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BEIS Select Committee publishes its report on corporate governance

  • Corporate Governance  Image

06 Apr 2017

The Business, Energy and Industrial Strategy (BEIS) Select Committee has published its report following its inquiry and consultation on corporate governance launched in September 2016, recommending that action must be taken to address a lack of trust in business. Whilst the findings of the Select Committee are not binding on the Government, the proposals laid out in this report may be taken into consideration in any subsequent White Paper on Corporate Governance Reform.

The Report highlights the strong reputation of the UK as a place to do business, backed up by the “considerable asset” of the UK Corporate Governance Code ("the Code") and the fundamental principle of “comply or explain”. It adds, “We do not believe that there is a case for a radical overhaul of corporate governance in the UK.”

However, the Committee does see benefit in further embedding good corporate governance in all companies, including private companies, supported by investors, regulators and Government. In order to achieve this and find a way to enforce better compliance, the Report recommends far-reaching reforms to the FRC and the Code, in addition to certain legislative changes and a new corporate governance code for large private companies.

The key recommendations are:

Stakeholder engagement by companies

It was widely anticipated that the Report would comment on the importance of s172 of the Companies Act 2006, which focuses on long term thinking and consideration of wider stakeholders by company directors. Without proposing legislative change, the Report recommends that the FRC should amend the Code to require more transparent narrative reporting regarding stakeholders, with any identified failures to apply s172 reported on and explained.

Stakeholder advisory panels are also encouraged for all companies as a way of providing valuable feedback from stakeholders to boards.

In order to hold company directors to account, the Report recommends that the FRC should be given additional powers to address failings in directors’ duties. These powers would include “name and shame” public reporting on such failings and, ultimately, the authority to initiate legal action for continued breach of duties under s172.

Non-executive directors

The Report emphasises the importance of the role of non-executive directors in holding companies and executive directors to account. 

The Report calls on the FRC to revise the Code to include best practice guidance on additional professional support for non-executive directors, such as advice, training and continuing professional development. It draws out the importance of continued training of board members, which should take account of the responsibilities of individual non-executive directors, and of focusing on the importance of director evaluation. 

When a non-executive director plans to serve on more than one board, they should be asked to demonstrate convincingly to their companies that they have the time to fulfil their responsibilities to each board. 

Diversity

The Report is positive about current initiatives, including the Hampton Alexander Review and the McGregor Smith Review. It encourages the FRC to address these in the revision of the Code and to embed ethnic diversity in the revised Code with as much prominence as gender diversity. 

The Report argues for stricter targets for the Hampton Alexander Review, suggesting that from May 2020 at least half of all new appointments to senior and executive management level positions throughout listed companies should be women. 

The Committee recommends that Government should legislate for disclosure of workforce data broken down by ethnicity and pay band, in the spirit of the McGregor Smith review published recently. 

Corporate reporting 

In addition to reporting on s172, described above, the Report calls on the FRC to be active in working against “boilerplate” corporate reporting and to revise the Code to: 

  • require a section in annual reports on engagement with investors;
  • require disclosure of training of board members;
  • require companies to identify any specific responsibilities held by particular non-executive directors and how they should be held to account for their performance;
  • require all listed companies from May 2020 to explain in annual reports if strict diversity targets are not achieved, to report on gender diversity of the executive committee in line with the Hampton Alexander Review, and to explain how they plan to rectify gender composition of the executive committee;
  • require a public explanation of why board members are appointed to the board and a detailed narrative about actions taken to promote diversity and how seriously it is taken by the board;
  • require the use of open advertising and / or use of an external search consultancy for appointments to the board with detailed disclosure if these methods are not used; and
  • require companies to set out clearly their people policy, including approach to investing in and rewarding employees and clear reporting on remuneration levels. 

In addition, the Report recommends that the Institute of Directors’ Good Governance Index should be adopted and adapted by the FRC to provide FTSE 350 companies with a new annual rating of their governance arrangements on a “traffic light” system, which should then be reported in their annual reports. 

