Article:

MPs recommend changes to the Corporate Governance Code

08 May 2017

The Business, Energy and Industrial Strategy (BEIS) Select Committee published its report on corporate governance on 5 April 2017. The report is entirely separate from the Government’s Green Paper on corporate governance reform (see Business Edge December 2016). The key recommendations from this wide-ranging report, which might affect companies that adopt the Financial Reporting Council’s (FRC) UK Corporate Governance Code (the Code), are set out below:

Reporting on directors’ Companies Act s172 duties and wider FRC enforcement powers

The Report does not advocate a change in the law on directors’ duties. Instead, it recommends that the FRC amends the Code to require boards to explain:

  • How they considered non-investor stakeholders’ interests
  • How this was reflected in financial decisions
  • How they pursued the company’s objectives and had regard to the consequences of their decisions for the long term 
  • Any failure to have due regard to stakeholders’ interests.

The report indicates that these disclosures need not necessarily be an annual report disclosure requirement.

The Select Committee recommends that the FRC develops a corporate governance rating system (for FTSE 350 companies) and that it should have additional powers to engage with directors on matters relating to their duties under s172. If this engagement is ‘unsuccessful’, it is recommended that the FRC should report publicly on any failings of the board or of individual directors and also have power to take legal action for breach of s172. Finally, the Report also recommends that the Secretary of State be more active in using existing corporate investigation powers.

Executive pay recommendations

On executive pay, the Select Committee makes several recommendations encouraging a move away from complex pay structures. In particular, it recommends that changes to the Code seek to:

  • Phase out Long Term Incentive Plans (LTIPs) as soon as possible and replace them with pay structures that are based on a salary and long-term equity lock-in periods
  • Ensure that short-term performance-related bonuses are used on a more limited basis and feature genuinely stretching targets.

The report does not recommend a move to an annual binding vote on pay. However, it suggests that the Code should include a requirement for a binding vote on executive pay in the year following a significant vote against in the advisory vote. It also recommends that this requirement is brought into law.

It is suggested that the Code should recommend that there be employee representation on the remuneration committee. The report also suggests that an individual should normally have served for one year as a member of the committee before being appointed chairman and that chairmen should be expected to resign if they fail to achieve backing for their proposals from at least 75% of voting shareholders.

In terms of pay reporting, the report:

  • Supports the introduction of a CEO pay ratio reporting requirement in the Code which would compare CEO pay both with other senior executives and with all UK (but not international) employees
  • Recommends a Code requirement for the disclosure of a company’s ‘people policy’ – their rationale for the employment model used and their overall approach to investing in and rewarding employees at all levels, and including clear reporting on remuneration levels.

Transparency, engagement and the role of advisers
The report recommends that the Code is revised to stipulate that companies include details of how they are engaging with stakeholders in their annual report. It also suggests 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.

Non-executive directors (NEDs)

The report suggests that the Code should set out best practice on professional support for NEDs, provide guidance on how companies should define the roles of NEDs who have particular responsibilities, and how they should hold NEDs to account for their performance. It recommends that NEDs who serve on multiple boards should have to demonstrate ‘more convincingly’ that they can devote sufficient time to each company.

Boardroom composition

The report highlights the importance of ethnic and ‘cognitive’ diversity as well as gender diversity and recommends that this is reflected in the Code. It makes a number of recommendations for enhanced diversity policy and metric disclosures in the annual report together with changes to the FRC guidance that applies to the nominations committee.

Finally, while it encourages companies to include workers on their boards, the report does not say that this should be a requirement. Where employees are appointed to boards, it notes the view that they should be full board members (with all relevant rights and duties) rather than just workforce representatives.

Next steps

The Select Committee’s recommendations will not be adopted directly in the Code but they will feed into the Government’s reform process and are likely to feed into the FRC’s thinking during the fundamental review of the Code announced in February 2017. It seems certain that significant changes to corporate governance requirements will result from this process.

Read the Select Committee report.

For help and advice on Corporate Governance issues please contact Gary Harding

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