Companies must think ‘beyond profit’€¦ · latest data in board composition, governance practices and director compensation among leading public companies in more than 20 countries

Essential, Authoritative Analysis and Opinion for Board Directors, Senior Executives, Investment Professionals and Advisers

Content

News 3 UK Board Index 2016

In addition to the usual analysis of composition, remuneration and committee data, the 2016 edition of the

Spencer Stuart UK Board Index continues to monitor diversity in its widest sense, exploring gender, nationality,

age and ethnicity in leading UK companies

International 4 CG and boardroom composition

A new KPMG report identifies some of the key challenges or barriers to building high-performing boards,

as well as steps boards are taking to overcome these hurdles and position themselves as strategic

assets for their companies

Global News 5 Better CG disclosures in Malaysia

FT-ICSA Boardroom Bellwether survey

Guidelines on board evaluation in India

Dutch CG Code compliance

Features 7 Companies must think ‘beyond profit’

Sallie Pilot considers the findings of an annual global survey of business leaders which found that most

of the executives polled believe that their organisations must shift their attention beyond profit to wider

value creation

10 A surprising interest in governance

Paul Lee considers the proposals in the UK Governments’ recent Green Paper on corporate governance

Companies must think ‘beyond profit’‘Encouragingly, almost all executives believe that being able to bring together financial and non-financial information, to better explain how value is created over time, would lead to a more effective identification and management of risk; a more forward-looking, longer-term view of company performance; and improvements in decision-making.’

Sallie Pilot

A surprising interest in governance‘The political imperative seems to arise from a clear reading of the Brexit referendum: that there is a disconnect between business and the people …. Developments in corporate governance may assist in that regard, but perhaps the real challenge arising from that assessment is that very different behaviour and thinking will be required from many in the business community.’

Paul Lee

January 2017 Issue 271

Governance January 2017 Issue 271

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Editorial Board

Executive EditorMichelle EdkinsManaging Director, Global Head of Corporate Governance & Responsible Investment, Blackrock

Editorial Advisory BoardJamie AllenSecretary General, Asian Corporate Governance Association

David W. AndersonPresident, The Anderson Governance Group

Philip ArmstrongDirector of Governance, Gavi

Kit BinghamPartner & Head, Chair & Non-Executive Director Practice, Odgers Berndtson

Peter ButlerFounder Partner, GO Investment Partners

Richard DaviesManaging Director, RD:IR

Stephen DavisAssociate Director, Harvard Law School Programs on Corporate Governance & Institutional Investors

Alison Gill Director, Bvalco Ltd

Sandra GuerraFounder Partner of Better Governance, Brazil

Paul LeeHead of Corporate Governance, Aberdeen Asset Management

Robert McCormickChief Policy Officer, Glass Lewis & Co

Colin MelvinCEO of Hermes Equity Ownership Services Ltd

Paul MoxeyVisiting Professor in Corporate Governance at London South Bank University

Liz MurrallDirector, Corporate Governance and Reporting, IMA

Sean O’Hare Founder, Boardroom Dialogue

Chris PierceCEO, Global Governance Services Ltd

Geof StapledonVice President Governance for BHP Billiton

Kerrie WaringExecutive Director at ICGN

PublisherLesley StephensonTel: +44 (0) 1278 793300 Email: [email protected]

News EditorKatharine JacksonEmail: [email protected]

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Spencer Stuart, one of the world’s leading executive search consulting firms, has published its 2016 UK Board Index, a comprehensive review of governance practice in the largest 150 companies in the FTSE rankings.

In addition to the usual analysis of composition, remuneration and committee data, the 2016 edition of the UK Board Index continues to monitor diversity in its widest sense, exploring gender, nationality, age and ethnicity in leading UK companies. Also included is a review of five- and 10-year trends in board governance and a chart showing how UK companies compare with other European markets and the US on a range of key governance measures.

Board leadership and gender diversity

Diversity remains an important theme for boards and the proportion of women serving as non-executive directors (non-execs) on the boards of the top 150 listed companies in the UK has reached 29.9 per cent. On those boards where there is a female chairman, 39.5 per cent of non-execs are women. Similarly at senior management level, 35.4 per cent of executive committee members are women where there is a female CEO. For the first time the 2016 Board Index includes a five- and 10-year comparison on key data and over the past 10 years there has been a 146 per cent increase in the number of women on boards and a 105 per cent increase in female executive directors.

