BEIS: Government response to Green Paper consultation on corporate governance reform
The Department for Business, Energy & Industrial Strategy (BEIS) published the Government’s response to its Green Paper on corporate governance reform (Green Paper) on August 20, 2017. The response document identifies nine proposals for reform which the Government intends to take forward. It also includes a summary of the responses to the Green Paper.
Background to the Green Paper
The Green Paper was published on November 29, 2016 and its purpose was to consider changes that might be appropriate to the UK’s corporate governance regime to help improve business performance and ensure that the economy works for all. The Government consulted on three specific aspects of corporate governance, namely executive pay, strengthening the employee, customer and supplier voice and corporate governance in large privately-held businesses. The nine proposals for reform relate to these aspects of corporate governance.
The Government is to invite the Financial Reporting Council (FRC) to revise the UK’s Corporate Governance Code:
- To be more specific about the steps that premium listed companies should take when they encounter significant shareholder opposition to executive pay policies and awards (and other matters). The FRC will need to consult on the new measures in the UK Corporate Governance Code and the Government notes that the new provisions could include, for example, provisions for companies to respond publicly to dissent within a certain time period, or to verify that dissent has been sufficiently addressed by putting the company’s existing or revised remuneration policy to a shareholder vote at the next annual general meeting. Stakeholders will also be able to comment on whether the new measures should apply to all premium listed companies or only to those in the FTSE 350. The Government notes in the response document that it will monitor the impact of these measures carefully once they are in place and will consider further action at a future point unless there is clear evidence that companies are taking active and effective steps to respond to significant shareholder concerns about executive pay outcomes.
- To give remuneration committees a broader responsibility for overseeing pay and incentives across their company and require them to engage with the wider workforce to explain how executive remuneration aligns with wider company pay policy (using pay ratios to help explain the approach where appropriate). This will involve the FRC consulting on revisions to the UK Corporate Governance Code and its supporting guidance and the Government notes that this consultation will provide an opportunity to seek best practice examples from those remuneration committees that already proactively engage with the wider workforce while enabling current work in this area by a number of prominent think-tanks to be taken into account. The Government also proposes to ask the FRC to include in its consultation a proposed new provision that chairs of remuneration committees should have served for at least 12 months on a remuneration committee, unless there is a clear and valid explanation why this may not be appropriate in a particular case.
- To extend the recommended minimum vesting and post-vesting holding period for executive share awards from three to five years to encourage companies to focus on longer-term outcomes in setting share based remuneration. The Government notes that lengthening the holding period in this way would bring the rules for executive remuneration closer to those introduced in 2015 for the banking sector which lengthened deferral periods for variable pay to seven years.
The Government is to introduce secondary legislation to require quoted companies:
- To report annually the ratio of CEO pay to the average pay of their UK workforce, along with a narrative explaining changes to that ratio from year to year and setting the ratio in the context of pay and conditions across the wider workforce. The Government notes that the new pay ratio reporting requirement should, for reasons of consistency and simplicity, cover UK employees only. However, multinational companies could publish a broader ratio alongside, covering all employees in their group. Currently the Government proposes that the ratio should be calculated based on the CEO’s total annual remuneration relative to the average total remuneration of the company’s UK workforce. This will enable the new reporting requirement to be based in most cases on existing payroll data. Further details will be set out in a draft statutory instrument to be published later in the year.
- To provide a clearer explanation in remuneration policies of a range of potential outcomes from complex, share-based incentive schemes. This proposal reflects the arguments of a number of investors and other respondents that companies’ executive remuneration policies should be required to set out more clearly the potential remuneration outcomes of long-term incentive plans under a range of scenarios, including significant share price growth. The new requirement will build on the existing requirements governing the content of remuneration policies set out in Schedule 8 of the Large and Medium-Sized Companies and Groups (Accounts and Reports) Regulations 2008 (as amended). The Government will also invite the FRC to seek stakeholder views during its consultation on changes to the UK Corporate Governance Code on whether and how new principles or detailed guidance on share-based remuneration could be included there.
The Government intends to invite the Investment Association to maintain a public register of listed companies encountering shareholder opposition to pay awards of 20 per cent or more, along with a record of what these companies say they are doing to address shareholder concerns.
Other issues in relation to executive pay
The Government notes in the response paper that it will commission an examination of the use of share buybacks to ensure that they cannot be used artificially to hit performance targets and inflate executive pay. The review will also consider concerns that share buybacks may be crowding out the allocation of surplus capital to productive investment and the Government will announce more details shortly.
In terms of other options included in the Green Paper in relation to executive pay, the Government will not be taking these forward at the moment. These are as follows:
- The possibility of establishing a Shareholder Committee to oversee executive pay, directors’ nominations and strategy at every quoted company;
- Mandatory disclosure of investor voting records;
- Increasing retail investor voting through industry-led action or legislative change; and
- Adding further regulation to the existing disclosure framework for directors’ bonus targets.
