As trailed in our recent blog post, the green paper on the reform of corporate governance was published today by the Department for Business, Energy and Industrial Strategy (formerly BIS). The paper sets out 14 questions for consultation.
The consultation covers three main areas:
- executive pay, “which has grown much faster over the last two decades than pay generally and than typical corporate performance”;
- strengthening the voices of employees, customers and wider stakeholders; and
- corporate governance in large private companies (BhS springs to mind).
This takes the lion’s share of the questions. Three are aimed at increasing the influence and engagement of shareholders in directors’ remuneration. It is acknowledged that a binding vote on the remuneration report (as well as the existing binding vote on remuneration policy) could be tricky, since it would involve directors’ service contracts having to state that pay was conditional upon shareholder approval. Views are sought on whether a binding vote should apply only to variable parts of the pay package (increase in salary, annual bonus and LTIP awards) or just to companies that have “encountered significant shareholder opposition to the remuneration report” (perhaps a vote against in the range 20% to 33% for the previous one or two years). Alternatively, it is suggested that a remuneration policy must contain an upper threshold for all elements of pay and a binding vote at the AGM must be sought for any package that exceeds that threshold during the relevant year. Another option is to make the remuneration policy subject to an annual vote (although it is admitted that this may encourage short-termism, which investors have all said they want to discourage), or to allow shareholders to require a binding policy vote sooner in the current three-year term in a case where the company’s circumstances change. Finally the FRS could be asked to make the Corporate Governance Code more specific about how companies should engage with shareholders, particularly when there is a significant vote against the remuneration report.
One question asks whether more needs to be done to encourage shareholders to make more use of their votes, perhaps by making disclosure of institutional voting records mandatory, or by establishing a “senior shareholder committee” to scrutinise remuneration (whilst acknowledging that this would go against the UK’s long-established unitary board structure) and/or doing more to help individual investors to use their vote.
Suggestions for increasing the effectiveness of remuneration committees include requiring them to consult shareholders and the company workforce before formulating pay policy and requiring a director to have served on the committee for at least 12 months before becoming chair.
Then there is the vexed question of whether the ratio of the CEO’s pay to that of the “median employee” should have to be disclosed, as will be mandatory for US companies from January 2017 and as encouraged by the Investment Association in its recently-updated principles of remuneration. Highlighted issues are “context is vital if ratio reporting is to add value” and the unintended consequence of encouraging companies to outsource or “offshore” their lower-paid employees.
The nettle of investors’ complaints about annual bonus targets not being disclosed is firmly grasped. Certainly within the FTSE100 in the 2016 season, there was almost blanket reliance on the “commercial sensitivity” get-out allowed under the directors’ remuneration regulations, with most companies disclosing retrospectively the next year, some committing to disclose once the board considers the sensitivity has gone away and a very few saying never.
Finally in this section, should the release of LTIP awards be increased from a minimum of 3 years to 5 years? This is currently encouraged by all investors’ guidelines and certainly within the FTSE100, there is already widespread compliance (albeit by varying routes), so this should be pushing at an open door. Also, should “restricted shares” (annual share options with no performance conditions, just a requirement for the participant to remain employed) be used in preference to LTIP awards?
Strengthening the shareholder voice
Theresa May’s pledge in pre-PM days and since to have employee representation on boards has been largely watered down to questions as to how stakeholders, including employees, customers and other “interested parties”, can be given more say in board decisions, in particular how remuneration is structured. Suggestions as to how this might be done include the creation of stakeholder advisory panels; the designation of a non-executive director (possibly a member of the remuneration committee) as the conduit to ensure that the views of interested groups, particularly employees, are put to the board; strengthening reporting requirements as to stakeholder engagement; and only as one option the appointment of stakeholder representatives to boards (acknowledging that election of representatives, potential conflict, delayed decision-making and confidentiality are challenges of this last approach and emphasising that this would not be made mandatory). Ideas are invited as to which companies this should apply to – measured by number of employees or another size metric? Should this aspect be legislative, code-based or voluntary?
Large private companies
According to the table of figures given in the paper, there are 33,000 private companies (excluding LLPs and subsidiaries of UK quoted companies) that have an annual turnover of more than £36 million or total assets of more than £18 million and 2,200 that have more than 1,000 employees. Views are sought as to whether to strengthen the corporate governance regime applying to these companies, and if so, how – extend the Corporate Governance Code to them, or invite the FRC or the Institute of Directors to formulate a code specifically for them? Which companies should be caught and what should be the size threshold? Should non-financial reporting requirements for private businesses (for example, gender pay issues, modern slavery prevention, prompt payment practices), currently based on their legal form, be applied on the basis of a size threshold?
The deadline for responses is 17 February 2017.