Foreign directors

Including both executive and non-execs, one-third of all directors in the top 150 FTSE companies are foreign nationals. Seventy-five per cent of boards have at least one foreign non-exec and 43 per cent have at least one foreign executive director, reflecting the fact that the majority of companies at the top of the FTSE have a truly global footprint and boards have long understood the importance of having directors with knowledge and experience of strategic markets. It is interesting to note that 25 per cent of CEOs and 17 per cent of chairmen are foreign and that 10 per cent of all FTSE 150 companies have both a foreign chairman and a foreign CEO. Over the past 10 years, there has been a 23 per cent increase in the proportion of foreign directors sitting on UK company boards.

Ethnicity

Although there has been a small increase in the number of directors in the top 150 FTSE companies who fall into the BAME category (black, asian and minority ethnic), only 23 out of 73 are British citizens, representing 1.6 per cent of all directors (excluding companies domiciled outside the US, UK, Europe and Australia).

New directors

Over a quarter of directors joining the top 150 FTSE boards have not previously served on the board of a listed company as a non-exec. Of these first-time directors, 39.6 per cent are women and 33 per cent are foreign. Nevertheless, the new cohort of non-execs includes slightly fewer women and foreigners than in 2015. Sixty-one per cent of new non-execs have held a CEO, general manager or divisional CEO role in the past and 40 per cent of new non-execs held a full-time executive role at the time of their appointment (down from 47 per cent in 2015).

Audit committee chairmanship

Fewer than one-fifth of directors chairing audit committees in the top 150 FTSE companies are women, reflecting the relatively low number of female CFOs in FTSE companies (10.3 per cent), whereas twice as many women (37.3 per cent) chair remuneration committees, reflecting the recent trend towards appointing senior human resources professionals, a high proportion of them women, to remuneration committees.

Non-executive director fees

Retainers for non-execs have risen by 10 per cent since 2011 and by 41 per cent since 2006. While the average is £64,019 across the top 150 FTSE companies, there is a clear gradation of director pay depending on the market capitalisation of the business. Across all companies, the average total remuneration for non-execs (including committee membership and other additional fees) is £87,194. It is interesting to note that the average total fees for UK non-execs is lower than for directors in Germany, Spain, Switzerland and the US. The average additional fee for chairing an audit committee is £22,343 and the average fee for chairing a remuneration committee is £20,455. Twenty per cent of boards (mainly in the financial services sector) have a separate risk committee and their chairmen are paid an additional £29,655 on average.

Spencer Stuart has launched a new one-stop online resource for the

latest data in board composition, governance practices and director

compensation among leading public companies in more than

20 countries. ‘Board Governance Trends’ is an exclusive source of

insight into the way board practices are changing around the world

and how they compare across countries. The UK Board Index

2016 and Board Governance Trends can be found at: https://www.

spencerstuart.com/research-and-insight/board-indexes

News

UK Board Index 2016


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International

CG and boardroom composition

‘Many boards are reassessing how they approach board composition from start to finish – from recruiting and onboarding to board evaluation and succession’, according to a recent survey report by KPMG. ‘Aligning boardroom talent with the company’s strategy is a key driver of many boards’ increasing focus on board composition and succession planning today.’

The report, Building a great board: Global views on board composition, identifies some of the key challenges or barriers to building high-performing boards, as well as steps boards are taking to overcome these hurdles and position themselves as strategic assets for their companies.

Key findings

Directors see much room for improvement. Only 36 per cent said they are ‘satisfied,’ and 49 per cent ‘somewhat satisfied’ that their board has the right combination of skills, background and experiences.

Board composition and alignment with strategy. A key priority for most boards is alignment of boardroom talent with company strategy, both for the short-term and the long-term, as the strategy evolves. Survey respondents identified several related reasons for this focus on board composition, including the need for greater diversity (61 per cent) and the need for directors with an understanding of the competitive environment, the pace of technology change and the potential disruptors of the company’s business model (54 per cent).

