The Government has published its response (linked here) to the green paper consultation it published in November on strengthening corporate governance in the UK.

The response identifies nine headline proposals for reform, across the three specific areas of corporate governance discussed in the green paper, namely: (1) executive pay; (2) strengthening the employee, customer and supplier voice; and (3) corporate governance in large private companies, as summarised below. To implement the changes proposed:

  • the FRC will consult in late autumn on changes to the UK Corporate Governance Code (Code) as part of its previously announced fundamental review of the Code;
  • the Government will introduce secondary legislation, to go before parliament before March 2018; and
  • the Government has invited other bodies, including ICSA, the IA and the GC100 amongst others, to produce codes and guidance,

with the intention being to bring the reforms into effect by June 2018 to apply to company reporting years starting on or after that date.

The Government's proposals do not include some of the more controversial suggestions from the green paper, whilst much of the detail of the proposals is not yet fleshed out and will emerge over the coming months. Although the majority of the proposals will be on a voluntary "comply or explain" basis with the emphasis on disclosure, if the Government does not perceive the result to be effective as a catalyst for change, it may look in the future to bring in more prescriptive, inflexible and onerous requirements. Quoted companies (in particular FTSE 350 companies) should start considering (to the extent that they have not already done so) the approach they may take in many of these areas and, potentially, whether and to what extent they may start to reflect some of the proposed new requirements early on a voluntary basis.

Executive pay

  • The Government invites the FRC to revise the Code to:
    • be more specific about the steps that premium listed companies should take when they encounter significant shareholder opposition (likely to be 20% or more) to remuneration and other resolutions - this may include, for example, provisions requiring companies to respond publicly to dissent within a certain timeframe or, more significantly, requiring companies to put their existing or revised remuneration policy to a shareholder vote at the next AGM;
    • require remuneration committees to broaden their role including to take greater responsibility to demonstrate how pay and incentives align across the company and to engage with the wider workforce to explain how executive remuneration aligns with wider pay policy (using pay ratios where appropriate);
    • provide that chairs of remuneration committees should have served for at least 12 months on a remuneration committee unless there is a clear and valid explanation why this may not be appropriate or possible in a particular case; and
    • increase the recommended minimum holding and vesting periods for executive share awards from 3 to 5 years.
  • The Government invites the IA to implement a proposal it made to maintain a public register of listed companies who encounter shareholder opposition of 20% or more to executive pay and other resolutions, along with a record of what these companies are doing to address shareholder concerns. The IA has announced that the register would be launched by the end of 2017.
  • The Government will introduce secondary legislation to require quoted companies to:
    • report annually the ratio of CEO pay (current proposal is total annual remuneration figure) to the average pay of the UK workforce (multinational companies would be free, but not obliged, also to publish a broader ratio covering all group employees), with narrative explanation; and
    • provide clearer explanations in remuneration policies of the range of potential outcomes from LTIPs.
  • Although the majority of these measures (all but the secondary legislation) will only affect premium listed companies (and some may only affect FTSE 350 companies, depending on the outcome of the FRC consultation process) and will be on a "comply or explain basis" and driven by requirements to disclose what is being done rather than prescriptively to dictate what must be done, the response states that "The Government will consider further action at a future point unless there is evidence that companies are taking active and effective steps to respond to significant shareholder concerns about executive pay outcomes".
  • The Government will also commission an examination into the use of share buybacks to ensure that they cannot be used artificially to hit performance targets and inflate executive pay. It will also consider concerns that buybacks may be "crowding out the allocation of surplus capital to productive investment".

Strengthening the employee, customer and wider stakeholder voice

  • The Government will introduce secondary legislation to require all large companies (both public and private) to explain in their strategic report, and possibly also on their websites, how their directors comply with the requirements of section 172 of CA 2006 to have regard to employee and other interests (the Government's initial view is that "large" would mean having over 1,000 UK employees but will consider this further). The Government will consider further how this reporting requirement should operate but envisages that it would include a requirement to explain how the company has identified and sought the views of stakeholders, why the mechanisms adopted were appropriate and how this information has influenced decision-making in the boardroom.
  • The Government will invite the FRC to consult on the development of a new Code principle to strengthen employee and other non-shareholder interests at board level, by requiring premium listed companies either to have:
    • a designated NED responsible for this;
    • a formal employee advisory council; or
    • a director from the workforce.
  • The Government will encourage industry-led solutions by (1) asking ICSA and the IA to complete their joint guidance on practical ways in which companies can engage with their employees and other stakeholders and (2) inviting the GC100 to complete and publish new advice and guidance on the practical interpretation of the directors' duties in section 172 of CA 2006.
  • Similarly to the section on executive pay, in relation to the measures on strengthening the employee, customer and stakeholder voice, the response states that the Government will "monitor the extent to which these measures are effective and will consider further action in the future if progress is insufficient".
  • Whilst not referenced in the response, companies will also need to be mindful of the current consultation paper published by the FRC in August (linked here) on amendments to its 2014 Guidance on the Strategic Report. The proposed amendments seek to update the Guidance to: (i) take account of the implementation of the Non-Financial Reporting Directive (Directive 2014/95/EU); (ii) strengthen the link between s.172 (directors' duties) of the Companies Act 2006 and the Strategic Report by encouraging companies to ensure that the Strategic Report contains sufficient information to help shareholders to assess how directors have performed their duties under section 172; and (iii) take account of various developments in corporate reporting and practice, such as the publication of the ESMA Guidelines on Alternative Performance Measures, since the Guidance was published. The closing date for the consultation is 24 October 2017 and the FRC has indicated that it will update the Guidance to reflect any legislative changes that are included in the response to the green paper.

