By Prof Charlotte Villiers, Professor of Company Law and Corporate Governance (University of Bristol Law School).
The UK currently faces huge economic and political challenges. The Brexit negotiations are clearly of central importance and the outcome will strongly influence our country’s future as a trading nation. Our economic prospects will also be dependent on the strength of our corporate governance system. During the past couple of years, a number of corporate scandals and failures such as the demise of BHS with its huge pension losses and the worker exploitation at Sports Direct as well as continued publicity of ‘fat cat’ executive pay have threatened the reputation of the UKs corporate governance framework. In light of these negative reports a corporate governance inquiry was launched by the House of Commons Committee of the Department for Business, Energy and Industrial Strategy and the Government published a Green Paper on Corporate Governance Reform in November 2016. Despite a busy schedule with Brexit and a slimmed down Queen’s Speech, the Government continues to pursue its plans for corporate governance reform with its publication of a Government Response to the Green Paper in August 2017.
When Theresa May made her speech launching her campaign to become Prime Minister in July 2016 she announced her intention to ‘have not just consumers represented on company boards, but employees as well.’ She repeated the promise as Prime Minister at the Conservative Party Conference in the same year. In that same campaign speech in July Theresa May also noted that during the previous eighteen years executive pay had more than trebled and there was ‘an irrational, unhealthy and growing gap between what these companies pay their workers and what they pay their bosses’. She said that she wanted ‘to make shareholder votes on corporate pay not just advisory but binding’ and ‘to see more transparency, including the full disclosure of bonus targets and the publication of “pay multiple” data: that is, the ratio between the CEO’s pay and the average company worker’s pay’ and ‘to simplify the way bonuses are paid so that the bosses’ incentives are better aligned with the long-term interests of the company and its shareholders.’
By November 2016, in her keynote speech to the CBI, she appeared already to be backtracking from her ambition to place worker representatives in boardrooms. The House of Commons Committee’s Inquiry on Corporate Governance concluded in its report in April 2017 that ‘it should become the norm for workers to serve on boards.’ The Committee observed that ‘John Lewis, First Group, and the NHS Foundation Trust Boards do not appear to have suffered from some of the disadvantages that sceptics have suggested.’ The Committee also stressed that any worker director would have equal status to other boardroom directors: ‘Employees appointed to boards should be directors in their own right, with the necessary skills and aptitudes to play a part as a full board member rather than a representative of the workforce. They would not be a delegate, but would provide the same strategic evaluation and challenge that every director should bring.’ What has been proposed falls considerably short of any of these ambitions.
Section 2 of the Response document sets out three key proposals for reform to strengthen the voice of employees, customers and wider stakeholders in boardroom decision-making. The document acknowledges that the Green Paper consultation revealed strong support for action to strengthen the stakeholder voice to improve boardroom decision-making and deliver better, more sustainable business performance. The document also noted that respondents to the consultation wanted to see that companies are being run, not just to satisfy the interests of the board and the shareholders, but with a recognition for their responsibilities to employees, suppliers, customers and wider society. A large number of respondents also thought that section 172 of the Companies Act 2006 could be made more effective through improved reporting, Code changes, raising awareness and more guidance.
The Government proposes therefore 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 to have regard to employee and other interests; . The Government has stated that it will 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.
- Invite the Financial Reporting Council (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. 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
- 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.
We can see from these proposals that the Government has softened its stance. The purported reporting requirements do not add very much to what is already required in law. Indeed Section 414C (1) of the 2006 Act (as amended) expressly states the purpose of the strategic report as being ‘to inform members of the company and help them assess how the directors have performed their duty under section 172 (duty to promote the success of the company).’ Company lawyers are familiar with the limitations of section 172 of the Companies Act 2006. In reality, section 172 does little to change the priority already given to shareholders over the other stakeholders. At best, the proposed new change will remind directors that consideration has to be given to the interests of other stakeholders but not necessarily allowing for their interests to take precedence over the interests of the shareholders and not giving to those other stakeholders any right to challenge directors where it is clear that their interests have not been considered sufficiently.
