration committee, provided he or she was independent on appointment. Before appointment as chair of the remuneration committee, the appointee should have served on a remuneration committee for at least 12 months.

The separation of chairperson and CEO is one of the key checks and balances of the UK system. It has been recognised for some time that combining the roles increases the likelihood of one individual having unfettered decision-making powers. The Code recommends splitting the role of chairperson and CEO, and that the division of responsibilities between the two positions should be clearly established. If the roles of chairperson and CEO are combined (or if the CEO succeeds as chairperson), this must be publicly justified in accordance with the comply or explain principle, and the company should consult with major shareholders ahead of appointment, from whom it should expect close questioning.

Executive pay

The Code states that executive remuneration should be aligned to the company's purpose and values. A significant proportion of executive directors' remuneration should be structured to link rewards to the successful delivery of the company's long-term strategy (but pay for non-executive directors should not include performance-related elements).

Levels of executive remuneration have been heavily criticised by the public and in the media in recent years. In December 2017, the CEO of a house-building firm was awarded a bonus of more than £100 million under his long-term incentive plan (LTIP), which was widely criticised in the media and by politicians, and led to the chairperson and chair of the remuneration committee resigning over the design of the bonus scheme, shortly followed by the CEO himself. The Code now contains enhanced governance requirements in respect of LTIPs, namely a requirement for a five-year combined holding period between award and the participant receiving any economic benefit, and a requirement for companies to have a formal post-employment shareholder policy as well as clawback powers. For financial years commencing on or after 1 January 2019, there is a statutory requirement to disclose the impact of the company's share price on executive remuneration.

The Code also requires additional disclosures to be made by the remuneration committee, for example on why the remuneration package is appropriate, how factors such as risk (behavioural and reputational) have been considered, and whether any discretion has been applied to the remuneration outcomes. The remuneration committee is also required to engage with shareholders and the workforce in setting executive remuneration, and to report on this engagement and its outcomes.

Shareholders of UK-incorporated, listed companies have a binding vote on companies' directors' remuneration policy. In broad terms, shareholders are required to approve, at least every three years, a policy setting limits and conditions for directors' remuneration. If payments and awards made by the company to its directors are not consistent with the shareholder-approved policy, they are recoverable from the director in question, and the directors responsible for approving the unauthorised payment or award are liable to compensate the company. Shareholders have, in addition, an annual advisory (i.e., non-binding) vote on the implementation of the approved policy during the previous year. Companies are also obliged to publish a report on directors' remuneration in their annual report, including the remuneration policy in the years it is being put forward for approval. This regime does not apply to employees or consultants who are not directors.

Where a company has 250 or more employees, it is also required to publish statutory calculations each year showing the size of the pay gap between male and female employees. For financial years commencing on or after 1 January 2019, companies of that size are also required to report on the ratio of the CEO's pay to the average pay for its employees.

ii Directors

The role of the independent director is seen as essential in providing a balance on the boards of listed companies, and the Code and related guidance emphasise the need for independent directors to be suitably experienced, committed and prepared to challenge the executive directors. The Code emphasises the need for the board to promote the long-term sustainable success of the company, generating value for shareholders and contributing to wider society. It is the board's responsibility to establish the company's purpose, values and strategy, aligning each with the culture of the company. The concept of purpose is a novel and much-discussed requirement of the Code and there is little in the way of guidance as to how a company should establish, articulate, monitor and report against a statement of purpose (to the extent it does not do those things already). Statements of purpose are necessarily unique to each company, but it is anticipated that they will focus on the stakeholder considerations necessary to ensure the long-term sustainable success of that company (i.e., the derivative generation of economic value for shareholders).

The primary function of independent directors, according to the Code, is to scrutinise the performance of management and monitor the reporting of performance. The board should appoint an independent director to be the senior independent director to provide a sounding board for the chairperson and to serve as an intermediary for the other directors when necessary. The senior independent director should be available to shareholders if they have concerns that contact through the normal channels of chairperson, CEO or other executive directors has failed to resolve, or for which such contact is inappropriate. The FRC's Guidance on Board Effectiveness (2018) further emphasises the critical role of the senior independent director to help resolve significant issues when the board is under periods of stress. Independent directors should hold meetings without the executives being present both with the chairperson and, at least annually, without the chairperson (led by the senior independent director) to evaluate the chairperson's performance.

In practice, independent directors generally meet with the other directors for board meetings at least eight times per year in addition to attending committee meetings. They should (and often do) have direct access to all staff below board level and all advisers and operations, and receive information at an early stage (before executive directors have made key decisions). The Code provides that, as part of their role as members of a unitary board, independent directors should constructively challenge and help develop proposals on strategy. On the other hand, a conscientious and independent standard of judgement, free of involvement in the daily affairs of the company, is seen as an independent director's key contribution to the boardroom. In this regard, the board is required to determine annually whether a director is independent in character and judgement and whether there are relationships or circumstances that are likely to affect the director's judgement.

Independent directors should also monitor the performance of management in meeting agreed performance objectives. They should satisfy themselves on the integrity of financial information and that financial controls and systems of risk management are robust and defensible. They are responsible for determining appropriate levels of remuneration of executive directors, and have a prime role in appointing and, where necessary, removing, executive directors, and in succession planning.

Directors' duties

All directors, both executive and non-executive, owe the same fiduciary duties and a duty of care and skill to the company. These duties are derived from common law but have now been largely codified under the Companies Act. These statutory duties are:

  1. to act within their powers (i.e., in accordance with the company's constitution);
  2. to exercise their powers in good faith in the manner they consider most likely to promote the success of the company for the benefit of its shareholders;
  3. to exercise independent judgement;
  4. to exercise reasonable care, skill and diligence;
  5. to avoid conflicts of interest;
  6. not to accept benefits from third parties; and
  7. to declare any interest in a proposed transaction or arrangement with the company.

