The BEIS Parliamentary Select Committee published its Corporate Governance Report on 5 April 2017. The BEIS Report is entirely separate from the Government’s Green Paper on corporate governance reform published in November last year and the two exercises should not be confused with each other (for our Green Paper briefing see here). While the Government is likely to take an interest in the Select Committee’s recommendations, it remains to be seen whether it chooses to adopt any of them.We set out the key recommendations below.
New mandatory reporting on s172 and wider FRC enforcement powers
The Committee has not called for any change in the law on directors’ duties - in particular the duty to promote the success of the company for the benefit of its members as a whole in s172 of the Companies Act 2006. Instead it recommends that the Financial Reporting Council (FRC) amends the Corporate Governance Code (the Code) to require boards to explain:
- precisely how they considered stakeholders’ interests (including employees, customers and suppliers);
- how this was ref lected in financial decisions;
- how they pursued the company’s objectives and had regard to the consequences of their decisions for the long term; and
- any failure to have due regard to stakeholders’ interests.
These disclosures should not necessarily appear in the annual report.
The Committee supports the ‘comply or explain’ application of the Code but recommends that the FRC should have additional powers to engage and hold directors to account (the report raises the possibility of new powers to obtain information).
If this engagement is ‘unsuccessful’ (no criteria for success are specified), the FRC should report publicly on any failings of the board or of individual directors. It should have power to take legal action for breach of s172 (the mechanism for this is unclear as the director owes his s172 duty to the company alone). The Committee also recommends that the Secretary of State be more active in using existing corporate investigation powers.
Rating companies’ governance practice
In the Committee's view, business organisations (including the FRC) should develop metrics to inform an annual rating of companies’ governance compliance, using a traffic light system. FTSE 350 companies should be required to disclose their rating in their annual reports. It is not clear whether the Committee envisages a rating for individual aspects of a company’s governance, or an overall rating for each company.
Better company and investor engagement
The Committee is looking to improve dialogue between companies and investors and urges companies to consider creating stakeholder advisory panels to provide a formal framework for seeking stakeholders’ views on specific issues. The Code should be revised to require annual reports to explain how companies are conducting engagement with stakeholders.
The Report also calls on the FRC to encourage companies to be more imaginative in communicating digitally with stakeholders throughout the year.
Reviewing the Stewardship Code
The Committee believes that the FRC should provide clearer guidance in the Stewardship Code on the quality of engagement required of investors, and should publicise poor performance. It should also require better disclosure of voting by asset managers and name those who do not vote.
Transparency and the role of advisers
It is recommended that the Government consults on new requirements for listed and large private companies to disclose information about advisers engaged in transactions above a ‘reasonable’ size threshold - no further detail is provided on transaction type or amount.
The Report suggests that the Code should:
- set out best practice on professional support for NEDs; and
- provide guidance on how companies should identify the roles of NEDs who have particular responsibilities and how to hold them to account for their performance.
NEDs who serve on multiple boards should demonstrate ‘more convincingly’ that they can devote sufficient time to each company.
New governance code for large private companies
The Committee recommends a new voluntary governance code for large private companies (initially those with more than 2,000 employees). The FRC has offered to develop and oversee it.
Companies should report against the private company code on a comply or explain basis. It should require disclosure of, for example, revenues, company structure, executive pay, employee numbers and pension scheme contributions, and the proposed listed company s172 reporting requirements should also apply. The disclosure could be made on a website rather than in an annual report.
The Committee makes a number of recommendations about executive pay. It endorses a move away from what it views as unduly complex pay structures towards a simpler structure with heavier reliance on basic pay.
Perhaps the most significant pay recommendation is that LTIPs should be phased out as soon as possible (with no new LTIPs agreed from the start of 2018). The Committee views them as too complex and too unpredictable. Instead, the Committee recommends the use of annual share awards, not subject to performance targets, which vest on a phased basis over a period “generally…above five years”. This is not a new proposal – the Executive Remuneration Working Group report published in July 2016 contained a similar recommendation. However it is far from clear that a move away from a link to performance would be universally welcomed by institutional investors.
