On 5 April 2017, the House of Commons Business, Energy and Industrial Strategy (BEIS) Select Committee published a report following its inquiry into corporate governance. The inquiry was launched in September 2016 in the wake of high profile cases such as BHS and Sports Direct. The inquiry considered whether the UK corporate governance framework is still fit for purpose. The report concludes that corporate governance in the UK remains strong and that there is no need for a radical overhaul. The report, however, makes a number of recommendations for improvements to the regime including the development of an appropriate code for large private companies. The BEIS inquiry is a separate initiative to the Government's Green Paper on corporate governance. It remains to be seen whether the Government will adopt any of the BEIS Select Committee recommendations.
New governance code for large private companies
The report concludes that it would not be sensible to extend the existing UK Corporate Governance Code (Code) to private companies. Instead, a new voluntary governance code for large private companies (initially those with more than 2,000 employees) is recommended.
The Financial Reporting Council (FRC), the Institute of Directors and the Institute for Family Business should develop, with private equity and venture capital interests, an appropriate governance code for private companies. It is suggested that the new governance code adopt the "comply or explain" model. Disclosures could include revenues, compliance with section 172 of the Companies Act 2006 (directors' duty to promote the success of the company), company structure, executive pay, number of employees and pensions scheme contributions.
If the voluntary regime fails to raise standards after a three year period, or reveal high rates of non-compliance, then a mandatory regulatory regime should be introduced.
The FRC should amend the Code to require informative narrative reporting on the fulfilment of directors' duties under section 172 of the Companies Act 2006. Boards should be required to explain precisely how they have considered each of the different stakeholder interests, including employees, customers and suppliers and how this has been reflected in financial decisions. Boards should also explain how they have pursued the objectives of the company and had regard to the consequences of their decisions for the long term. Where there has been a failing to have due regard to any one of these interests, this should be addressed directly and explained.
Legislation should be introduced to give the FRC additional powers to engage and to hold directors to account in respect of their duties. If engagement is unsuccessful, the FRC should publish any collective or individual failings of the board. It is also recommended that the FRC be given authority to initiate legal action for breach of section 172 duties. The Secretary of State should also be more pro-active in using existing corporate investigative powers.
Rating corporate governance compliance
The FRC should work with business organisations to develop appropriate metrics to inform an annual rating of companies' governance compliance, using a traffic light system. FTSE 350 companies should be required to disclose this rating in their annual reports.
The Investor Forum should seek to become a more pro-active facilitator of a dialogue between boards and investors by engagement in regular routine dialogue in order to pick up on any widespread concerns, such as those identified by the new FRC traffic light rating system.
Companies should consider establishing stakeholder advisory panels. The report recommends amendments to the Code to require a section in annual reports detailing how companies are engaging with stakeholders.
The FRC should review the UK Stewardship Code to provide more explicit guidelines on what high quality engagement would entail; a greater level of detail in terms of requirements; and an undertaking to call out poor performance on an annual basis.
A consultation should be launched on new requirements on listed and large private companies to provide full information on advisors engaged in transactions above a reasonable threshold, including on the amount and basis of payments and on their method of engagement.
The FRC should update the Code:
- to provide guidance on how companies should identify the roles of non-executive directors who have particular responsibilities and how they should be held to account for their performance; and
- set out best practice on professional support for non-executive directors
Non-executive directors should be required to demonstrate more convincingly that they are able to devote sufficient time to each company when they serve on multiple boards.
A number of recommendations are made in respect of executive pay. The report supports calls for executive pay structures to be simplified.
Companies should make it their policy to align bonuses with broader corporate responsibilities and company objectives and to take steps to ensure that they are genuinely stretching.
Long-term incentive plans (LTIPs) should be phased out as soon as possible as they are unnecessarily complex. No new LTIPs should be agreed from the start of 2018. Existing LTIPs should not be renewed. The report recommends annual share awards which vest over a period of about 5 years.
The report supports one of the options proposed in the Green Paper on votes on pay. Rather than an annual binding vote on pay, an escalation mechanism is proposed. A 25 per cent. vote against a pay award in one year should trigger a binding vote on executive pay in the subsequent year.
Remuneration committee chairs should normally have served on the committee for at least one year. The remuneration committee chair should be expected to resign if their proposals do not receive the backing of 75 per cent of voting shareholders. Employees should be represented on remuneration committees.
The FRC should consult with other relevant stakeholders on the publication of pay ratios between the CEO and both senior executives and all UK employees. Equivalent pay ratios should be published by public sector and third sector bodies above a specified size.
In February 2016, the Hampton-Alexander review set a target of women holding 33 per cent. of executive positions by 2020. The report goes further than this and recommends
a target that at least half of all new appointments to senior and executive management level positions in the FTSE 350 and all listed companies should be women by 2020. Companies should explain in their annual report the reasons why they have failed to meet this target, and what steps they are taking to rectify the gender inequality on their executive committees.
The FRC should embed the promotion of ethnic diversity within boards into its revised Code. At the very least, the FRC should include a reference to ethnicity wherever there is a reference to gender. The Government should also legislate to ensure that all FTSE 100 companies and businesses publish their workforce data, broken down by ethnicity and by pay band. It is unclear whether this recommendation could translate into a requirement to publish an ethnicity pay gap report similar to the gender pay gap reporting regime which is now in force.
Board diversity should be a key priority. The Code should require boards to disclose diversity information in their annual reports covering diversity of gender, ethnicity, social mobility, and diversity of perspective. Annual reports should be required to include a narrative on the current position, and an emphasis on what steps the company has taken, and will continue to take to enhance the diversity of the executive pipeline, with agreed targets. This narrative should include how accurately the board mirrors the diversity of both the workforce and the customer base.
The detailed narrative of board diversity in annual reports should be a working document throughout the year, informing the board, the nomination committee, middle and senior managers, and the workforce and other stakeholders, about the seriousness that companies are taking diversity and succession issues.
Companies should recruit non-executive and executive directors from the widest possible net of suitable candidates, which should include recruiting internally. The report encourages more companies to appoint workers on boards but it is not recommended that this is made a mandatory requirement.
The FRC should oversee the rigour of the evaluation process to ensure that it is genuinely independent, thorough and consistent across companies. Best and worst practice among nomination committees should be highlighted by the FRC.