Significant barriers to building a high-performing board. The barrier most frequently cited is ‘finding directors with both general business experience and specific expertise needed by the company’ (69 per cent); identifying the board’s future talent needs ranked second (55 per cent), followed by resistance to change due to ‘status quo’ thinking (43 per cent). Including the board as an element of the company’s strategic plan and effective director recruitment and selection are regarded as key to building an effective board and positioning the board for the future.

Formal succession planning. Whilst the vast majority of survey respondents said that a formal board succession plan is a key mechanism to achieving the right board composition, only 31 per cent reported having a formal succession plan in place, robust board discussion or succession planning in process. Thirty-three per cent of respondents reported little or no discussion about board succession and another 36 per cent reported only informal discussion or when a seat needs to be filled.

Mechanisms for optimal board composition. Respondents overwhelmingly cited robust board evaluations (87 per cent) and formal succession plans (77 per cent) as the most effective mechanisms to achieve the right board composition,

followed by tenure limit (years or terms) for individual directors (49 per cent), monitoring the board’s average director tenure (33 per cent) and age limit (22 per cent). However, few boards actually have formal succession plans in place and nearly one-third cite ‘lack of robust board and individual director evaluations’ and ‘difficulty in removing underperforming directors’ amongst the greatest barriers to building and maintaining a high-performing board.

Strategic and integrated approach. Generating the necessary change and turnover to achieve the ‘right’ board composition requires an active approach. Forty-seven per cent of respondents reported that their board is assessing its future needs and 45 per cent said that their board is actively recruiting for specific expertise or skills. Other actions include improving both board and individual evaluations to help identify gaps, as well as improving director onboarding and evaluation.

Country and industry trends

Israel, Singapore, Australia and Chile are the most satisfied that the board has the right combination of skill sets, backgrounds, experiences and perspectives to probe management’s strategic assumptions, whilst Korea, Japan and Nigeria are the least satisfied. The highest percentage reporting little or no discussion about board succession are in Poland, Japan, Brazil, Turkey, Bahrain, Colombia and Chile and in Belgium, Canada and Chile no respondents reported a formal board succession plan. The highest percentage, at 38 per cent, reporting a formal board succession plan are Nigeria and Switzerland.

Cyber risk is cited as a key driver in thinking about board composition in the banking/financial services sector, the highest percentage citing the need for international perspectives and experience are in the industrial manufacturing/chemicals sector and the highest percentage citing alignment of board talent with strategy is the healthcare industry. The retail/consumer goods sector is least satisfied that the board has the right combination of skill sets, backgrounds, experiences and perspectives to probe management’s strategic assumptions and the highest percentage reporting only informal discussion of board succession planning is the tech/software sector.

The survey findings point to the need for a strategic, integrated approach to board succession planning, composition and diversity, all of which should be part of board discussions about long-term strategy. Robust board and individual director evaluations are also vital and a key area that requires board attention.

For the full survey report go to: https://boardleadership.kpmg.us/content/dam/blc/pdfs/2016/global-pulse-survey-building-a-great-board.pdf


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Global News

Better CG disclosures in Malaysia

Bursa Malaysia has published its third Analysis of Corporate Governance Disclosures in Annual Reports which shows improvement in listed issuers’ corporate governance disclosures in 2016, a high level, overall, of adherence to the Listing Requirements and embracement of the Malaysian Code of Corporate Governance Principles and Recommendations.

The quality of disclosures amongst all listed issuers has improved on average by eight per cent to approximately 69 per cent: large-cap companies achieved average scores of 72 per cent, mid-cap companies 67 per cent and small-cap companies recorded significant improvements to approximately 68 per cent. Furthermore, 30 per cent of small-cap listed issuers scored bonus points for meaningful disclosures which provided insights into their corporate governance practices, as did 30 per cent of large-cap and 15 per cent of mid-cap companies. Listed issuers have also uploaded comprehensive board charters on their website and included details on the formal schedule of matters reserved for the board and the board’s oversight of management.

There was an increase in the number of listed issuers who separated the position of Chairman and CEO, in line with best practice. Ninety-four per cent also disclosed that they assessed their independent directors annually and 96 per cent who retained their independent directors beyond nine years provided justification in their AGM notice. Seventy-six per cent

FT-ICSA Boardroom Bellwether survey

‘The structure and composition of boards remains in the spotlight and the drive to improve board diversity continues’, according to the second 2016 FT-ICSA Boardroom Bellwether survey which canvasses the views of the FTSE 350 on the external environment as well as key governance issues such as board diversity, regulation, risk and compliance.

