The Government has published its response to the green paper on corporate governance reform. The proposed reforms are intended to “improve corporate governance and give workers and investors a stronger voice“.
On 29 August 2017, the Department for Business, Energy and Industrial Strategy (BEIS) published its formal response to the Government’s green paper on proposed reforms to corporate governance. There are three main areas of reform:
- executive pay;
- greater employee and other stakeholder input at board level; and
- corporate governance in large privately-owned companies.
The intention is to implement the reforms so that they apply to accounting periods starting on or after 1 June 2018. The implementation will be via secondary legislation and changes to the UK Corporate Governance Code (the Code).
CEO pay ratio reporting
Quoted companies will be required to disclose in their annual remuneration report the ratio of their CEO’s pay to the average pay of their UK workforce. There will also be a requirement to include 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.
This new CEO pay reporting requirement will sit alongside the existing requirement to disclose in the directors’ remuneration report the annual increase in CEO pay compared to the annual increase in the average pay of the entire workforce.
Reporting on LTIPs
Secondary legislation will be introduced to require quoted companies to provide a clearer explanation in their remuneration policies of the range of potential outcomes of long-term incentive plans (LTIPs). This will build on the existing requirements governing the content of remuneration policies contained in The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 and will tackle the issue of some LTIPs generating awards which are out of line with the original expectations of investors.
Structuring of LTIPs
The Government proposes that the minimum vesting and post-vesting holding period for executive share awards be extended from three to five years to encourage companies to have a longer-term focus when setting pay. BEIS will invite the Financial Reporting Council (FRC) to consult on this proposal. Since many companies are operating their plans on this basis anyway it is not thought that it will meet with much resistance.
Remuneration committees will be given broader responsibility for overseeing pay and incentives across the company and to engage with the workforce to explain how executive pay aligns with the wider company pay policy. In addition, the chair of a remuneration committee will need to have served for 12 months on the committee before holding the position of chair. The FRC will be asked to revise the Code accordingly.
Shareholder opposition to pay awards
Premium listed companies which encounter significant opposition (such as a shareholder vote of 20 per cent. or more) to executive pay proposals will need to take specific steps to address the problem. The Investment Association will maintain a public register of listed companies which encounter shareholder opposition along with a record of what the companies say they are doing to address the shareholders’ concerns. In addition the FRC will consult on revisions to the Code to set out the steps which a company should take when they meet with opposition.
Strengthening the employee, customer and wider stakeholder voice
Section 172 compliance
Secondary legislation will be introduced to require all companies of a significant size (probably more than 1,000 employees), both private and public, to explain how their directors comply with the requirement to consider the wider stakeholders when promoting the success of the company under section 172 of the Companies Act 2006.
Employee engagement mechanisms
The FRC will develop a new principle within the Code which establishes the importance of strengthening the voice of employees and other non-shareholder interests at board level. There will be a requirement for 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.
Corporate Governance in large privately-held businesses
A corporate governance code for large, private companies
The FRC will be asked to work with other industry bodies such as the IoD, CBI and BVCA to produce a corporate governance code for large private companies. It is thought that the code will only apply to companies with more than 2,000 employees.
Corporate governance reporting
Secondary legislation will be introduced requiring companies with more than 2,000 employees, whether private or public, to disclose their corporate governance arrangements in their directors’ report and on their website, including whether they follow any formal code.
The reforms are a somewhat watered down version of those proposals that were trumpeted during Theresa May’s leadership and subsequent election campaigns. They arguably strike a balance between mandatory pay caps and employee board representation at one end of the ideological scale and concerns about snuffing out talent at the other.
The aim of implementation by June 2018 is ambitious since legislation will need to be passed. We will keep you updated on developments and whether or not the timetable is likely to shift.