Strengthening the employee, customer and wider stakeholder voice
The Government intends to introduce secondary legislation to require all companies of significant size (private as well as public) to explain how their directors comply with the requirements of section 172 Companies Act 2006 to have regard to employee and other interests. The Government notes that the operation of this new reporting requirement will be subject to further consideration. It envisages that it would include a requirement to explain how the company has identified and sought the views of key stakeholders, why the mechanisms adopted were appropriate and how this information has influenced decision-making in the boardroom. Such disclosures might have to be included on the company’s website as well as in its annual strategic report.
In terms of determining which companies should be subject to the new reporting requirement, the Government’s initial view is that a threshold based on employee numbers would be reasonable and its initial view is that a threshold of 1000 employees should be used. However, this will be subject to further consideration.
The Government will invite the FRC to consult on the development of a new UK Corporate Governance Code principle establishing the importance of strengthening the voice of employees and other non-shareholder interests at board level as an important component of running a sustainable business. As part of this, the Government will ask the FRC to consider and consult on a specific provision requiring premium listed companies to adopt, on a “comply or explain” basis, one of three employee engagement mechanisms:
- A designated non-executive director;
- A formal employee advisory council; or
- A director from the workforce.
The Government notes that many companies already have mechanisms in place to ensure that employee and other stakeholder voices are heard and taken into account in boardroom decision-making but it wants to ensure that good practice is adopted more widely and more consistently, including potentially to larger private companies.
The Government intends to encourage industry-led solutions by asking the Institute of Chartered Secretaries and Administrators (ICSA) and the Investment Association to complete their joint guidance on practical ways in which companies can engage with their employees and other stakeholders. This is something that they are already developing. The Government will also invite the GC100 to complete and publish new advice and guidance on the practical interpretation of directors’ duties in section 172 Companies Act 2006. The Government notes that it has no plans to amend section 172 but it does consider that it would be useful to have more guidance for companies of all sizes on how the “enlightened shareholder value” model enshrined in section 172 should work in practice. It notes the recommendations in relation to employee voice made by Matthew Taylor in his Review of Modern Working Practices published in July 2017 and the Government will consider these and respond to the whole report later in 2017.
Corporate governance in large privately-held businesses
The Government is to invite the FRC to work with the Institute of Directors, the CBI, the Institute for Family Businesses, the British Venture Capital Association and others to develop a voluntary set of corporate governance principles for large private companies under the chairmanship of a business figure with relevant experience. In making application of these principles voluntary, the Government notes that private companies would be able to continue to use other industry-developed codes and guidance if they are considered more appropriate. Companies will also be able to adopt, or to continue to use their own preferred approaches.
Secondary legislation will be introduced to require companies of a significant size to disclose their corporate governance arrangements in their directors’ report and on their website, including whether they follow any formal code. This requirement will apply to all companies of a significant size unless they are subject to an existing corporate governance reporting requirement. The Government will also consider extending a similar requirement to limited liability partnerships of equivalent scale. Further consideration is to be given to the size of company that would be covered by the new reporting requirement, but the Government’s initial view is that it should apply to companies with over 2000 employees. It will apply to privately-owned and public companies but there will be an exemption for premium listed companies required to report against the UK Corporate Governance Code or companies required by the Disclosure Guidance and Transparency Rules to issue a corporate governance statement. The disclosure will include details of any UK Corporate Governance Code or other formal set of corporate governance principles that the company has adopted. Where a company departs from any of the provisions in the adopted code or principles, it should explain which parts these are and the reasons for the departure. If a company has decided not to adopt a formal code or set of principles, it will be required to explain the reasons.
Other issues relating to strengthening the UK’s corporate governance framework
The Government notes that consultation on the Green Paper revealed questions over whether the FRC has the powers, resources and status to undertake its functions effectively. To address this, the Government is to ask the FRC, the Financial Conduct Authority and the Insolvency Service to conclude new, or in some cases revised letters of understanding with each other before the end of 2017 to ensure the most effective use of their existing powers to sanction directors and ensure the integrity of corporate governance reporting. In light of this work, the Government will then consider whether further action is required.
The Government notes that the FRC intends to consult on amendments to the UK Corporate Governance Code in the late Autumn. The Government intends to lay before Parliament draft secondary legislation, where required, before March 2018. The work on developing voluntary corporate governance principles for large private companies will commence in the Autumn.
The current intention is to bring the reforms into effect by June 2018 to apply to company reporting years commencing on or after that date.
The Government notes that many of the recommendations set out in the House of Commons Business, Energy and Industrial Strategy Committee’s report on Corporate Governance published April 2017 are concerned with potential amendments and enhancements to the UK Corporate Governance Code and guidance. While the Government supports many of these recommendations, it notes that they are ultimately matters for the FRC to consider and states that many will be addressed in the consultation on the UK Corporate Governance Code that the FRC intends to undertake in the Autumn.
The Government also notes that the reforms set out in the response document will complement wider work that the Government and others such as Mathew Taylor, Sir Philip Hampton, Sir John Parker and Baroness McGregor-Smith have done and are leading in relation to matters such as increasing gender and ethnic diversity in the boardroom and the workforce.
(BEIS, Government response to Green Paper consultation on corporate governance reform, 20.08.17)