Some of the evidence heard by the Select Committee highlighted large fees paid to advisors on transactions and lack of transparency regarding the basis for those fees, and how and by whom advisors were engaged. The Report calls on government to consult on new requirements for listed and large private companies to disclose engagement with advisors on certain transactions that exceed a threshold to be determined. 

Recommendations for investors and the Stewardship Code 

The Report calls on the FRC to review and improve the Stewardship Code. The new Stewardship Code should encourage high quality engagement between investors and companies, include more detail on requirements and undertake to flag poor performance annually. 

The Report also proposes that the Stewardship Code should require disclosure of voting records by asset managers to continue to promote active engagement, and that those who do not vote should be named. 

It also calls upon the Investor Association’s Investor Forum to seek to be a more “pro-active facilitator of dialogue between boards and investors.” 

Executive pay 

The Report indicates that high and unwarranted executive pay is an issue that needs to be addressed for the benefit of society as a whole, however ‘the current scale of opposition to remuneration reports and policies’ does not justify annual binding votes on pay levels. 

The Report includes the following recommendations on pay:

  • Companies should make it their policy to align bonuses with broader corporate responsibilities and company objectives and take steps to ensure that they are genuinely stretching.
  • Following consultation with stakeholders, the FRC should amend the Code to establish deferred stock rather than LTIPs as a best practice in terms of incentivising long-term decision making.
  • LTIPs should be phased out as soon as possible. No new LTIPs should be agreed from the start of 2018 and existing agreements should not be renewed.
  • The FRC should revise the Code to include a requirement for a binding vote on executive pay awards the following year in the event of there being a vote against of more than 25%. This requirement should be included in legislation at the next opportunity.
  • Any Chair of a Remuneration Committee should normally have served on the committee for at least one year previously. To further incentivise strong engagement, the Chair of a Remuneration Committee should be expected to resign if their proposals do not receive the backing of 75% of voting shareholders.
  • The FRC should amend the Code to require the publication of pay ratios between the CEO and both senior executives and all UK employees. 

It also believes that employee representation on remuneration committees would represent a powerful signal on company culture and commitment to fair pay and that this should be included in the Code. The Report adds that it expects leading companies to adopt this approach. This would only be possible where an employee is a full board member, as recommended elsewhere in the Report. 

Private companies 

A newer area of focus on which the Report issues recommendations for potential reform is private company corporate governance. The Report recommends that the FRC works together with the Institute of Directors and with the Institute for Family Business to develop a new Code for the largest privately held companies, to be followed on a comply or explain basis. This Code should broadly mirror the proposed amendments to the Code for listed companies in terms of reporting on duties under s172. The Report suggests that the initial threshold for private companies could be those with over 2,000 employees. 

The challenge with private companies is to determine a method to oversee compliance, and the Report proposes establishing a new body to oversee the Code and report on compliance, with a complaints mechanism to raise concerns with the companies concerned. The body would be funded by a levy on companies subject to the scheme. 

The Report contemplates a mandatory regulatory regime if standards remain low or there is a significant level of non-compliance in a three year timeframe. 

Board composition 

In addition to diversity, the Report supports the inclusion of workers on boards in the form of an employee being appointed as a director in their own right with full responsibilities. It cites NHS Foundation Trusts, John Lewis and First Group as boards where this is the norm and encourages companies to consider this as something that should become the norm. The Report does not recommend a compulsory requirement but believes the insight and challenge brought by worker directors would benefit many boards. 

Board evaluation 

Finally, the Report proposes that the FRC should be given new powers to oversee the three-yearly external board evaluation process to ensure it is “genuinely independent, thorough and consistent across companies.” 

Select Committees do not form part of Government but scrutinise the work of Government departments and therefore their recommendations may not be followed through unless Government agrees. 

The Government is expected to respond to the Select Committee report within two months and the Financial Reporting Council (FRC) has indicated (link to FRC website) it will be consulting on changes to the UK Corporate Governance Code in the autumn. 

The press release and full report of the BEIS Select Committee are available on the BEIS Select Committee website.

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