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Corporate governance - more to be done to improve trust in business says FRC

16 January 2017

The FRC has published its annual report looking at compliance with the UK Corporate Governance Code (the Report).

Although the FRC says that compliance with the principles of the UK Corporate Governance Code remains high, it acknowledges the Government’s Corporate Governance Reform Green Paper (see Business Edge December 2016) and states that it may need additional powers in order to demonstrate the alignment of business, investor and public interests. These include:

  • Monitoring governance information in annual reports
  • Requiring governance reporting by large private companies
  • Improving reporting by companies about the elements of section 172 of the Companies Act 2006
  • Taking action against directors who are not members of the professional bodies that the FRC oversees.

The FRC also recommends a wider remit for the remuneration committee and shareholder consultation where there is a significant vote against an AGM resolution.

The FRC plans to consult on revisions to the UK Corporate Governance Code, the Guidance on Board Effectiveness and the Guidance on the Strategic Report. The consultations will take into account the FRC’s work on culture (see Business Edge September 2016) and succession planning, the Non-Financial Reporting Directive and wider corporate governance changes in light of feedback to the Government’s Green Paper.

Viability statements

The Report covers the first full year of reporting under the new 2014 Code provisions which included (Code provision C.2.2)   on viability statements. The FRC analysed 89 FTSE 350 companies across 10 sectors and found a small but promising number of comprehensive viability reports (13 companies). These statements were clear about why the period selected is right for the company. They also detailed the process undertaken, who was involved, how specific principal risks had been stress tested, and information on the range of assumptions that had been considered. The FRC was also encouraged to hear from many chairmen that the preparation of the statement has provided a positive focus for a better discussion of risk in the boardroom.

More generally, the FRC found the lack of variation in time horizons between sectors surprising. For example, there was little difference between mining and retail despite their different business cycles. The FRC encourages investors to engage with companies to discuss what improvements they wish to see in order to stem any criticism of future ‘boilerplate’ reporting. It also notes that the Investment Association’s (IA) published Guidelines on the Viability Statement should help companies with these disclosures by setting out the expectations of institutional investors.

The FRC encourages companies to provide more constructive viability statement reporting in line with the spirit of the Code, including a clear rationale for their choice of timeframe, what qualifications and assumptions were made, how the underlying analysis was performed and improving the quality of reporting of the principal risk linkages. It states that the sections covering business model, strategy, principal risks and the viability statement should align.

The FRC’s Financial Reporting Lab will be launching a project in 2017 to look at best practice reporting in viability statements and disclosures of risk.

Remuneration

The Report notes increased shareholder resistance with lower majorities backing policies and reports resolutions than previously. The Report also notes the need to demonstrate the link between strategy and remuneration and that 2017 is set to bring even more scrutiny with around half the FTSE 350 putting remuneration policies to a shareholder vote.

The Report notes that the IA sent an open letter to all companies in the FTSE 350 setting out new shareholder expectations on executive pay and is also calling upon companies to disclose pay ratios between the CEO and median employee, and the CEO and the executive team.

The IA’s letter also informed companies of the need to improve shareholder consultation on remuneration issues and to ensure that this engagement is based upon how pay is in line with the company’s strategy.

Code compliance

This year the FRC has carried out a detail review of Code Provision A.3.1 (where the chairman is not independent on appointment or they were previously the company’s chief executive) and Code Provision D.1.1 (where provisions allowing for clawback and/or malus should be included in company remuneration arrangements). Overall, where there was non-compliance, too many explanations were of poor quality. Better practice explanations include company-specific context and historical background, and information on what mitigating actions have been taken to address any additional risk. It is important that a company explains how its alternative approach is consistent with the Code provision it is deviating from and whether it is time limited. Ideally, explanations should be sufficiently clear to be convincing and understandable to all shareholders, without the need to contact the company.

Read Developments in Corporate Governance and Stewardship 2016

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