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Making governance great again

23 Feb 2018
Smiling business leaders around a boardroom table

You will no doubt have noticed a great deal of change afoot in the world of corporate governance. Barely a week has passed without the government announcing reforms, directors being hauled in front of MPs, or a company unexpectedly imploding. Governance is truly experiencing a renaissance in the minds of regulators, practitioners, and politicians.

Two major changes to UK corporate governance are looming: the reform of the UK Corporate Governance Code and the creation of a set of voluntary principles for large unlisted companies. While both are in early stages, we thought it might be useful to update you on the progress to date.

UK Corporate Governance Code – changes

The UK Corporate Governance Code (the Code) is the primary governance document for UK companies and while it is only formally applied to companies with a Premium Listing of equity shares, in practice it provides a benchmark for many more companies across the UK and around the world.

Following a push from Government in their green paper on corporate governance, the FRC opened the Code up to consultation late last year. The new UK Corporate Governance Code which has come out of this is due to be published in September and will apply to companies from the start of the 2019 financial year. It will be published alongside a revised Guidance on Board Effectiveness, which is essentially the ‘how to’ guide that accompanies the Code.

After several previous revisions where additions were tacked onto the existing document, the FRC has rightly concluded the time was right for a comprehensive redraft. The resulting Code is noticeable shorter and sharper in nature.

The central mechanism of ‘comply or explain’ remains and its longevity is testament to the unique flexibility this approach affords companies. Greater emphasis is now placed on the Principles of the Code alongside the Provisions. You will remember that the Code’s Principles are the overarching conceptual assertions, while the Provisions are the more practical compliance points. By shifting the emphasis over to the Principles it is hoped that Boards and Directors will begin to use the Code to critically inform their own governance decisions. Put simply this could lead to more boards following the spirit of the code as well as just the letter.

An interesting change in the wording of the Code is that in the very first Principle it states that: 

‘A successful company is led by an effective and entrepreneurial board, whose function is to promote the long-term sustainable success of the company, generate value for shareholders and contribute to wider society.’

The final part, tying the company to its contribution to wider society, is a marked intervention into the purpose we believe companies should have and the move very much reflects the current climate. How well this is received by companies and the degree to which it is heeded is likely to be dictated by the existing culture of the individual company.

The next sentence of the Code develops the role of the board and includes the welcome assertion that the ‘board should establish the company’s purpose, strategy and values, and satisfy itself that these and its culture are aligned.’ The IoD has long believed this should be the case and we are glad to see it crystallised in the new Code.

Other, less abstract changes include a push for greater employee representation on boards. While pulling back from the Prime Minister’s original pledge to put workers on boards, the Code does explicitly state that companies should ‘establish a method for gathering the views of the workforce. This would normally be a director appointed from the workforce, a formal workforce advisory panel or a designated non-executive director.’ This rather significant change is relatively welcome, though arguably it is an admission that company law, namely Section 172 of the Companies Act, is failing. 172, in case you are in need of a refresher (the IoD’s Role of the Company Director course ought to fix that), outlines a director’s duties, which include having a mind for employees. It remains to be seen what effect this change will have to plc Boards but one imagines some teething problems, namely around the induction and training of any employee director. 

Another significant change is the provision to impel companies who receive more that 20% votes against a resolution from their shareholders to explain what actions it intends to take to consult shareholders in order to understand the reasons behind the result. The 20% figure fits in with a separate initiative (not in the Code) where the Investment Association has started to publish a list of companies who received a 20% or higher vote against a resolution. Both of these reflect a growing sense that while most resolutions pass, an increasing number are receiving significant opposition from shareholders. While few reach the 50% + 1 share needed to block a resolution, there is a sense that large minority opposition should act as an indicator to boards that there are concerns.

On the independence of the non-executive and the chair, the Code goes further than before. A fundamental underpinning our corporate governance framework is the role of the independent non-executive. Boards and directors need to be exposed to challenge, fresh thinking, and expertise from individuals without links to the company. The Code now calls for the majority of the board to be made up of non-executives, including the chair, and goes on to list the criteria by which independence should be judged on. Another first is the proposal for Chairs to be expected to step down from their role after nine years on the board which will include time spent in previous non-executive director roles. The impact this could have was highlighted in the Financial Times who estimate that the change would catch out the chairs of 67 companies, with 19 in the FTSE 100 index. 

Some other changes put forward are of concern to the IoD, namely the moving of several important Code Principles and Provisions over to the revised Guidance. While the effort from the FRC to make the code shorter and sharper is laudable, the non-statutory nature of the guidance may limit the impact on visibility to boards. We are particularly concerned that the Code’s main current recommendation with respect to the professional development of board members is being moved across to the Guidance. 

It’s all too easy to fall into the sense of being the ‘finished article’ in terms of knowledge and skills. The role of a director is increasing complex and specialised, and is not merely an extension of a senior executive role. Particularly in respect of large and complex listed companies, it requires specific training, mentoring and skills development. 

For these reasons the IoD will be pushing for professional development remaining a prominent feature of the main UK Corporate Governance Code. If anything, its role in good governance should be further emphasised and developed rather than placed in the background.

The remuneration committee has not escaped reform either and here we see its remit significantly expanded. Now, as well as having responsibility for determining the policy for director remuneration and setting remuneration for the board and senior management, it will also oversee remuneration and workforce policies and practices, taking these into account when setting the policy for director remuneration. Worries around this change focus on the additional pressure being put upon the committee at a time when public distaste with executive pay is rising. An attempt to tie executive pay is also present in the new Code and going forward a 5 year vesting period for incentive plans and share awards will be recommended. 

As stated this Code revision represents one of the most significant changes to the corporate governance framework of the UK in several years. It comes at a time when, under the frame of Brexit, the nation is focused on making us as competitive and attractive a place to do business as possible. For those of us who see our corporate governance framework as a competitive advantage and a selling point globally, it is overall a welcome continuation of a trend for incremental improvement. It doesn’t matter if your business doesn’t formally fall under the jurisdiction of the Code; the concepts and processes it outlines are applicable and of benefit to all organisations. Read it here. 

Large unlisted company principles

While large listed companies have long had their governance arrangements scrutinised, the same cannot be said of the UK’s largest unlisted firms. This is changing and the government is planning to introduce secondary legislation to require companies of a certain size to disclose their corporate governance arrangements in their Directors’ Reports and on their website.

While the timeline for this is still unsure the FRC has wasted little time in coordinating a coalition of industry groups and stakeholders to produce a set of voluntary governance principles aimed at these large private companies. Chaired by James Wates, the group includes representative from the CBI, the Investment Association, ICSA and of course the IoD.

To find out more about the IoD's commitment to corporate governance, join the Good Governance debate here.
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