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Essential Corporate News – Week ending January 13, 2016

Publication January 13, 2016


Welcome to Essential Corporate News, our weekly news service covering the latest developments in the UK corporate world.

Takeover Panel: Panel Statement 2017/1 – Messrs Morton and Garner: Hearings Committee imposes cold-shouldering

On January 10, 2017 the Takeover Panel published a Panel Statement in which it announced that the Hearings Committee has decided to cold-shoulder Bob Morton and John Garner for breaching section 9(a) of the Introduction to The City Code on Takeovers and Mergers (the Code). Section 9(a) provides that the Takeover Panel expects any person dealing with it to do so in an open and co-operative way and it requires, among other things, persons dealing with the Takeover Panel to disclose to the Takeover Panel any information known to them and relevant to the matter the Takeover Panel is considering. Reasonable care should be taken to ensure that information disclosed  is not incorrect, incomplete or misleading. The Hearings Committee concluded that Mr Morton and Mr Garner systematically provided false information to the Takeover Panel in the course of an investigation by the Panel Executive into a potential breach by Mr Morton of an obligation to make a Rule 9 offer for the remaining shares in Hubco Investments Limited not owned by him.

Cold-shouldering an offender is the most serious disciplinary power exercisable by the Takeover Panel and it involves declaring that the offender is a person who, in the opinion of the Takeover Panel, is not likely to comply with the Code. While the sanction remains effective, members of the Financial Conduct Authority (FCA) and other professional bodies are obliged in certain circumstances not to act for the person in question in a transaction subject to the Code. Cold-shouldering has only been used twice before by the Takeover Panel.

Despite pleas in mitigation from Mr Morton and Mr Garner, the Hearings Committee concluded that Mr Morton should be cold-shouldered for six years and that Mr Garner should be cold-shouldered for two years. Mr Morton had argued that the six year duration of the cold-shouldering was too long but, in the circumstances, the Hearings Committee felt that Mr Morton is someone who is not likely to comply with the Code and so a six year period was appropriate. However, the Hearings Committee did reduce the period for which Mr Garner should be cold-shouldered from the four years submitted by the Panel Executive to two years.

The cold-shouldering became effective from the date of the ruling, namely December 21, 2016.

Following publication of the Panel Statement, the FCA published a statement in which it draws the attention of regulated firms to MAR 4.3 in its Market Conduct sourcebook (Support of the Takeover Panel’s functions), which relates to ‘cold–shouldering’. The FCA  reminds all regulated firms that they should not deal with the two individuals identified in the Panel Statement, or their principals, on any transactions to which the Takeover Code applies. The FCA also expects regulated firms to inform all approved persons at their firms that they should not deal with these individuals on such transactions.

(Takeover Panel, Panel Statement – 2017/1, 10.01.17)

FRC: Developments in corporate governance and stewardship 2016

On January 11, 2017 the Financial Reporting Council (FRC) published its annual report, “Developments in Corporate Governance and Stewardship 2016”, together with an accompanying press release. The purpose of the report is to give an assessment of corporate governance and stewardship in the UK; to report on the quality of compliance with, and reporting against, the UK Corporate Governance Code and the Stewardship Code; to provide findings on the quality of engagement between companies and shareholders; and to indicate to the market where the FRC  would like to see changes in corporate governance behaviour or reporting.

UK Corporate Governance Code

In respect of the UK Corporate Governance Code (Code), the FRC highlights the following:

  • Overall compliance rates – The number of FTSE 350 companies reporting full compliance with all provisions has increased from 57 per cent to 62 per cent, with 90 per cent reporting full compliance with all but one or two of the Code’s provisions.
  • Explanations – The FRC notes that overall too many explanations for non-compliance are of poor quality. Better practice explanations include company-specific context and historical background, and information on what mitigating actions have been taken to address any additional risk. The FRC comments that it is important the company explains how its alternative approach is consistent with the Code provision it is deviating from and whether it is time limited.
  • Frequent non-compliance – The Code provision most often not complied with is for at least half the board, excluding the chairman, to be independent non-executive directors – 26 FTSE 350 companies in 2016, compared to 42 in 2015, did not comply with this provision.
  • Clawback and malus provisions – The majority of FTSE 350 companies have taken forward the 2014 Code recommendation for companies to put in place arrangements to enable them to recover or withhold variable pay. 91 per cent have now implemented a clawback provision on the annual bonus and 78 per cent on long-term plans.
  • Viability statements – Amendments to the Code in 2014 introduced reporting of a longer-term view of a company’s prospects in the form of a viability statement. There is little variation in time horizon between the different business sectors, with two thirds of the sample reviewed choosing three years and the remainder mainly electing five years. The FRC finds the lack of variation between sectors surprising and encourages companies to provide clearer disclosure of why the period of assessment selected is appropriate for the particular circumstances of the company. In addition, the FRC notes that there is room for improvement in explaining what qualifications and assumptions have been made and the quality of reporting of the principal risk linkages.

