Revised UK Code Focuses On Workers And A Broader Definition Of Corporate Governance

"Companies do not exist in isolation" states the revised UK Corporate Governance Code published today by the Financial Reporting Council (FRC).  A new provision asks for much greater board engagement with workers as part of an emphasis on the company's relationship with a wider range of stakeholders, and overall the Code demands more accountability.

For engagement with workers, it suggests companies either appoint a director from the workforce, and/or a formal workforce advisory panel and a designated non-executive director. If the board has not chosen one or more of these methods, it says, "it should explain what alternative arrangements are in place and why it considers that they are effective."

Prime Minister Theresa May first mentioned putting workers on boards of UK listed companies even before she took office. Little noted at the time as a commitment - and with the country's attention focused elsewhere in the last two years - it has since been regarded with a mix of scepticism and derision. But the wider conversation in corporate governance around the role of business in society has been fuelled globally since then too, and there have been multiple highly publicised corporate failures in the UK involving profound failures of corporate governance.

To succeed in the long-term, "directors and the companies they lead need to build and maintain successful relationships with a wide range of stakeholders" says the revised Code.

Companies are being asked to describe in the annual report how the interests of all key stakeholders and the duties set out in section 172 of the Companies Act have been considered in board discussions and decision making. There should be a means, says the revised Code, for "the workforce to raise concerns in confidence and – if they wish – anonymously. The board should routinely review this and the reports arising from its operation. It should ensure that arrangements are in place for the proportionate and independent investigation of such matters and for follow-up action."

In response to public concern that executive remuneration can be excessive and ongoing efforts to foster trust in businesses, the new Code emphasises that remuneration committees "should take into account workforce remuneration and related policies when setting director remuneration."

Formulaic calculations of performance-related pay should be rejected, it says, and remuneration committees "should apply discretion when the resulting outcome is not justified." It goes on to say that "they should also include provisions that would enable the company to recover and/or withhold sums or share awards and specify the circumstances in which it would be appropriate to do so."

Share awards for executive directors are now to be subject to a total vesting and holding period of five years or more, instead of three years.

Demanding transparency on conversations that may in the past have taken place with investors behind closed doors, the revised Code states that the annual report must include "an explanation of the strategic rationale for executive directors’ remuneration policies, structures and any performance metrics and detail including what engagement has taken place with shareholders and the impact this has had on remuneration policy and outcomes."

It also asks for disclosure on "what engagement with the workforce has taken place to explain how executive remuneration aligns with wider company pay policy." In linking these demands on remuneration and all the way through this Code, the regulator is spreading the responsibility of meaningful company reporting to investors and proxy advisers to assess explanations given, and ask questions.

It expects much clearer reporting on remuneration. In 2018, changing business models that include the use of the 'gig economy' make remuneration across a company a much broader social issue than ever before.

The new Code - which has shaved a third off the old one and considerably sharpened its use of language for clarity - has moved beyond boardroom composition alone as the focus to assess corporate governance standards to the context in which a business functions within society. It has also made important alterations in the interests of independent, diverse and dynamic boardrooms, notably in the introduction of a nine year provision for Chair appointments.

Allowing for the possibility that a Chair may well be appointed internally, and mindful of the fact that women are often the ones likely to be promoted in that manner, the FRC stresses that the  nine-year rule for Chairs is 'comply or explain.' But the revised Code strengthens the consideration of 'overboarding' in appointments, stresses reporting on the gender balance of senior management and direct reports, and gives nomination committees responsibility for more effective succession planning.

The language is clearer on board composition and the role of the nominations committee. Both appointments and succession plans should be based on merit and objective criteria but, within this context, "should promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths."

After years of the UK pushing hard on gender diversity, there appears now to be growing recognition that it is perhaps also about making boardrooms more representative of the consumers who are their customers. It has been seven years since Lord Davies launched a review on behalf of the UK government for women on boards, and despite intense pressure and considerable progress made on targets, there are still ten all-male boards in the FTSE 350.

A focus on gender diversity alone in boardrooms will also not lead to the change that is required to keep up with technological transformation and new competitive challenges on the economic landscape. There is an important change in the revised Code on board evaluation, which could feed through to changing the composition of boardrooms.

The revised UK Code states that there should be a formal and rigorous evaluation of the performance of the board, its committees, the chair and individual directors every year, and the Chair should consider having a regular externally facilitated board evaluation.

Insights into Chairs in the FTSE 350 was provided not long ago in a piece of research that I covered here.

Board evaluation has long been an area on the corporate governance business gravy train that is open to abuse and exploitation, with boards adopting a box-ticking mentality and board evaluators content to pick up high fees in return for uncritical evaluations.

It is a subject I have addressed repeatedly, here on Board Talk and on Forbes - where in 2014 I wrote a piece entitled Tesco's Meltdown Shines A Light On Board Evaluation. More recently, we have had the case of Carillion plc, a lesson in the failure of corporate governance at almost every level.

With these changes to the revised Code, the FRC is stressing the value of good board evaluation properly executed in circumstances where there is no conflict of interest - while acknowledging that many external facilitators have done evaluations that have involved no direct contact with the board, relying merely on questionnaires and questioning by telephone.

"As far as we are aware, the evaluation done for Carillion plc did not involve any contact with the board" said  David Styles, Director of Corporate Governance for the FRC, in answer to my question. An annual formal rigorous evaluation of the board required for all companies could go a long way towards best practice in the UK's boardrooms.

The revised Code states that the annual report should describe the work of the nomination committee, including the process used in relation to appointments, its approach to succession planning and how both support developing a diverse pipeline. It also asks for information on how the board evaluation has been conducted, the nature and extent of an external evaluator’s contact with the board and individual directors, the outcomes and actions taken, and how it has or will influence board composition.

The nominations committee will also be expected to reveal in the annual report the company  policy on diversity and inclusion, its objectives and linkage to company strategy, how it has been implemented and progress on achieving the objectives and the gender balance of those in senior management and their direct reports.

Board evaluation could become a critical tool to bring together many aspects of good corporate governance while exploding networks that have existed in this area for years, raising eyebrows around potential 'conflict of interest.'

Audit is one area of the revised Code where there appears to be little that is new - hardly surprising perhaps, given that some changes were made quite recently. It is also likely to be because the  FRC and its role as the accounting regulator as well as the guardian of the UK's Corporate Governance Code is currently under investigation by the Kingman Review.

But the timing of many initiatives in the last two years has been odd on multiple fronts, given the domination of the uncertainties surrounding Brexit on the economic landscape. For companies struggling with that, the Code's recognition that they do not "exist in isolation" may seem bittersweet, and the demands made by these revisions another questionable Brexit dividend.

"Britain has a good reputation internationally for being a dependable place to do business, based on required high standards. It is right that we keep under review and update our corporate governance code to ensure the highest standards. That is why I supported the FRC in deciding to update their Corporate Governance Code, and I am pleased to see the revised Code" said Greg Clark, UK Business Secretary.

“These changes will drive improvements in how boardrooms engage with employees, customers and suppliers as well as shareholders, delivering better business performance and public confidence in the way businesses are run. They will help the UK remain the best place in the world to work, invest and do business” he added.