Raising the Stakes on Stakeholder Engagement
Peter Reilly, Director, Corporate Governance, F T I Consulting writes:
The proposed revisions to the UK Corporate Governance Code (“the Code”) effective January 2019 will, for the first time, extend its focus to explicitly include direct interaction with stakeholders – other than shareholders – as being central to the long-term prospects of a business. Given public opinion on appointing workers to Boards and a general erosion of corporate trust, these revisions are not surprising. Notably, this is not the first time companies have been asked to engage with other stakeholders when shaping their governance and remuneration frameworks.
Consulting on Remuneration
The Business Enterprise and Regulatory Reform Act (2013) and the Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013, set out requirements for voting on – and reporting – executive pay. These included the introduction of a binding vote on companies’ remuneration policies. Despite increased shareholder engagement, and more extensive reporting, certain requirements have been less successful in changing approaches to remuneration and associated reporting. Section 38 of the regulations provides that companies should include:
“a statement of how pay and employment conditions of employees (other than directors) of the company…were taken into account when setting the policy for directors’ remuneration.
The statement must also set out –
(a) whether, and if so, how, the company consulted with employees when drawing up the directors’ remuneration policy set out in this part of the report.”
A small number of companies extended reporting to include details of interactions with employees when setting remuneration policies for Executive Directors; however, the vast majority indicated that they had not done so. Instead, these companies included language indicating that, while employee views are important, they are not so important as to merit being consulted on pay practices.
Shareholders, as owners, are arguably ‘more entitled’ to provide input into the shape and structure of remuneration frameworks, however, against the backdrop of a number of high profile corporate governance failings, from 2019, companies will be required to engage with employees on a far larger scale (or explain why they have chosen not to).
Employee Engagement for 2019
As part of the revised Code, Provision 3 will extend the remit of the Board to “establish a method for gathering the views of the workforce”; implement “a means for the workforce to raise concerns in confidence and (if they wish) anonymously”; and, “ensure that arrangements are in place for the proportionate and independent investigation of such matters and for follow-up action.”
For the majority of companies, value creation stems from financial performance; financial performance stems from revenue; revenue is driven by products/services; products/services are driven by ideas, innovation and technology; and, ideas, innovation and technology are driven by people – all of which should be overseen by a committed, skilled and diverse Board. Through the extension of reporting requirements under the Code to include a focus on a wider set of stakeholders than shareholders, Boards will be forced to develop a broader understanding of what makes their organisations ‘tick’ from the bottom up, beyond the scope of financial performance and strategy.
Benefits of Employee Engagement
From 2019, the Code will extend Board responsibilities to include another key aspect of enhancing and protecting value – their workforce. Simultaneously, investors are also beginning to highlight the benefits of an engaged workforce. In January 2018, in his annual letter to CEOs of listed companies, Larry Fink, Chairman and CEO of the world’s largest asset manager, Blackrock, extolled the virtues of investing in employee development as a central part of a company’s ability to create and protect value. Employees manage thousands of processes and control the vast majority of companies’ business relationships. Their views can be hugely informative to a Board in terms of operational effectiveness and strategy development; and, their commitment to a company can uncover business risks at an early stage.
Engaged employees are those fully invested in their firm and their work. They are the ones who actively think about the firm’s processes – and identify improvements. They’re enthusiasm reflects a corporate culture that encourages engagement. Most importantly, they are productive. Conversely, disengaged workers can be an insidious negative drag on productivity and value creation, but are also a risk which can permeate throughout the organisation. Ensuring employees’ voices are heard – and demonstrating that to shareholders and the market – is a competitive advantage for companies and enriches the broader economy.
The Importance of Reporting
Since the first version of the Code, the responsibilities of the Board have included “reporting to shareholders on their stewardship.” Failure to do so adequately in recent years has played a role in legislators and regulators proposed revisions to the corporate governance regime. Under the revised Code, Provision 4 will state:
“The board should explain in the annual report how it has engaged with the workforce and other stakeholders, and how their interests and the matters set out in section 172 of the Companies Act 2006 influenced the board’s decision-making.”
A new Provision (41) will also extend the responsibility of the Remuneration Committee, which must now provide:
“an explanation of the company’s approach to investing in, developing and rewarding the workforce, and what engagement with the workforce has taken place to explain how executive remuneration aligns with wider company policy.”
By taking steps to truly meet regulatory expectations and – as importantly – report objectively against those expectations, companies will gain the trust of their shareholders, employees and wider stakeholders. For Boards and company secretaries, the value of strong reporting as AGMs approach is clear; however, the Annual Report should not be drafted solely with shareholders in mind. The Annual Report should be recognised as a document that will be reviewed by all stakeholders, with its content reflective of its broader audience.
Strong corporate governance and reporting are a touchstone of confidence in business; and, trust in Boards and management from all stakeholders. As employees, it may be demotivating to learn that, after consulting with shareholders (and not consulting employees), C-suite salaries were increased to reward performance and promote retention. Productivity, firm performance and shareholder returns may be the eventual victims.
Prior to the revised Code’s formalisation, companies would be best served dedicating time and resources to ensure there are appropriate channels and forums to interact with employees and wider stakeholders; and, demonstrate a willingness to report on those activities in their Annual Report. Boards should view this as an opportunity to develop a more fundamental understanding of a company’s most important asset – its people. For all stakeholders – Boards, Directors, Shareholders, Employees, Pensioners and Communities – the focus should be a welcome one.
As proposed, the revised Code’s provisions will continue to allow Boards and companies latitude in electing how best to channel feedback and engage their workforce. There is growing recognition – from investors and regulators – that employee interests must be considered as part of ensuring strong corporate governance and promoting long-term value creation. An opportunity to tackle this issue has been missed before. Without engagement by Boards to ensure that meaningful employee engagement takes place, and is reported on, further – more stringent – regulation may well follow.