Board composition: Although significant progress has been made on improving gender diversity, there is still much more to be done to encourage wider ethnic and cultural diversity. Ethnic diversity has dropped to 22 per cent from 34 per cent in May 2016 and lower ratings are being seen across all categories of diversity. Companies face mounting pressure to pay more attention to identifying and developing future talent from a much wider pool of candidates in order to improve the spread of experience and perspective. Only 52 per cent of respondents feel their company’s executive pipeline is sufficient to provide a sustainable pool of talented and diverse board members, down from 56 per cent in May 2016.

Gender diversity: Sixty-three per cent of respondents report that their boards are diverse in terms of gender, down slightly from 67 per cent in May 2016, 68 per cent in December 2015 and 69 per cent in December 2014. Twenty-eight

also provided relevant information on how they assessed the suitability and independence of their external auditors.

The most significant improvement, from 58 per cent in 2014 to 68 per cent in 2016, was in relation to financial reporting disclosures about the audit committee and internal audit’s activities.

While disclosures have improved there is still room for improvement, especially disclosures on the activities of the board, board committee and individual directors. Only 56 per cent disclosed the criteria for evaluation of individual directors, 40 per cent disclosed criteria for evaluation of the board committee and 65 per cent disclosed criteria for evaluation of the board. Most listed issuers also continued to issue generic disclosures in their Statement of Risk Management and Internal Control.

In addition to this Report, each of the listed issuers reviewed will receive their individual disclosure scores and a detailed report showing where they have made adequate disclosures, as well as areas for improvement. The consolidated reports are useful to both listed issuers and investors in providing a comparative analysis of corporate governance practices across a wide segment of companies.

For the full report go to: http://www.bursamalaysia.com/misc/system/assets/19929/BURSA_MALAYSIA_ANALYSIS_OF_CORPORATE_GOVERNANCE_DISCLOSURES_REPORT_2016.pdf

per cent of FTSE 350 respondents have achieved less than 20 per cent representation on boards, with 40 per cent of FTSE 250 companies admitting to being below 20 per cent. The lack of progress is connected to the effectiveness of the female executive pipeline. The Hampton/Alexander Review, which calls for the number of women executive committee members to increase to one-third by 2020, reinforces this.

Risk: The pressure on boards to become more actively involved in risk management and reporting has increased over the past year and most boards receive regular updates from a chief risk officer or equivalent. Cyber risk is the primary concern, with 80 per cent of respondents rating the risk as increasing, followed by social media risk (52 per cent) and reputational risk (51 per cent). Political risk was rated joint lowest with legal risk at 41 per cent. As cyber security is seen as the main risk, 69 per cent of companies have assessed the vulnerability of their information assets and over half (59 per cent) have discussed and acted upon the Government’s ‘Ten Steps’ guidance, though there is much less take up (32 per cent) of the Government’s Cyber Essentials scheme.

For the full report go to: https://www.icsa.org.uk/knowledge/research/bellwether-winter-2016


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Global News

Guidelines on board evaluation in India

The Securities and Exchange Board of India (SEBI) has issued guidance on how companies should evaluate the performance of their directors to ensure objectivity and improve corporate governance.

The note, Guidance Note on Board Evaluation, is intended as guidance and does not constitute new rules. It covers all major aspects of board evaluation including: who is to be evaluated; the evaluation process including setting objectives and criteria to be adopted; feedback to those being evaluated; an action plan based on the results of the evaluation process; disclosure to stakeholders; frequency of board evaluation; responsibility for board evaluation; and reviewing the entire evaluation process.

The Guidance clarifies where responsibilities lie: overall responsibility for the board evaluation process and ensuring its effectiveness in improving board efficiency lies with the chairman and the chairman’s role needs to be laid out clearly in advance. Responsibility for reviewing the evaluation process lies with the board; and the nomination and remuneration committees are responsible for formulating the

performance evaluation criteria for independent directors and the board of directors.

