News July 2018 Blog: A Code fit for the future

Blog: A Code fit for the future

16 July 2018
Paul George, Executive Director of Corporate Governance and Reporting, Financial Reporting Council
 
It has been a tumultuous time for UK corporate governance, with Prime Ministerial statements, select committee inquiries, public consultations, a government green paper and a fundamental review of the UK Corporate Governance Code. Despite the spotlight, corporate governance in the UK remains the international gold standard, yet there are opportunities to raise standards further and restore trust.
 
Decline in public trust in business has been fueled in part by high-profile business failures such as BHS and Carillion, excessive executive pay packages, accusations of multinational firms avoiding paying their fair share of tax, stagnant real wage growth, and an increase in what are perceived to be insecure or even exploitative employment contracts.
 
Today’s publication of a new shorter, sharper UK Corporate Governance Code raises the bar for UK businesses – and they need to make sure they are up to the challenge.
 
So, what’s new?
 
The UK’s corporate governance framework is based on a system of shareholder primacy, but public opinion has shifted to focus on boards’ responsibilities towards other stakeholders including their workforce, their suppliers, and the broader community in which they operate. This is encapsulated in section 172 of the Companies Act 2006 but directors’ explanations of how they have complied with it have often been insufficient.
 
So as part of a broader reform package, the Government is introducing secondary legislation to require all companies of a significant size (private as well as public) to explain how their directors comply with the requirements of section 172. The new Code asks companies to explain how they have done this, consistent with the FRC’s guidance on the Strategic Report.  In the case of staff there is a new provision to enable greater board engagement with the views of the workforce.
 
To address public concern over executive remuneration, the new Code emphasises that remuneration committees should take into account workforce remuneration policies and practices when setting director remuneration, and, importantly, to step back from formulaic calculations of performance-related pay awards and apply discretion when the resulting outcome is not justified.  Inevitably Remuneration Committees will need to earn the trust of shareholders with downward discretion before proposing upward discretion.
 
The new Code strengthens the role of the Nomination Committee on succession planning and on establishing a diverse Board.  Board Effectiveness reviews are fundamental to effective governance, and the requirements, particularly for independently facilitated reviews, have been strengthened.
 
Shareholders play a vital role in holding businesses to account but this is only effective if companies regularly engage with shareholders and provide accurate and timely information to them.
 
To bolster this engagement, the new Code states that companies should explain the actions they intend to take to consult shareholders when more than 20% of votes have been cast against a resolution. They should also publish an update no later than six months after such a vote, and a final summary should be included in the annual report detailing the impact that shareholder feedback has had and any actions it has subsequently taken. Combined with the Investment Association’s Public Register which lists significant shareholder opposition to votes, this should facilitate greater dialogue, transparency and understanding between shareholders and the companies they invest in.
 
The new Code retains its ‘comply or explain’ approach, which enables the UK’s diverse range of listed businesses to engage meaningfully with it, while allowing a company’s specific circumstances to be taken into account. A renewed emphasis on the Principles of the Code and how they have been applied will also encourage more meaningful board engagement and shifts the trend from a tick box approach to governance.
 
A high-quality corporate governance framework cannot eradicate the possibility of business failure, but it is essential to steering good decision taking, to shaping the appropriate culture that enables business to thrive, and to maintaining public and investor confidence in the integrity of business.
 
Business continues to be a force for good in society. The new Code is designed to reinforce this and help businesses demonstrate their value to – and consider their impact on, their employees and wider society.
 
The new Code has set a higher standard for UK corporate governance that businesses must now step up to meet. Not only must leaders engage with the letter of the new Code, but to begin restoring public trust they must also engage with its spirit if the UK is to continue setting a benchmark for high-quality corporate governance internationally.
 

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