These statutory duties must still, however, be interpreted and applied in accordance with the pre-existing common law duties. Indeed, in respect of some directors' duties that have not been codified under the Companies Act, the common law rules remain the only relevant law. These include the duties not to fetter their discretion, not to make unauthorised profits by reason of their office and to keep the affairs of the company confidential.

UK law has adopted the enlightened shareholder approach to the orientation of its directors' duties. The Companies Act requires directors, when deciding how to exercise the powers of the company, to have regard to:

the likely consequences of any decision in the long term, the interests of the company's employees, the need to foster the company's business relationships with suppliers, customers and others, the impact of the company's operations on the community and the environment, the desirability of the company maintaining a reputation for high standards of business conduct, and the need to act fairly as between members of the company.

Much recent discussion of corporate governance reform has centred on the duties companies owe to stakeholders. The Code now seeks to ensure that companies are more open and accountable to their stakeholders, and particularly their workforce. Recent legislation also requires large companies to report on how directors have discharged their duty to consider the above-mentioned stakeholders. None of these developments will authorise directors to prefer the interests of other stakeholders to those of the shareholders; nor will it give other stakeholders any ability to hold directors legally accountable for their decisions. However, the recent trajectory of enhanced disclosures opens companies up to a new regime of public censure on such matters.

UK law takes a relatively strict approach to the enforcement of directors' duties. For example, unauthorised self-dealing is not reviewed ex post against an entire fairness standard, as it might be in Delaware; rather, the transaction is in principle voidable at the instigation of the company without any inquiry into its fairness. Breach of duty is in principle actionable only by the company to which the duty is owed, and not by its shareholders or creditors. While a shareholder may bring a derivative action on behalf of the company in relation to actual or threatened breaches of duty, the UK legal system is not well suited to private enforcement of directors' duties outside formal insolvency proceedings, so litigation by shareholders of a listed company alleging breach of duty by its directors is extremely rare.

In relation to control-seeking transactions (i.e., any proposed acquisition of 30 per cent or more of the voting rights), the Takeover Code requires shareholder approval for any proposed action by the directors that may result in any offer (or expected offer) for the company being frustrated, or in shareholders being denied the opportunity to accept or reject the offer on its merits. Shareholders are protected by the substantive and procedural rules regulating control transactions.

It would be extremely difficult for the board of a UK company unilaterally to adopt anything equivalent to a shareholder rights plan, or to issue shares to a white-knight bidder to block a hostile takeover. For better or worse, takeover regulation in the UK strongly favours the short-term interests of shareholders by depriving the board of anything other than the power to persuade shareholders to reject an unwanted offer. Changes to the Takeover Code from early 2018 do, however, give the board additional time for such persuasion, and require bidders to provide additional disclosures regarding their intentions for the target business (against which they can be held accountable after the takeover).

Other legislation imposes criminal and civil liability on directors, including health and workplace safety laws, environmental laws and competition and securities laws.

Appointment, nomination, term of office and succession

The Code provides that there should be a formal, rigorous and transparent procedure for the appointment of new directors to the board. The search for candidates should be conducted, and appointments made, on merit, against objective criteria and within that context should promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths. A nomination committee should lead the process for board appointments and make recommendations to the board. Independent directors should be appointed for specified terms subject to annual re-election. The Code prohibits the chairperson from remaining in post beyond nine years from the date of their first joining the board; however, this can be extended, where necessary and with explanation, to facilitate effective succession and the development of a diverse board.

The Code states that all directors should be re-elected annually by shareholders. Each director's election is voted on separately, with statute requiring majority rather than plurality voting (i.e., an ordinary majority of shareholders can vote against – and hence block – a director's election). In theory, an ordinary majority of shareholders also has a statutory right to remove a director at any time and without cause, but annual re-election renders this right largely irrelevant in practice. Consequently, there is no concept of a staggered board under UK law.

The board should satisfy itself that plans are in place for the orderly succession of appointments to the board and to senior management with a suitably diverse pipeline, so as to maintain an appropriate balance of skills and experience within the company and on the board and to ensure progressive refreshing of the board.


The Hampton-Alexander Review (2016 and 2017) and the Parker Review (2017) have both made a series of recommendations for companies to further gender and ethnic diversity, respectively, at board level.

The Parker Review recommended that all FTSE 100 boards should have at least one director from an ethnic minority background by 2021, and the same for FTSE 250 boards by 2024. The Hampton-Alexander Review set a target of 33 per cent women on FTSE 350 boards and 33 per cent women in FTSE 100 executive leadership teams by 2020. Both also make a number of recommendations to facilitate attainment of those targets.

Recent additions to the Code seek to reflect these recommendations in asking boards to intensify their efforts. Nomination committees will be required to ensure a diverse pipeline for succession, and annual reports will be required to explain actions taken to increase diversity and inclusion, as well as their outcomes. The Code also recognises a wider concept of diversity, which covers gender, social and ethnic backgrounds, cognitive and personal diversity. The Listing Rules already require that companies' annual reports include a description of their diversity policy, how it is being implemented and the results.

As of November 2018, the number of women on FTSE 100 boards exceeded 30 per cent (up from 12.5 per cent in 2011), but within the FTSE 350 there were still five all-male boards and 75 companies with only one woman on their board, with women still underrepresented in chair and CEO roles. Despite the seemingly modest target, representation of ethnic minorities on FTSE 100 boards actually fell in 2018 from 85 to 84 of the 1,048 total directorships.