Evaluations should be carried out internally through questionnaires and oral assessments, as well as through external experts to ensure objectivity and action plans should be based on these evaluations. Providing feedback to individual directors, the board and the committees is crucial and feedback may be provided orally by the chairman/external assessor to each director separately, to the entire board and to the committees; or by written assessment to every director, the board and committees. Whichever means of feedback is used, it is essential that it is given honestly and without bias.

Disclosure about the formal annual evaluation of the board, its committees and individual directors and of performance evaluation criteria for independent directors, should be made to the shareholders annually. Many organisations provide additional disclosures, including the results of the board evaluation, action taken on the basis of the evaluation and current status, to various stakeholders.

For the full guidance go to: http://www.sebi.gov.in/cms/sebi_data/attachdocs/1483607537807.pdf

Dutch CG Code compliance

The Dutch Corporate Governance Code Monitoring Committee has published its report on compliance with the Code by listed companies for the 2015 financial year. In addition to reviewing compliance with the Code, Monitoring Report 2016 also focuses on the composition of the supervisory board, remuneration for management and supervisory board members and shareholders.

Compliance with the Code: Overall compliance with the Code remains high (97 per cent), despite the modified, stricter assessment and four out of every five companies have an overall compliance rate of 95 per cent or more. Compliance varies slightly per stock market index. Providing an overview of the remuneration policy in the remuneration report is the provision most frequently not complied with and the profile for the supervisory board also shows relatively low compliance rates. Although companies do draw up a board profile, often they fail to disclose whether diversity targets have been achieved.

Supervisory board composition: Fifty-nine per cent of the companies surveyed have a supervisory board consisting entirely of independent supervisory board members and 27 per cent have one independent supervisory board member. Fouteen per cent stated that their supervisory board includes more than one supervisory board member

who can be considered to be dependent (often relating to their representing or owning more than 10 per cent of the shares in the company).

Remuneration: The provision on capping severance payments for management board members is one of the provisions that is most often explained (ie not applied). Reasons for not using the maximum severance payment of one full year’s salary largely relate to previous agreements. Companies comply well with the provision which stipulates that supervisory board members may not be remunerated in shares, however, share ownership by supervisory board members in their own companies occurs regularly. Companies do not always ensure that shares in these cases are being held for long-term investment purposes, the interpretation of ‘long-term’ varying from one company to the next.

Shareholders: The provision on the publication of the policy on bilateral contacts with shareholders is among the least complied with amongst smaller companies, these companies indicating that no such policy exists. Half of the companies surveyed have an anti-takeover foundation, however one-third of the companies do not know whether the board members of their anti-takeover foundation are also on the boards of any other anti-takeover foundations.

For the full report go to: www.commissiecorporategovernance.nl


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Sallie Pilot considers the findings of an annual global survey of business leaders which found that most of the executives polled believe that their organisations must shift their attention beyond profit to wider value creation.

Almost 90 per cent of executives believe that their organisations must shift their attention beyond profit to wider value creation. This is one of the findings from our latest Black Sun research, Purpose Beyond Profit, that was conducted jointly with the IIRC and accountancy bodies CIMA and AICPA. Launched in December, as part of a joint conference between the International Corporate Governance Network (ICGN) and the International Integrated Reporting Council (IIRC), the research also found that 79 per cent of the executives polled believe a longer-term perspective on strategic planning would improve value creation.

Scandals, distrust of big business and the financial system continued to be underlying themes in 2016, but our survey reinforces an emerging belief that business should be about more than turning a profit. Across all regions, the majority of executives agreed that organisations need to shift focus from pure shareholder value creation to value creation that includes wider stakeholder groups.

Companies need to think differently: ‘We have to get better at looking at the bigger picture, where our driver is not profit above all else, as this is an unsustainable business model’, commented one respondent. Today, organisations are considering a shift from short-term to long-term thinking, from financial capital to broader capitals, and a movement

from shareholder driven value to a stakeholder value model. Another respondent added: ‘The concept of shareholder value can actually lead to dysfunctional short-termism, so there is need for a more long-term value creation initiative, especially in Wall Street.’