In these proposals the Government’s handing over to the FRC the lead role in developing a new principle in the Corporate Governance Code for supporting a strengthened stakeholder voice and to consult on a specific code provision for premium listed companies to adopt, on a comply or explain basis, a choice of three engagement mechanisms for worker representation, is little short of a cop out. It is much weaker than what the House of Commons Committee recommended and the possibility of a designated non-executive director for employee engagement removes the opportunity for workers themselves to have any input in boardroom discussions or decisions. Moreover, the comply or explain basis of this proposed code provision makes possible the opportunity for companies to avoid any such requirement altogether, so long as they explain their position. Numerous commentators have noted the poor quality of some explanations under the comply or explain rule. Then we might ask why the Government prefers to ask ICSA and the Investment Association to provide guidance on the practical ways to engage with employees and other stakeholders. Important work has been published recently by the TUC on employee engagement, and it is disappointing that they are not being given a place at this table of discussion.
The proposals on executive pay are also disappointing. The Response document notes that while many companies have responded positively to the reforms on executive pay introduced in 2013, ‘a persistent small minority of businesses continue to disregard the views of shareholders on pay each year.’ The Government adds that ‘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 and uncertainty of executive pay, particularly around the potential outcomes of long-term incentive plans.’ In light of these observations the Government proposes to invite the FRC to revise the UK 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);
- 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.
The Government proposes further 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; and
- Provide a clearer explanation in remuneration policies of a range of potential outcomes from complex, share-based incentive schemes.
The Government will also 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.’ In addition to these proposals, the Government plans to 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.
These proposals are not as demanding as Theresa May initially hoped. Her ambition to turn the shareholder vote into a fully binding vote has not materialised. Whilst they focus on the shareholder interest, the intention to bring about more long term strategic thinking from the directors is unlikely to be fulfilled. The longer-term vesting and post vesting holding period for executive share awards is mere tinkering around the edges. The stress on shareholder voting has typically not generated longer term thinking but in fact resulted in the opposite – short termism and greater levels of risk taking. Whilst there have been examples during the last year of shareholder revolts (e.g. at BP and Pearson) these remain few and far between. Therefore, the register being proposed where there is shareholder opposition of 20% or more is unlikely to be very extensive but it might at least focus directors’ minds on the possibility of negative publicity. Whether that would be a sufficient deterrent is open to question given the fact that business media pages already publicise corporate greed and attempt to name and shame the so-called fat cats, but they still take the eye-watering packages.
Another disappointment is the proposed publication of pay ratios. In principle, this is welcome but why limit this to showing the ratio between the CEO and the average pay in a company? What is meant by the average pay? Will it be the mean average or the median pay? What about those companies that pay workers at the level of the minimum wage (or lower!)? The ratio then would look significantly larger. Arguably, the most positive of these proposals is that directed at the remuneration committee to be given a wider remit and the requirement for that committee to engage with the wider workforce on pay and incentives across the company. Again, however, this proposal falls short. It might be more beneficial to have worker representatives sitting and participating fully in the decisions made by the remuneration committee. The current focus on pay and wealth inequality is a global political challenge and corporate governance mechanisms influence the landscape here. A genuine discussion is required on how companies may contribute to reducing the levels of inequality that we are witnessing (see further, Villiers, ‘Executive Pay: A socially oriented distributive justice framework’ 2016 (37) The Company Lawyer 139) but this Response document does not provide for that.
The Response document contains a number of other miscellaneous proposals but the main proposals on worker engagement and executive pay indicate that, despite the need for the UK to show leadership in its corporate governance system if only to help it through the potential Brexit fallout, the Government is failing to do that. A shareholder-centred approach to corporate governance is now being questioned widely and numerous organisations are seeking to develop company laws and corporate governance systems that will be fit for dealing with the serious challenges of the 21st Century such as climate change, technological revolution and inequalities national and global. This set of proposed reforms looks tired, half-baked and half-hearted. Brexit threatens to isolate the UK and to leave it behind economically. These proposed reforms offer little to protect the UK from this threat. More radical and ambitious reforms are necessary and without delay.