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The UK Corporate Governance Code celebrated its 20th anniversary this year. Over that period it has made a big difference to corporate governance standards and practice in the UK. It has a history of success in pushing out the boundaries of best practice, such as the separation of the chairman and chief executive, the independence of audit committees and the practice of regularly reviewing the board’s effectiveness. It is the flexibility inherent in the “comply or explain” approach that has enabled those boundaries to be pushed, and the FRC believes it is important that flexibility is retained if the Code is to continue to do so. The FRC is pleased that the European Commission has recognised the important role that national “comply or explain” codes have to play in raising governance standards across the EU.
Not all governance problems have been solved by any means. Two that have been highlighted this year are the perennial question of how to set executive remuneration in a way that is seen as fair reward for good performance, and wider concerns about governance in the banking sector. In both instances the UK Corporate Governance Code operates alongside regulation which the Government is in the process of reforming.
The FRC will consider during 2013 whether changes are needed to how the Code addresses remuneration, and will consult on this question once the Government’s legislation has been finalised. The FRC is also contributing to the debate on the governance of banks. The FRC believes that the Code itself should continue to be applicable to all companies and that, as a general rule, any governance issues specific to the financial sector are best addressed through the existing framework for regulating that sector.
There have also been significant changes in ownership structure since 1992 that have created some challenges that might not have been anticipated when the “comply or explain“ approach was first devised.
One of these is the increase in recent years in the number of Premium listed companies with controlling shareholders. The pure “comply or explain” approach can be less effective in these cases, where the majority shareholder is in effect reporting to themselves, and for this reason the FSA is currently consulting on proposals to give greater protection to the minority shareholders of such companies.
While this is a relatively recent development, underlying changes in the ownership of listed companies in the UK - and in particular the declining share held by UK-based long-term investors - go back much further.
The impact of these changes has been significant in many respects, as Professor Kay has identified in his report. In terms of corporate governance, it means that the critical mass of investors with a long-term perspective who are willing and able to engage with boards has to be established internationally, not just within the UK. Establishing a critical mass that enables the chain of accountability from companies through to savers to work as it should, in a difficult economic environment, is possibly the greatest challenge, and is the over-arching objective of the Stewardship Code.
The events of the so-called “Shareholder Spring” indicated a greater willingness on the part of investors to challenge boards. This is welcome in many ways, but will not in itself create a stewardship culture where all parties work together to deliver sustainable returns to savers. Indeed, genuine stewardship may suffer if public confrontation becomes the default mode of engagement. As well as the implications for the relationship between individual boards and their shareholders, it may deter exactly those sorts of investors - particularly international investors - that should be encouraged to engage more.
The development of a stewardship culture among investors is not something that happens overnight. It requires cultural and behavioural change rather than prescription. Looking back over the first two years of the Stewardship Code it is clear that much has changed, and the recent changes to that Code will hopefully moves things on another stage. Stewardship is firmly on the investment agenda and the evidence suggests that leading investors are taking their responsibilities seriously, and looking to engage more effectively both individually and collectively. Stewardship needs to develop further, however, if the FRC is to reach the critical mass needed. As emphasised in the revised Stewardship Code, it is not something that can be delegated to proxy advisors or other third parties; and just as the quality of governance within companies is determined by the board, it needs senior management within institutions to provide leadership and commitment.
Report - Development in Corporate Governance 2012