Reforms to corporate governance are multiple and varied. This briefing discusses the Government's plans and work in this area, and other proposals.Jump to full report >>
Corporate governance is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies.
The Code sets out good practice that boards should adopt to be effective, accountable, transparent and focused on sustainable success over the longer term. The Code covers board composition, remuneration, shareholder and stakeholder relations, accountability and audit.
The Code applies to public listed companies – private companies are not concerned. In law companies are primarily accountable to their shareholders, and the Code is mostly, though not only, written to protect and benefit shareholders.
The Code consists of principles rather than detailed rules. Companies must apply these principles but have latitude over how they do so. Indeed, a key job of a company’s board is to decide how to apply the Code’s principles, and communicating their approach to shareholders and other stakeholders.
A fundamental feature of the application of the Code is the “comply or explain” principle. Under this principle, companies are required to comply with official guidance, or to explain why they have not done so. Comply or explain preserves flexibility for businesses that wish to deviate from best practice as laid out in the guidance. But the deviations must be duly noted, and justified, in the company’s annual report.
A key component of the corporate governance framework in the UK are the duties that company directors must discharge in law under the Companies Act 2006. The seven general duties of directors are:
The duty to promote the success of the company (section 172 of the Act) requires directors to act in the best interests of the company’s members (i.e. the shareholders in companies limited by shares), but also to have regard to other stakeholders, including employees, suppliers, customers, the community and the environment.
The first paragraph of the Code says that the purpose of corporate governance is ‘to facilitate effective, entrepreneurial and prudent management that can deliver the long-term success of the company’.
But recent proposals for reform have had a much wider purpose and scope than simply facilitating long-term success. For example, the impetus to reform executive pay has come from concerns about social justice as much as from concerns about the effective management of companies.
Similarly, the current Code only applies to public companies with a premium listing, but the Government is also reforming the governance of large private companies. So the proposed reforms go beyond the Code to look at corporate governance more widely.
A consultation on corporate governance reform was launched on 29 November 2016. On 29 August 2017, the Government published its response to the consultation. It proposed eight reforms across the three areas of pay, employee and stakeholder voice, and the governance of large private companies. The Government also agreed to look at the powers of the Financial Reporting Council – an issue that was raised independently by respondents and by the BEIS Committee. On 12 June 2018, the Government published draft legislation that will bring some of the Government’s planned reforms into effect, starting in 2019: The Companies (Miscellaneous Reporting) Regulations 2018.
The Business, Energy and Industrial Strategy (BEIS) Select Committee published its report on corporate governance on 5 April 2017. The corporate governance inquiry followed the Committee’s investigations into major corporate failings at BHS and Sports Direct.
The Committee made 28 recommendations across a number of areas. Board diversity and executive pay received the highest number of recommendations, with eight and five respectively. Of the 28 recommendations, the Government accepted four in full and partly accepted another four. It rejected seven and responded to the remainder by saying that these recommendations were for others to consider.
The Government will require public companies with more than 250 UK employees and listed on the stock exchange to report annually the ratio of CEO pay to the median pay, 25th-percentile and 75th-percentile pay of their UK workforce, along with a narrative explaining changes to that ratio from year to year. To illustrate, a median pay ratio of 50 means that the CEO is paid 50 times the median pay in the company.
This briefing calculates pay ratios in the UK based on available data for 319 companies (most of the FTSE 350). Analysis shows that:
Taken together, company size, industry and the volatility of CEO pay can largely explain a company’s ratio, and changes from year to year. One can expect these factors to feature heavily in the narrative that companies will be required to provide along with their ratios.
Commons Briefing papers CBP-8143
Author: Federico Mor