The Report believes there is still a place for short term performance-related bonuses, but envisages that these should operate on a more limited basis than at present with genuinely stretching metrics aligned to wider company objectives or corporate governance responsibilities.
Votes on pay
The Committee does not believe that it is necessary to move to an annual binding vote on pay. Instead, it endorses one of the alternatives put forward in the Green Paper – that there should be an escalation procedure where there is a significant vote against pay. The Committee’s view of how the escalation procedure should work is that a 25 per cent. vote against pay awards in one year should trigger a requirement for a binding vote on executive pay awards in the following year.
- Pay ratios – The Committee supports the introduction of CEO pay ratio reporting (comparing CEO pay both with other senior executives and with all UK (but not international) employees), without giving the impression that it is fully committed to the principle. It considers that a requirement to publish CEO pay ratios will have a limited impact on pay inequality and that extensive information on pay is already available. However, the Committee suggests that ratios should be published because they are easy to produce. It is far from clear that this is the case, and the experience from the US is that the calculations raise significant complexities.
- People policy – Companies should set out clearly their ‘people policy’ – their rationale for the employment model used and their overall approach to investing in and rewarding employees at all levels. They should also report clearly on remuneration levels on a consistent basis. The FRC should consult on implementing this recommendation for inclusion in the Code.
The Committee recommends that remuneration committee chairs should normally have served on the committee for at least one year previously. It also recommends that chairs should be expected to resign if their proposals do not receive the backing of 75 per cent. of voting shareholders.
Importance of diversity
In addition to the issues considered also in the Green Paper, the Report looks in detail at boardroom diversity and how it might be improved.
The Report recommends that the Code be revised to make diversity a key priority and to require companies to give a public explanation of why their board members have been selected. Annual reports should include information about diversity on their boards and in their workforce, including a narrative on what the current diversity position is, what steps the company has taken and will take to improve the diversity of its executive pipeline, and agreed diversity targets.
Lord Davies’ 2011 review set a target of 25 per cent. of boardroom positions to be held by women. Whilst this target has been met, the Report highlights that this rise in female board representation is deceptive. In the FTSE 100, only 10.4 per cent. of executive directors are currently women, compared with 33.7 per cent, of non-executive directors. In February 2016, the Hampton-Alexander review set a target of women holding 33 per cent. of executive positions by 2020. The Report recommends taking this further – it proposes that by 2020 50 per cent. of all new appointments to senior and executive management level positions in the FTSE 350 and all listed companies should be women, to ensure a strong pipeline of women for executive director roles. Any company which does not meet this target should explain in its annual report why it has failed, and what steps it is taking to rectify the gender inequality on its executive committees.
Ethnicity should be treated in the same way as gender when it comes to diversity on boards. The Report recommends that the FRC embeds the promotion of ethnic diversity into the Code, at the very least by making a reference to ethnicity wherever there is a reference to gender. It also wants to ensure that all FTSE 100 companies publish their workforce data, broken down by ethnicity and pay band. It is not clear whether this is a recommendation for an ethnicity pay gap report, similar to that required for gender under the gender pay gap reporting regime which came into force yesterday.
Cognitive and social diversity
The Committee is clear that more needs to be done to ensure that there is cognitive and social diversity on boards – directors will not challenge each other or make the best informed decisions if they are all cut from the same cloth. The Report recommends that the FRC work to provide improved guidance on this aspect of boardoom diversity.
As expected, the Report encourages companies to include workers on their boards, but does not recommend that this be a requirement. It states that where employees are appointed to boards, they should be full board members (ie Companies Act directors) rather than merely representatives of the workforce. The Report also recommends that there should be employee representation on remuneration committees and this option should be included in the Code.