UK Stewardship Code

In respect of the Stewardship Code, the FRC highlights the following:

  • The tiering exercise – The tiering exercise involved consideration of all signatory statements to identify best practice reporting against the Stewardship Code. Initial assessments of statements, sent to signatories in early 2016, indicated whether the FRC considered the signatory to be in Tier 1 or Tier 2 on the basis of their reporting. Many signatories improved their statements in response to this exercise and following feedback from market participants, the FRC decided to introduce a third tier for asset managers. The third tier reflects the greater relevance of the Stewardship Code’s provisions to asset managers, their role as agents and the wide range of quality in the statements in the initial Tier 2.
  • Engagement in the 2016 annual general meeting season – The FRC continues to hear from both companies and investors that there is too much focus on remuneration at meetings and while remuneration is inextricably linked to issues such as performance and strategy, both company and investor representatives feel that it can overshadow these important topics. Additionally, some investors have displayed a growing appetite for more disclosure on a broader range of risks, including climate-related matters where these are relevant to the company. 
  • Compliance with other stewardship codes – After the introduction of stewardship codes in a number of international markets, the FRC states that if signatories meet the reporting requirements of the UK Stewardship Code, the FRC is comfortable for their statements also to address the requirements of other codes and will publish a matrix of the differences between the UK and international codes.

Future developments

The FRC notes that during 2016 there were two major consultations about corporate governance in the UK, specifically the Department for Business, Energy and Industrial Strategy (BEIS) Select Committee’s inquiry and the Government’s Corporate Governance Reform Green Paper. In response to the issues raised by the BEIS inquiry, the FRC suggested that additional powers may be necessary in order to demonstrate the alignment of business, investor and public interests, including:

  • monitoring governance information in annual reports; 
  • requiring governance reporting by large private companies; 
  • improving reporting by companies about the elements of section 172 of the Companies Act 2006; and 
  • taking action against directors who are not members of the professional bodies that the FRC oversees.

The FRC also recommends a wider remit for the remuneration committee and shareholder consultation where there is a significant vote against an AGM resolution.

The FRC will consider how to encourage further improvements in reporting and possible revisions to the Stewardship Code in 2018. It also plans to consult on revisions to the Code, the FRC’s Guidance on Board Effectiveness and the FRC’s Guidance on the Strategic Report, taking account of the FRC’s work on culture and succession planning, the EU Non-Financial Reporting Directive and wider corporate governance changes in light of the Government’s Green Paper. In addition, it is considering guidance for nomination committees as part of wider consultation in light of responses to its October 2015 discussion paper on succession planning.

(FRC, Developments in Corporate Governance and Stewardship 2016, 11.01.17)

Glass Lewis: 2017 Proxy Paper Guidelines – UK

On January 3, 2017 Glass Lewis published an update to its UK corporate governance policy guidelines, which incorporate recommendations of the UK Corporate Governance Code, requirements of the Companies Act 2006 and the UK Listing Authority, as well as global corporate governance best practices.

Updates from the 2016 Guidelines include:

  • Authority to set general meeting notice period at 14 days – Glass Lewis has revised its  policy with respect to companies’ request for authority to call general meetings (other than AGMs) on 14 days notice to generally support such requests. This change has been made in light of constructive engagement with a significant number of UK companies, a multi-year review of market practice, general shareholder support for such authorities and absence of misuse of the authority. Therefore, from 2017, Glass Lewis will generally support such authorities when, as is best practice in the UK, companies provide assurances that such authority would only be used when merited by exceptional circumstances.
  • Remuneration – The Guidelines have been updated to reflect current best practice as advocated by the  Investment Association’s Principles of Remuneration, specifically to highlight the role of remuneration committees in selecting “a remuneration structure which is appropriate for the specific business, and efficient and cost-effective in delivering its longer-term strategy.”
  • Related party transactions – Glass Lewis’ policy on recommending a vote against directors who face a potential conflict of interest from a related party transaction with the company has been clarified. Generally, Glass Lewis will refrain from recommending a vote against directors with a material business relationship with a company that falls under the normal course of business conducted on reasonable terms for shareholders. Rather, such relationships will be considered in Glass Lewis’ assessment of the independence of the board and key committees. Glass Lewis generally recommends voting against directors with a material professional services relationship with a company, such as consulting or legal services, on that basis alone.
  • Director tenure – The policy on evaluating the independence of directors based on board tenure has been updated. Glass Lewis will generally refrain from recommending a vote against any directors on the basis of tenure alone. However, it may recommend voting against certain long-tenured directors when lack of board refreshment may have contributed to poor financial performance, lax risk oversight, misaligned remuneration practices, lack of shareholder responsiveness, diminution of shareholder rights or other concerns. In conducting such analysis, Glass Lewis will consider lengthy average board tenure over nine years, evidence of planned or recent board refreshment, and other concerns with the board’s independence or structure.