Future success is dependent on creating value for wider stakeholder groups

In sync with the increasing emergence of a greater need to demonstrate how organisations create value, executives’ views of the traditional pyramid of influence – with profitability and financial return on top – has been challenged. The result is a new paradigm where future success will be dependent on creating value for broader stakeholder audiences. When executives were asked to rate the extent to which factors will be important to the success of their business in the future, ‘meeting the expectations and needs of customers’ was most important at 90 per cent, ‘profitability and financial return for investors’ followed at 80 per cent and ‘inspiring and engaging people’ not far behind at 75 per cent. ‘Partnering with suppliers and external partners’ as well as ‘transparency and public trust’ are also predicted to play a significant role.

When asked, although executives still feel that the value creation discussion is most useful for investors; this is now followed closely by employees and customers. This means

Feature

Companies must think ‘beyond profit’


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Feature

not only moving away from a sole focus on providing financial returns to investors, but also meeting expectations of customers and employees and communicating more effectively with broader stakeholders.

Longer-term perspectives on strategic planning will improve value creation potential

Granted that barriers to longer-term thinking and behaviour exist, if given the choice, almost two-thirds of executives feel they should be using a longer-term time horizon for strategic planning than they are currently. Additionally, despite the focus on short-termism, three quarters of executives believe that investors want a longer-term perspective on strategic planning when analysing performance. Dialogue for longer-term value creation and bridging the gap between participants in the capital markets was not only the title of the joint ICGN/IIRC conference, but seems to be a key theme for the future as longer-term perspectives become more desired by both executives and investors. Seventy-nine per cent of executives believe that this longer-term perspective would improve value creation potential; a clear sign that things need to change.

This importance of building trust and confidence with stakeholders, for the majority of executives, is seen to be a key element of an organisations communication strategy, with 93 per cent agreeing on the importance of effectively explaining how their business creates value through their corporate reporting. Furthermore, across the board, the importance and potential benefits of bringing together broader information to encourage integrated thinking, better explain value creation and improve strategic decision-making, was undisputed.

Encouragingly, almost all executives believe that being able to bring together financial and non-financial information, to better explain how value is created over time, would lead to a more effective identification and management of risk; a more

forward-looking, longer-term view of company performance; and improvements in decision-making. Despite executives globally agreeing on the increasing value of understanding and communicating the value creation potential of their organisations, the survey clearly highlights a significant ‘knowledge and skills gap’ that needs to be addressed. Only a handful of executives feel that they currently have the management and reporting information to understand and interpret the future drivers of their business in order to make strategic decisions, and less than a quarter feel that they are meeting external information needs.

‘We have to get better at looking at the bigger picture, where our driver is not profit above all else, as this is an unsustainable business model.’Reporting can be a powerful tool to drive behavioural change

There’s a growing appreciation that the 21st century requires an evolved approach. Many organisations are beginning to understand how the reporting process can be used to highlight their ability to create value in the short, medium and long-term and drive positive behavioural change. An overwhelming 93 per cent of executives agree that corporate reporting is critical to capture the value creation story.

Combine this with the increasing alignment between the issues that organisations face and those that Integrated Reporting


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seek to resolve. While there is no one solution, momentum has been growing for broader reporting and we agree with the 83 per cent of executives that believe that adopting Integrated Reporting would help deliver success to their organisations. Such a commitment from boards would help address some of the key challenges, whilst also strengthen the role business can play in aligning corporate behaviours to wider goals of financial stability and sustainable development.

‘The concept of shareholder value can actually lead to dysfunctional short-termism, so there is need for a more long-term value creation initiative, especially in Wall Street.’Purpose beyond profit is an imperative in today’s world and this will only be achieved through a better understanding and communication of the wider factors, which contribute to value creation and building successful relationships with a range of stakeholders. The more business leaders who understand the business case for broader reporting, the faster progress will be towards better business in a better world.

Key stats:

89 per cent agree business must deliver purpose beyond profit

93 per cent agree corporate reporting is critical to the value creation story

83 per cent believe that adopting IR would help deliver success to their organisations

This AICPA-CIMA-Black Sun-IIRC Board-Level Value Insight: Purpose beyond Profit is an annual global survey that finds out how business leaders think they can best tell their value creation story. This survey is based on the views of over 400 AICPA and CIMA executive members from over 50 countries. For a full report go to www.blacksunplc.com

Sallie Pilot is Director of Planning, Research and Strategy at Black Sun Plc. She is responsible for setting overall strategic direction for client work and the integrity of all of Black Sun’s industry leading research.

