Directors should be required to take their corporate governance and legal duties more seriously the House of Commons Business, Energy and Industrial Strategy select committee believes. The committee’s report on corporate governance was published this week.
While the MPs state that there is no need for a radical overhaul of corporate governance in the UK, “We do believe that there is scope for significant improvements in order to address the changing nature of company ownership in a globalised economy.”
Iain Wright MP, Chair of the BEIS select committee, said: “The UK corporate governance system is recognised throughout the world as of high quality. However, recent scandals and the issue of executive pay have undermined public trust in corporate culture. That, together with rising stakeholder expectations, changing business models and technology, means that corporate governance needs to evolve to provide assurance to investors and wider society.”
The MPs suggest that enforcement of the law relating to is currently not strong enough and that more pressure could and should be applied to companies to ensure they comply with their legal responsibilities and those under the corporate governance code. Giving evidence to the Committee, Sarah Wilson, CEO of Manifest said: “We have a misalignment between all the parties in the system. Yes, we have very good laws and the UK Companies Act and Governance Code is something to be very proud of. But I am not in favour of new law; I want the existing ones to be enforced correctly.”
The report notes that the Companies Act 2006 was trying to strike a balance between the traditional primacy of shareholders in companies and responsibilities that might relate to other stakeholders. Section 172 of the Act gives directors responsibilities “to have regards to” other stakeholders such as employees and suppliers.
The MPs observe that the primacy of shareholders have been retained at a time when the average length of time shares are held for is far shorter than in the past – six years in 1950 to less than six months today. There has also been a sharp fall in the proportion of shares held directly by individuals, from about half in the 1960s to about 10% today. These individual shareholdings are often now held via nominee accounts and intermediaries the MPs note.
Giving evidence to the committee Catherine Howarth, chief executive of responsible investment pressure group, ShareAction, argued that investors think that they have a single overriding duty to maximise short-term profitability, which produces “constant short-term pressures” on companies.
While shareholders exert these short-term pressures other stakeholders such as their suppliers or employees may be very reliant on the company and need to have a long term future with it. These other stakeholders, however, the report notes, do not have a mechanism to influence decision-making.
The MPs’ recommendations suggest that they agreed with Sarah Wilson Manifest chief executive in her evidence to the committee that there is no need for “new rules, just better enforcement of existing ones.”
The report recommended that the Financial Reporting Council (FRC) amend the corporate governance code to require informative narrative reporting on the fulfilment of section 172 duties. The select committee stated that “Boards must be required to explain precisely how they have considered each of the different stakeholder interests, including employees, customers and suppliers and how this has been reflected in financial decisions. They should also explain how they have pursued the objectives of the company and had regard to the consequences of their decisions for the long term, however, they choose to define this.”
The MPs also recommend that the FRC should be given additional powers by the government in order to engage and hold to account company directors in respect of the full range of their duties. Where engagement is unsuccessful, the select committee said it would support the FRC in reporting publicly to shareholders on any failings of the board collectively or individual members of it. If companies were not to respond satisfactorily to engagement with the FRC, the MPs recommend that the FRC be given authority to initiate legal action for breach of section 172 duties.
The select committee emphasised the importance of good stewardship by institutional investors. The MPs suggested that transparency is required on the role of asset managers and proxy agents in order to demonstrate how they are taking stewardship seriously and investment managers needed to articulate their approach to engagement. In order to improve engagement between companies and stakeholders more generally the MPs also recommended that stakeholder advisory panels should be established.
Addressing remuneration the MPs said they agree with the prime minister, Theresa May, that high executive pay is an issue for society as a whole. The select committee noted that executive pay has become increasingly complex. The MPs recommended that the use of long term incentive plans should be phased Any bonuses to be paid should reflect corporate governance and corporate responsibilities the select committee recommended so that no new schemes will be come into effect after the start of next year.
We recommend that companies make it their policy to align bonuses with broader corporate responsibilities and company objectives and take steps to ensure that they are genuinely stretching. Policy in this respect would be considered by the FRC in their corporate governance rating system.
Key recommendations:
Director responsibilities:
The Financial Reporting Council (FRC) should amend the corporate governance code (the Code) to require informative narrative reporting on the fulfilment of section 172 duties.
The government should bring forward legislation to give the FRC the additional powers to hold to account company directors in respect of the full range of their duties.
Investor stewardship
The FRC should review its Stewardship Code with a view to providing: more explicit guidelines on what high quality engagement would entail; a greater level of detail in terms of requirements; and an undertaking to call out poor performance on an annual basis.
The FRC should include in its revised Stewardship Code stronger provisions to require the disclosure of voting records by asset managers and undertakes to name those that subsequently do not vote.
Non-Executive Directors
The FRC should include best practice guidance on professional support for non-executive directors (NEDs) when it updates the Code and that companies include training of board members as part of reporting on their people or human resources policy.
The Code should provide guidance on how companies should identify clearly and transparently the roles of NEDs where they have particular responsibilities and how they should be held to account for their performance. Meanwhile NEDs should be required to demonstrate more convincingly that they are able to devote sufficient time to each company when they serve on multiple boards.
Executive Pay
Companies should make it their policy to align bonuses with broader corporate responsibilities and company objectives and take steps to ensure that they are genuinely stretching.
The FRC should consult with stakeholders with a view to amending the Code to establish deferred stock rather than LTIPs as best practice in terms of incentivising long-term decision making. The MPs recommend that this consultation should develop guidelines for the structure of executive pay with the following features:
- A simpler structure based primarily on salary plus long-term equity, to divest over a genuinely “long-term” period, normally at least five years, without large steps;
- Limited use of short-term performance-related cash bonuses, which should be aligned, where possible, to wider company objectives or corporate governance responsibilities;
- Clear criteria for bonuses: they should be genuinely stretching and be aimed to provide incentives rather than just reward.