Corporate Advisory

Corporate Governance – The Road to Revamp

A financial watchdog is starting to comb through more than 250 responses to its proposed overhaul of the UK’s best practice rules for listed companies.

Companies, investors and politicians have made submissions to the Financial Reporting Council, which is consulting on the first big revamp of the 25-year-old corporate governance code since 2014. Theresa May pledged action against corporate excess shortly before she became prime minister, although some of her most radical proposals have been ditched.

Against this backdrop, the FRC’s update to the corporate governance code, companies must comply with, or explain why they do not,  is nevertheless expected to unleash some significant changes when it takes effect in the summer.

 1. Board independence

One of the most contentious proposals outlined by the FRC in December was the introduction of a nine-year tenure limit for independent chairs and directors in the code, in an attempt to put an end to stale and insular boards.

This revision could prove embarrassing for the chairs of dozens of listed companies who have already served more than nine years on the board when their time as a non-executive director is taken into account.

Aviva, the insurer that has a big investment management arm, said it was happy for the FRC proposal to apply to non-executive directors, but not chairs.

The International Corporate Governance Network, a coalition of investors managing assets worth $26tn, said: “We are concerned that this more rigid definition of independence might be overly prescriptive and could result in unintended consequences, particularly if applied equally to the company’s chairman as to other non-executive directors.”

2. Executive pay

With investors increasing their focus on excessive executive pay, the FRC is proposing new provisions in the code on bonuses, in order to promote long-term decision making at companies.

The FRC says in normal circumstances, shares received as part of an executive bonus should be held for at least five years, a proposal welcomed by many big investors, including Norges Bank, which oversees Norway’s sovereign wealth fund.

Aviva said: “We believe that five years should be considered the minimum. We still consider there to often be a gap between the business and capex cycle and the periods in which management teams are evaluated and rewarded.”

The Pensions and Lifetime Savings Association, the UK trade body for 1,300 pension schemes with £1tn in assets, called for tougher rules, saying many of its members and the public believe executive pay is out of control.

3. Financial reporting

The collapse of Carillion has raised fresh concerns about the quality of companies’ financial reporting as well as the work done by their internal and external auditors, and the FRC has been urged to update the code to improve confidence in accounting.

The Chartered Institute of Internal Auditors said the new code should explicitly require “regular monitoring and reviewing of the independence and objectivity of internal audit”.

Old Mutual Global Investors, the UK asset manager, said some corporate viability statements, which provide an assessment of a company’s long-term solvency and liquidity, have recently proven to be “fatally flawed”.

It suggested that companies should be required to disclose what stress testing they undertook, and the results, when formulating these statements.

4. Diversity drive

Under the proposed revamp to the code, companies will be asked to disclose what action they have taken to increase ethnic and social diversity in their “executive pipeline”.

This revision has been backed by ShareAction, a charity campaigning for better practice by investors, although it called for the focus to extend beyond company managers tipped to reach the top.

The Investment Association, the UK trade body that represents 200 asset managers overseeing a combined £6.9tn, urged caution, saying that more work needed to be done on the best ways for companies to report on diversity.

Meanwhile, Rachel Reeves, Labour chair of the Commons business select committee, urged the FRC to require companies to explain how their remuneration policy “will address any gender pay gap in the company”.

5. Contribution to society

The FRC is proposing that companies should for the first time disclose how they “contribute to wider society”, alongside their efforts to promote the long-term success of their businesses and generate value for shareholders.

Richard Buxton, one of Britain’s best-known fund managers who runs Old Mutual Global Investors, has described this revision as “radical” and “terrific”. “This makes it clear that generating value for shareholders is not the sole raison d’être [for companies] but equal to contributing to wider society,” he said in December.

But many rival fund managers strongly disagree, including those represented by the Investment Association.

“We are concerned that the wording of the [proposed] code does not fully acknowledge shareholder primacy reflected in [the Companies Act], as it puts contributions to society on the same level as generating value for shareholders,” said the Investment Association.

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