While most attention in the corporate governance arena has focused on the recent Government Green Paper (see the article from our December newsletter here), a near-parallel process has been underway in the form of an inquiry into corporate governance by the Business, Energy and Industrial Strategy (BEIS) Committee. In contrast to the Green Paper, which was relatively narrow in its focus, the Committee's report, published on 5 April, looks at corporate governance in the round. The report considers whether the UK corporate governance framework is fit for purpose, whether it provides the right structures to assist businesses in making high quality decisions for the long term (taking the wider interests of society fully into account) and how good behaviour can be embedded in business through cultural change and persuasion.
The Committee recognises the strength of corporate governance in the UK but also notes the erosion of public trust in business and the "dramatic racheting up" of executive pay in recent years. It concludes that, although a radical overhaul of the current framework is not necessary, there is scope for significant improvements and makes a number of recommendations which are discussed below:
Prompting good corporate governance generally
The Committee did not recommend any change to the directors' duties set out in section 172 of the Companies Act 2006 (in part, at least, in recognition that with Brexit a priority there would be insufficient legislative time), but did recommend a number of measures designed to ensure that directors demonstrably take seriously their duties to have regard to other stakeholders and the long-term consequences of decisions. These include:
- the Financial Reporting Council (FRC) should amend the UK Corporate Governance Code (the Code) to require informative narrative reporting on the fulfilment of duties under section 172, including a requirement for boards to explain precisely how they have considered each of the different stakeholder interests and how this has been reflected in financial decisions
- the FRC should be given additional powers to engage and hold to account company directors in respect of the full range of their duties. Where engagement is unsuccessful, this would include reporting publicly to shareholders any failings of the board. Where companies do not respond satisfactorily to engagement with the FRC, it should be given the authority to initiate legal action for breach of section 172 duties.
- an annual rating system should be developed by the FRC, working with business organisations, which would publicise examples of good and bad corporate governance practice by companies. Reference to the rating would be required to be published in a company's annual report. The danger here, of course, is that this simply encourages a "tick box" approach to corporate governance which is very unlikely to produce the improvements which the Committee is seeking.
- a voluntary code of corporate governance should be drawn up for large private companies (those with more than 2,000 employees) with compliance overseen and reported on by a new body. The scheme would be funded by a "small" levy on members. If the voluntary regime fails to raise standards after a three year period, or there are high rates of unacceptable non-compliance, a mandatory regime should be introduced.
- the structure of executive pay should be simplified. Long-term incentive plans should be phased out as soon as possible and the FRC should consult with stakeholders with a view to amending the Code to establish deferred stock rather than LTIPs as best practice in incentivising long-term decision making.
- the Code should be amended to include a requirement for a binding vote on executive pay the following year if there is a 25%+ vote against
- the Chair of the Remuneration Committee should be expected to resign if proposals do not receive the backing of 75% of voting shareholders.
Composition of boards
A number of recommendations are made in relation to board diversity (as to gender, ethnicity and social diversity). These include:
- the Government should set a target that, from May 2020, 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. An explanation for any failure to meet this target should be included in the annual report.
- the Code should be amended so that all references to gender are extended to cover ethnicity as well.
- the Government should legislate to ensure that all FTSE 100 companies publish workforce data broken down by ethnicity and pay band.
The Committee decided not to recommend a compulsory requirement for workers on boards, but suggested it is something which should be encouraged.
The next steps in this process, and how it will fit in with the Government Green Paper, are unclear. The consultation on the Green Paper closed on 17 February but there is no timetable for the Government's response. There is some overlap between the Green Paper and the Committee's report (for example on the question of whether there should be some sort of corporate governance regime for private companies) and it would be surprising if, in these areas, the Government did not take some account of the Committee's views. It does seem unlikely though, given other priorities, that the Government will choose to deal with the wider issues in the Committee's report in the near future.
The Select Committee's Report can be found here.