UK: Corporate Governance Reform – Government Response Published

Last Updated: 12 September 2017
Article by Nigel Watson

Last week the Department for Business, Energy & Industrial Strategy ("BEIS") published the British government's response to the Green Paper on consultation on corporate governance reform.

Click here to view our previous commentaries on the Green Paper on Corporate Governance Reform" and " Corporate governance: BEIS Committee report".

By way of recap, the aim of the Green Paper consultation was to consider what changes might be appropriate in the corporate governance sphere to help ensure improved business performance and to have an economy that worked for everyone and "not just for the privileged few" – to quote Theresa May.

The Green Paper identified a number of proposals for reform across the three specific aspects of corporate governance on which they consulted, namely:

  • Executive pay.
  • Strengthening the employee, customer and supplier voice.
  • Corporate governance in large privately-held businesses.

When Theresa May became leader of the Conservative Party she was very quick to threaten reform in the area of executive pay.

Under her leadership listed companies would be required to: hold annual binding shareholder votes on executive pay; put employees on boards and publish the ratio between CEO pay and their employees.

Of these 'threats' only the requirement for listed companies to publish a pay ratio has actually survived in the response paper leading many critics to accuse the Prime Minister of talking tough but acting soft on the area of executive pay.

Executive pay

Pay ratio

By next summer the government will introduce secondary legislation that requires listed companies to report annually in their remuneration report the ratio of CEO pay to the average pay of their UK workforce, along with a narrative explaining any changes to that ratio from year to year and how that ratio relates to pay and conditions across the wider workforce.

Pay protest register

This measure is new (or depending on your outlook, a climbdown) and essentially involves naming and shaming companies.

The government proposes to invite the Investment Association to collate and maintain a public register of those listed companies who have encountered shareholder opposition of 20% or more on executive pay and other resolutions, along with a record of what those companies are saying they will do to address concerns around pay.

Other proposals

There are some additional proposals around giving remuneration committees greater responsibility for demonstrating how pay and incentives align and to explain to their workforce how decisions on executive pay reflect the companies wider pay policy.

The Financial Reporting Council (FRC) will be invited to consult on a proposal to increase the holding period for share-based remuneration from three to five years and greater disclosure requirements around potential remuneration outcomes will also be introduced.

Strengthening the employee, customer and supplier voice

Worker representation

The government believes that there is strong support for strengthening the stakeholder voice in the boardroom in order to deliver long-term sustainability and greater board effectiveness.

Similar to how German companies operate, the original proposal was that quoted companies would be forced to have employee representatives on their boards. However British business was hostile to this proposal and so a compromise (or fudge) was required.

The watered down version proposed by the government is that the FRC will be invited to consider and consult on a specific UK Corporate Governance Code requiring quoted 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.

Of course with comply or explain there is always another option – do nothing and explain why.

Stakeholder engagement

Section 172 of the Companies Act 2006 already requires the directors of a company to have regard to wider stakeholder interests (employees, suppliers, customers, i.e. not just shareholder interests) in pursuing the success of that company but the government plans to legislate to include a new requirement for companies to explain how their directors comply with section 172.

Corporate governance in large privately-held businesses

The subtext here of course is all about preventing a repeat of the BHS (pension) saga, where the private owned high street retailer was sold by Sir Philip Green for Ł1 shortly before it collapsed, jeopardising the jobs and pensions of thousands of employees.

In addition to the new requirements around section 172 above, the consultation revealed broad support for action to encourage high standards of corporate governance in the UK's largest private companies reflecting the significant impact that these companies have on employees, suppliers, customers and others, irrespective of their legal status.

The government therefore wants to develop a voluntary set of corporate governance principles for large private companies and to legislate to require companies of a significant size to disclose their governance arrangements in their Directors' Reports and on their website – in very similar fashion to the reporting and disclosure regime that currently exists for listed companies.

Quite where the line will be drawn between private companies that qualify as being "large" and those that do not, remains unclear.

What is clear, is that we are almost certainly entering into a new paradigm of accountability and disclosure for both listed and large private companies.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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