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The aim of the green paper consultation was to consider what changes might be appropriate in the corporate governance regime to help ensure that we improve business performance and have an economy that works for everyone. This Government response now sets out nine headline proposals for reform across the three specific aspects of corporate governance on which we consulted:
• Executive pay;
• Strengthening the employee, customer and supplier voice; and
• Corporate governance in large privately-held businesses.
It also takes into account the need for effective enforcement of the corporate governance framework.
Executive pay
Section 1 of this consultation response sets out the Government’s plans for reform in relation to executive pay, which has risen faster than corporate performance. The green paper consultation provided convincing evidence to support the case for further, targeted reform. While many companies have responded positively to the reforms introduced in 2013, a persistent small minority of businesses continue to disregard the views of shareholders on pay each year. There are also few signs that many remuneration committees take seriously enough their existing obligations to take account of wider workforce pay and conditions in setting executive remuneration. The Government also recognises concerns expressed by many respondents about the unnecessary complexity 2 Government response: Corporate Governance Reform and uncertainty of executive pay, particularly around the potential outcomes of long-term incentive plans.
The Government therefore intends to:
(i) Invite the Financial Reporting Council (FRC) to revise the UK Corporate Governance Code (the “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);
• 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); and
• Extend the recommended minimum vesting and post-vesting holding period for executive share awards from 3 to 5 years to encourage companies to focus on longer-term outcomes in setting pay.
(ii) 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; and
• Provide a clearer explanation in remuneration policies of a range of potential outcomes from complex, share-based incentive schemes.
(iii) Invite the Investment Association to implement a proposal it made in its response to the green paper to maintain a public register of listed companies encountering shareholder opposition to pay awards of 20% or more, along with a record of what these companies say they are doing to address shareholder concerns.
The Government will consider further action at a future point unless there is evidence that companies are taking active and effective steps to respond to significant shareholder concerns about executive pay outcomes.
In addition to these proposals, the Government will take forward its manifesto commitment to 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. The Government will announce more details shortly.
Strengthening the employee, customer and wider stakeholder voice
Section 2 sets out three key proposals for reform to strengthen the voice of employees, customers and wider stakeholders in boardroom decision-making. The green paper consultation revealed strong support for action to strengthen the stakeholder voice. This was seen as an important factor in improving boardroom decision-making and delivering better, more sustainable business performance.
Many respondents also thought that big business should do more to reassure the public that companies are being run, not just with an eye to the interests of the board and the shareholders, but with a recognition that they have responsibilities to employees, suppliers, customers and wider society. Matthew Taylor’s Report on Employment Practices in the Modern Economy1 also noted that the tone for fair and decent work is set at the top of an organisation and that company owners have a wider responsibility towards the people who work for them – both directly and through their supply chain – and should take this responsibility seriously.
Section 172 of the Companies Act 2006 already requires the directors of a company to have regard to these wider interests in pursuing the success of the company, but a large number of respondents thought that this aspect of the legal framework could be made to work more effectively through improved reporting, Code changes, raising awareness and more guidance.
The Government therefore intends to:
(iv) 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 to have regard to employee and other interests;
(v) Invite the FRC to consult on the development of a new 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 a part of developing this new principle, the Government will invite the FRC to consider and consult on a specific Code 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; and
(vi) Encourage industry-led solutions by asking ICSA (the Institute of Chartered Secretaries and Administrators: The Governance Institute) and the Investment Association to complete their joint guidance on practical ways in which companies can engage with their employees and other stakeholders. The Government will also invite the GC100 group of the largest listed companies (FTSE100 General Counsels) to complete and publish new advice and guidance on the practical interpretation of the directors’ duties in section 172 of the Companies Act 2006.
These proposals are in line with recommendations made by the House of Commons BEIS Committee and will drive change in how big businesses engage with their key stakeholders,. Putting in place higher expectations for all our largest companies, and in particular for our leading, premium listed companies, should also encourage the development and uptake of good practice in the wider business community.
Corporate governance in large privately-held businesses
Section 3 sets out two proposals for reform regarding the corporate governance of large privately-held businesses, in addition to the new requirements in relation to section 172 set out above. The consultation revealed broad support for action to encourage high standards of corporate governance in the UK’s largest private companies reflectingthe significant impact that these companies have on employees, suppliers, customers and others, irrespective of their legal status.
The Government therefore intends to:
(vii) Invite the FRC to work with the IoD, 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; and
(viii) Introduce secondary legislation 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 (LLPs) of equivalent scale.
Other issues
Section 4 of the green paper provided respondents with an opportunity to raise other aspects of corporate governance not covered in the earlier sections. Consultation revealed questions over whether the FRC has the powers, resources and status to undertake its functions effectively.
(ix) To address this the Government will 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 this year to ensure the most effective use of their existing powers to sanction directors and ensure the integrity of corporate governance reporting. The Government will also consider, in light of this work, whether further action is required.
This package of policy measures, as a whole, is in line with the UK’s approach of strengthening corporate governance through non-legislative, code-based provisions and voluntary industry action to keep pace with higher expectations of business, and only legislating where necessary. Big business and institutional investors now have a clear opportunity to show that they can respond to the weaknesses explored in the green paper in relation to executive pay, stakeholder voice at board level and standards in large private companies without primary legislation.
Next steps
Implementing these reform proposals will require a combination of changes to the UK Corporate Governance Code (which is the responsibility of the FRC), voluntary industry action, secondary legislation and action by relevant regulators to improve co-ordination and the use of existing powers. 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. Where necessary, there will be consultation on the detail of the secondary legislation. 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. [...]