Sallie is a recognised commentator on corporate reporting and is very active in industry debate, regularly engaging with Government, industry and professional bodies, regulators and best practice organisations. An avid supporter of the International Integrated Reporting Council (IIRC), Sallie has collaborated on numerous research reports to evidence the business case for integrated reporting including Realizing the Benefits and What Good Looks Like as well as the creation and management of the Emerging Best Practice Database (www.examples.theiirc.org).

In the future, the importance of meeting the expectations and needs of customers and inspiring and engaging people will grow far more in importance than only profitability and financial return for investors.


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Feature

A surprising interest in governance

The government Green Paper on corporate governance (http://bit.ly/2iEsu4o) is a careful and measured response to a set of quite strong political announcements. Theresa May, speaking in Birmingham on the day she later became presumptive Prime Minister (as Andrea Leadsom withdrew from the Conservative Party leadership contest), made two key calls: that there should be binding votes on executive pay, and that companies should have both employees and consumers on their boards. She repeated the same calls in later speeches, urging these steps as necessary to reconnect business with the general public and to help generate an economy that works for everyone.

The proposals in the Green Paper include these ideas, but also offer up some alternative ways in which these same issues might be addressed. Some commentators, perhaps inevitably, have talked about this as back-tracking and a political u-turn, but it seems to me healthy to have a political class that listens to rational arguments and seeks to deliver its aims not just by the route first thought of but by ones that are both practical and effective. That is hopefully what the Green Paper represents, and what will be the outcome of the ultimate White Paper proposals that will follow.

The proposals follow a voting season that saw unprecedented opposition to certain remuneration proposals, leading to some resolutions being defeated and some passed by only very small margins. It seems clear that these significant votes reflect a coming of age of the greater disclosure and new powers only recently given to shareholders. And this is further to a record of restraint in executive pay increases in the UK. While the High Pay Centre figure for the ‘average’ growth in CEO pay in the UK – 10 per cent in the last year – is most frequently quoted, this is a mean figure the Centre itself acknowledges to be skewed by the pay of a few individuals. The Centre’s own data for median growth in pay in the last year for the FTSE 100 is a more sober 2.5 per cent, closer in line with broad market trends, and around three per cent annual growth over the last five years. In this context it is not immediately clear that further change is needed – though further change is clearly coming.

What a binding vote means

Thus, instead of simply the most obvious form of binding vote on pay, the Green Paper offers three versions of such a binding vote. The first is indeed the idea that some portion of incentive awards could only be made with the explicit approval of shareholders. The downsides of this are clear, as

it intrudes shareholders into decisions that are more properly the board’s, makes reward less certain and so executive director roles at UK PLCs less attractive, and probably also risks increasing the quantum of pay to compensate for the uncertainties. This latter point is presumably entirely the opposite of the government’s underlying intent. Investors may also vote more cautiously given the significant potential consequences of defeat.

Binding pay vote option two is rather more promising: a formalised process of escalation from a defeated vote (or perhaps from votes with significant levels of dissent). The required route that might arise is floated but not specified; investors have discussed an approach that bound the company to bring forward a revised remuneration policy at its next AGM, or maybe earlier, with perhaps a higher threshold for it to be passed – say 75 per cent support. This would intensify the nature of consultation with those companies where issues exist and give shareholders the opportunity for greater influence. It would be implicit that shareholders would be expected to take a view not only on the remuneration resolutions but also the director re-elections at that AGM.

Options three and four seem less likely to gain traction: neither overall caps on pay, nor more frequent votes on policy, seem particularly effectual or positive developments. The final element in this first segment of the Green Paper suggests greater specificity in the Corporate Governance Code on engagement between companies and shareholders, particularly when pay votes have gone awry; it’s not clear that this is necessary given the high level of activity and the rapid development of practice in this regard. Companies are already particularly avid to have pay consultations in such circumstances.

But this proposal is a neat segue into the next segment of proposals, which seeks to encourage greater engagement on pay. Perhaps it is enough to say that from the practitioner perspective it is hard to imagine how it could be possible for there to be more engagement on pay.