Corporate governance in large private companies

  • The Government intends to invite the FRC to work with the IoD, the CBI, the Institute for Family Businesses, the BVCA and others to develop a voluntary set of corporate governance principles for large private companies under the chairmanship of a business figure with relevant experience.
  • The Government will introduce secondary legislation to require companies of a significant size (the Government's initial view is that this would mean companies with more than 2,000 employees) to disclose their corporate governance arrangements in their directors' report and on their website, including whether they follow any formal code. There will be an exemption for companies who are already subject to an existing corporate governance reporting requirement.

Other issues 

  • The Government will give further consideration to whether the FRC has the appropriate powers, resources and status to operate effectively given its increasing remit in relation to corporate governance. In the meantime, the Government has asked the FRC, the FCA and the Insolvency Service to conclude new/revise existing letters of understanding with each other before the end of 2017 to "ensure the most effective use of existing powers to sanction misbehaving directors and ensure the integrity of corporate governance reporting".
  • In relation to diversity, the Government has established a Business Diversity and Inclusion Group, whose board includes the authors of recent reports on aspects of diversity (including Sir Philip Hampton and Sir John Parker) and others, the first meeting of which is to be scheduled shortly. The group is intended to "bring together business leaders and organisations to provide strategic leadership on diversity and inclusion issues, monitoring progress in tackling barriers and deliver a clear and coherent message to the business community on what needs to be done".

Comment 

The Government's proposals do not include some of the more controversial suggestions from the green paper, such as legislation to change directors' duties and annual binding votes on remuneration. Much of the detail of the proposals is not yet fleshed out and will emerge over the coming months including with the secondary legislation and, in particular, with the FRC's consultation on changes to the Corporate Governance Code, which promises to be a significant exercise giving rise to substantial changes. Whilst the full package of new reforms is only intended to come into effect by June 2018, some may be implemented earlier as detailed above. Quoted companies (in particular FTSE 350 companies) should start considering (to the extent that they have not already done so) the approach they may take in many of these areas and, potentially, whether and to what extent they may start to reflect some of the proposed new requirements early (in their reporting in 2018 for the 2017 financial year) on a voluntary basis.

On some of the specific proposals in respect of executive pay:

  • "Dissent register": there has been some criticism of the proposal to introduce the register of companies encountering significant shareholder dissent as being unnecessary. This is on the basis that the information regarding the dissent will already be public and generally subject to substantial press commentary, whilst there would probably only be a small number of companies on the register.
  • Further vote: if the Corporate Governance Code ultimately provides for companies who encounter such dissent to put their remuneration policy to a shareholder vote at the next AGM, that would be a significant new development.
  • LTIP holding period: the proposed increase of the recommended minimum holding and vesting periods for executive share awards from 3 to 5 years is unlikely to have a major impact as pressure from institutional shareholder bodies to do this has already been applied for some time.
  • Pay ratios: the Government has acknowledges some of the challenges inherent in calculating and using pay ratios, however it remains to be seen whether the detailed proposals will enable companies to do so without being unduly burdened or producing potentially misleading outcomes. Companies will also be keen to ensure that the inevitable media reporting of the pay ratios will put them in the necessary context.

On the proposed reporting obligations in relation to engaging with employees and other stakeholders, one of the more challenging elements of the proposal is the contemplated requirement for companies to report not only on how they have consulted stakeholders but also on how such consultation influenced board decision-making: the latter may be challenging and may require significant consideration by companies.

Although some of the proposals will become legally binding requirements under secondary legislation (most notably the content requirements for the strategic report), the majority will be on a voluntary "comply or explain" basis with the emphasis on disclosure. It is clear from the language used in the response, however, that the Government intends to assess whether this approach is effective as a catalyst for change and, if it is not perceived to be, the Government may look in the future to bring in more prescriptive, inflexible and onerous requirements.