Corporate Governance

What do the corporate governance reform proposals mean?

Simon Lowe Simon Lowe

The government has announced plans for corporate governance reform. How will the proposed changes affect business?

At the end of August, Theresa May announced plans for corporate governance reform1 “to enhance the public’s trust in business”2 by making the UK’s biggest companies more transparent and accountable. The changes received a mixed response3, with many critical that they do not adequately address the issues raised in the initial consultation4. The question remains, will the reforms improve transparency and accountability?

Key proposals

Remuneration – the biggest headline – although still just a reporting requirement – is the pay ratio requirement. Similar to Gender Pay Reporting5, companies will need to publish the pay ratio between the CEO and the average employee. Pay ratio data is a blunt instrument for addressing escalating executive pay and falling real-time wages. The big impact will come from how companies address the issue.

The symbolic value of capping pay at a ratio of average employees, for example6, sends a clear message to stakeholders that boards take pay inequality seriously. Most importantly, this reform puts employee pay on the board agenda as part of, rather than separate to, board remuneration. 

CEO pay has fallen considerably this year across the FTSE 1007.  It appears the intense spotlight placed on remuneration is already starting to have an effect.

Stakeholder and employee engagement - companies will be required to report against Section 172 of the Companies Act stating how the directors are ensuring they have regard to wider interests, suppliers, customers and society. This is no great surprise, Section 172 already requires boards to improve stakeholder engagement and, again, it is easier to enhance current requirements rather than reinvent the wheel.

On the topic of employee engagement, the more contentious ‘workers on boards’ legislation has evolved into a Code requirement. Under the proposals, companies will be required to have a designated NED, a formal employee advisory council, or a director from the workforce.

Preliminary findings from the 2017 Corporate Governance Review show that 109 of the FTSE 350 mention employee engagement in their annual report and only four already have one of the three recommended mechanisms. The reform is likely to lead either to changes in formalised employee engagement, or, less optimistically, to increased non-compliance.

Say on pay: Similarly, the potential of binding shareholder votes has shifted emphasis toward greater transparency. Companies facing significant shareholder opposition (more than 20%) will be put on a public register, maintained by The Investment Association.

Privately-held businesses: as referenced in the green paper8, the Government have asked the FRC to develop a voluntary set of corporate governance principles for large private companies, and to require companies to disclose their corporate governance arrangements in their directors’ report.

What these principles will look like remains to be seen, but they will require greater transparency from companies that have not traditionally been required to do so. This could have significant implications for the governance reporting for private companies and we will be watching this space to see how this develops.

Transparency and engagement are cornerstones of good governance and these changes are a positive start. Given that the government no longer has a significant majority in parliament, it is no surprise that there is little actual legislation change, with most of the green paper proposals watered down to reporting requirements. However, it is good to see the development of existing guidance rather than starting from scratch.

The real challenge is translating these aspirational principles into every day working practice. When the viability statement9 was introduced in 2014, the majority of companies simply produced a generic statement; few used it as an opportunity to look at their longer-term strategy and risks. While the flexibility of the Code is its strength, it will be of little effect if companies simply choose not to comply. It is likely that companies will require additional encouragement to properly embed these governance practices.

Our 2017 FTSE 350 Corporate Governance Review released in October. To receive a copy of our findings, please sign up to our mailing list.

References:

  1. UK Government – Corporate Governance Reform consultation  
  2. UK Government – Corporate Governance reforms announced
  3. Economia – Mixed response to corporate governance reforms
  4. FT - May’s corporate governance reform ‘feeble’, says TUC
  5. Grant Thornton – Gender pay gap reporting – what you need to know
  6. FT – Let’s keep a sense of proportion on pay  
  7. CIPD – Executive pay - Review of FTSE 100 executive pay packages
  8. UK Government – Corporate Governance Reform Green Paper  
  9. Grant Thornton – The longer term viability statement – a question of confidence