(Glass Lewis, UK Policy Guidelines 2017, 03.01.17)

ICSA: Project launched to help boards take account of employee and other stakeholder views

On January 13, 2017 the Institute of Chartered Secretaries & Administrators (ICSA) published a press release announcing the launch of a joint project with the Investment Association (the IA) intended to ensure that UK PLC boards understand the views of their employees and other stakeholders which should then be factored into their decision making.

ICSA and the IA will identify existing best practice and produce practical guidance to enhance understanding of the interests of employees and other stakeholders, in accordance with board duties under section 172 Companies Act 2006.

The guidance will identify different approaches to stakeholder engagement for companies to consider, summarising the issues to be addressed and the practical steps to be taken. These will include the different approaches identified in the Government’s November 2016 Green Paper on corporate governance reform. Specifically, the guidance will set out:

  • the ways in which companies can identify non-executive directors with relevant stakeholder experience;
  • the processes by which boards can receive the views of their key stakeholders;
  • how training and induction can be used to enhance directors’ understanding of their duties and the interests of, and impact on, different stakeholders; and
  • a set of options for companies to appropriately report how they have fulfilled their duties in this area.

The guidance will be published in the second quarter of 2017.

(ICSA, Investors and companies unite to help boards take account of employee and other stakeholder views, 13.01.17)

CFA: Analysis of CEO pay arrangements and value creation in FTSE 350 companies

In December 2016 the CFA Society of the UK (CFA) published a study carried out by Steven Young and Weijia Li of the Lancaster University Management School examining chief executive officer (CEO) pay structures and their alignment with corporate value creation for FTSE 350 companies between 2003 and 2014/15.

Specifically, the study analyses:

  • the performance metrics FTSE 350 companies use as the basis for determining CEO pay;
  • how commonly used performance metrics such as earnings per share (EPS) and total shareholder return (TSR) correlate with established measures of long-term value creation to all capital providers; and 
  • the strength of the association between realized CEO pay and company performance, where performance is measured using both traditional metrics and established measures of long-term value creation.

The major findings of the study include:

  • The total annual realised pay for the median FTSE 350 CEO during the sample period is £1.5 million measured at 2014 prices. Total pay for the median CEO has increased by 82 per cent in real terms over the period, with an otherwise linear trend halted only by the financial crisis in 2008-2009 when pay levels slipped back to 2006 levels.
  • The level of value creation over the period analysed has been low in absolute terms and erratic from year to year. The median FTSE 350 company generated little in the way of a meaningful economic profit over the period 2003-2009 and although performance improved from 2010 onwards, the median firm generated less than 1 per cent economic return on invested capital per year. The compound growth in annual mean return on invested capital benchmarked against the cost of capital over the 12 year sample period is less than 8.5 per cent.
  • Simplistic metrics of short-term performance such as EPS growth and TSR are the dominant means of measuring performance in CEO remuneration contracts. These metrics correlate poorly with theoretically more robust measures of value creation that relate performance to the cost of capital. For example, the association between ROIC – WACC and both EPS growth and TSR is essentially flat when measured over 3 year rolling performance windows.
  • Pay is correlated with value generation at a primitive level. CEOs generating positive economic profits receive 30 per cent higher median total pay than their counterparts generating negative economic profits. Additionally, pay outcomes distinguish between value creation realized in share prices and value creation that remains unrealized.
  • Despite relentless pressure from regulators and governance reformers over the last two decades to ensure closer alignment between executive pay and performance, evidence of more granular distinction between pay outcomes and fundamental value creation remains negligible.
  • Firm size, industry, and previous year remuneration remain the primary drivers of CEO remuneration in the UK. These dimensions may correlate with aspects of value-generation, but at best they represent imperfect tools for assessing long-term corporate success. Structural concerns over pay arrangements therefore persist.

The two key themes emerging from the study are:

  • the critical nature of performance measure choice in the debate over CEO pay arrangements; and 
  • the need for future recommendations on pay to focus more attention on linking incentives and rewards more directly to performance metrics that reflect long-term value creation for capital providers.

(CFA Society United Kingdom, An Analysis of CEO Pay Arrangements and Value Creation for FTSE-350 Companies, 02.12.16)

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