The other major innovation proposed on pay is the idea of pay ratios, disclosing the ratio between CEO pay and that of the average employee. Much has been said about this metric being largely meaningless and certainly not comparable between sectors or individual companies. The comparability point is certainly true, but disclosure by an individual company over time would be informative, and would provide some downwards pressure on pay escalation for top management. That seems to be the political intent,

Paul Lee considers the proposals in the UK Governments’ recent Green Paper on corporate governance.


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and certainly this disclosure would bring some reality to the Corporate Governance Code’s stricture that remuneration committees should ‘be sensitive to pay and employment conditions elsewhere in the group’. A further pay ratio that we and the Investment Association are promoting alongside this is the ratio of CEO pay to that of the average in the executive committee (or equivalent). We think this will be more comparable across companies and revealing of a number of things, not least succession planning.

The employee voice

Again with regard to increasing the voice of employees and other stakeholders in the boardroom, the Green Paper offers up a range of options. These include the original headline of stakeholder representative directors; this, particularly the concept of the employee representative director, has caused inordinate angst, with many claiming that the idea puts the unitary board structure at risk. This seems nonsense, and not only because First Group has already proved how possible it is to have such a director within the UK legal system and without undermining the unitary board. Nowhere has the government suggested that the UK should follow Germany down the route of substantial numbers of employee directors and a two-tier board structure.

But alongside this headlining proposal, the Green Paper offers other ways in which stakeholder views can be more actively considered by boards: either by the creation of stakeholder panels which are actively consulted on key issues, or by designating individual non-executive directors (non-execs) with the responsibility of being an active liaison for the board with particular stakeholders. And they propose requiring greater reporting by the board on its approach to stakeholder engagement, in effect attaching a reporting requirement to the duty in section 172 of the Companies Act 2006 to have regard to the interests of the full range of stakeholders. My personal expectation is that the reporting requirement will be put in place, and alongside this will be established an expectation that boards will put in place one or more of the formal mechanisms for gaining input from stakeholders, whether that is through representative directors, panels or designated non-execs.

It is well known that the Financial Reporting Council (FRC) has pitched for the right to oversee such s 172 disclosures and to in some way more actively police the work of non-execs. It is certainly an anomaly that the FRC can call to account directors (albeit through a very slow due process) who are members of the accountancy profession but that it has no broader remit for other directors. Addressing this anomaly would seem sensible, but it will be interesting to see if the government is willing to grant such broad additional powers to the FRC without also considering whether the

organisation needs reform and itself be more broadly-based and accountable.

Going private

The final segment of the Green Paper is very clearly written as a response to what might simply be called the BHS problem: it asks questions around whether there should be greater constraints and expectations set for large private businesses. The concern is that private businesses, even those with significant numbers of public stakeholders, including current employees and pensioners, have limited accountability to the outside world. While s 172 applies to their directors as much as it does to those of PLCs the lack of any enforcement mechanism raises concerns when abuses become apparent. Instead, their owners enjoy the benefits of limited liability without facing significant reporting or accountability burdens.

While some might argue that the specific issues at BHS might be addressed most readily by bolstering the powers of the Pensions Regulator, it seems inevitable that we will see some form of increased reporting requirements for the largest private companies, and some corporate governance standards also being applied to the sector. The most obvious model for the additional reporting requirements are the BVCA standards brought in following the Walker Review of 2012. Again on the corporate governance side the FRC has volunteered itself to create a Code for the private company sector.

While the readers of this journal, and this article’s author, regard corporate governance as of real importance and impact, perhaps the most remarkable thing about the Green Paper is its very existence at all. One of the new Prime Minister’s most pressing agenda items, pursued early in office having been flagged in the leadership campaign, is the issue of corporate governance, normally a matter of niche and esoteric interest. The political imperative seems to arise from a clear reading of the Brexit referendum: that there is a disconnect between business and the people, and a need to demonstrate that the economy and business delivers value for all our population. Developments in corporate governance may assist in that regard, but perhaps the real challenge arising from that assessment is that very different behaviour and thinking will be required from many in the business community.

Paul Lee is Head of Corporate Governance at Aberdeen Asset Management and is responsible for global stewardship activities - engagement and dialogue with the boards of companies in which the firm invests. http://www.aberdeen-asset.co.uk/

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