U.K. debate on corporate culture rolls on

It has been a tumultuous summer for U.K. business since the country decided to break away from the European Union. Uncertainty surrounding what shape Brexit will take—and what rights U.K. companies and exporters will retain—remains high three months after the referendum vote, and the indication that the government will trigger Article 50 by next April has done little to settle nerves.

But alongside Brexit, talk of reforming the United Kingdom’s corporate governance regime has gathered momentum, as well as support, from several quarters. Business tends to have an instinctive dislike of regulation, but it looks as though change is coming—and that it is necessary. “The reputation of corporate Britain has not recovered from the financial crisis, and there are important questions that need to be addressed on issues including transparency, executive pay, and board diversity,” said Simon Walker, director general of the Institute of Directors (IoD), one of the United Kingdom’s largest business lobby groups.

The United Kingdom’s corporate governance regulator, the Financial Reporting Council (FRC), has been trying to instil in boards the need for them to lead by example. On 20 Sept., it ran a conference called Culture to Capital: aligning corporate behaviour with long-term performance. Hot on the heels of its “report of observations” on corporate culture and the role of boards released on 20 July, the conference—which featured guest speakers such as Sir Roger Carr, chairman of U.K. defence company BAE Systems; Sacha Romanovitch, CEO of accountants Grant Thornton; and Philippa Foster Back, director of the Institute of Business Ethics—aimed to reiterate the importance of boards focusing on long-term goals rather than being incentivized by rewards for short-term gains, as well as the need for executives to set the tone for ongoing business behaviour within their organisations.

Sir Win Bischoff, FRC chairman, told attendees that “we need a concerted effort to improve the integrity of business and its connectivity with society. Codes put forward principles for best practice that make bad behaviour less likely to occur, and public reporting can make it harder to conceal such behaviour. But, by itself, a code does not prevent inappropriate behaviour, strategies, or decisions. Only the people, particularly the leaders within a business, can do that.”

“If you are saying that shareholders should be able to give a green or red light on pay every year, then we are in danger of treading on the toes of the board and taking control of the pay decision.”
Paul Lee, Head of Corporate Governance, Aberdeen Asset Management

The FRC’s July report essentially highlighted the areas that the regulator deems to be best practice—but deliberately did not press any company to follow suit, believing that boards should be free to take their own direction. However, the “takeaways” from the report are that companies should recognize the value of culture, align incentives with long-term performance, and demonstrate leadership (particularly from the CEO) in setting the tone.

The report also suggests that companies should foster a climate of being open and accountable, use indicators to assess and measure engagement with culture, and consider how they report on it. Outside of the boardroom, the FRC says that investors should also challenge themselves about the behaviours they are encouraging in companies and to reflect on their own culture, referring to the Stewardship Code it launched in 2010.

Currently, the regulator is not seeking to force companies to assess their culture—it is just encouraging more organisations to do so. But perhaps more of a prompt is needed: According to EY’s survey on narrative reporting in FTSE350 companies released in September, only 9 percent of annual reports provide an explanation of how the board monitors or measures culture.

Yet other developments may mean that the regulator will not have to implement any changes—the FRC will simply be there to oversee and enforce them.

Corporate governance has gained traction as a key political topic in the United Kingdom over the past few months. On 16 Sept., the House of Commons Business, Innovation, and Skills (BIS) Committee launched an inquiry on corporate governance, focusing on executive pay, directors’ duties, and the composition of boardrooms, including worker representation and gender balance in executive positions. The committee has asked for written submissions by 26 Oct.

Iain Wright MP, committee chair, said: “Irresponsible business behaviour and poor corporate governance ill serves workers, but it also tarnishes the reputation of business and undermines public trust in enterprise. We need to look again at the laws that govern business and how they are enforced.”

BIS INQUIRY INTO CORPORATE GOVERN ANCE

There are three main areas that BIS’ inquiry will examine regarding the state of corporate governance in the U.K., and whether further reform is necessary. Below is an excerpt from the inquiry.
Executive pay
The BIS committee wants to examine whether executive pay should take account of companies' long-term performance, and reflect the value added by executives relative to junior employees. The inquiry will also look at whether recent high-profile shareholder actions suggest the current framework is working or whether shareholders need a greater role.
Director duties
The inquiry will examine whether company law is sufficiently clear on the role of directors and non-executive directors, and look at how the interests of shareholders and employees are best balanced to ensure effective challenge and transparency, and retain public confidence.
Composition of boards
The committee wants to examine what more should be done to increase the number of women in executive positions, explore proposals on worker representation on boards and remuneration committees, and consider how greater boardroom diversity can be achieved.
Source: Parliament

Theresa May—just days before she became Prime Minister in July—unveiled her thoughts about how corporate accountability needs to be overhauled to ensure that companies are run responsibly. Though no actual policy has been put forward yet—there have been hints that the proposals will come before Christmas—Prime Minister May has argued for worker representation on boards (as is the case, to varying degrees, in 19 of the 31 European Economic Area member states), and for the state to take a more strident role in protecting U.K. companies from being snapped up by foreign buyers to prevent asset stripping.

She has also championed increased diversity in boards, lamenting the fact—as she described in a speech she gave in Birmingham in July while on the campaign trail—that the United Kingdom’s pool of non-executive directors are still “drawn from the same, narrow social and professional circles as the executive team” and that “the scrutiny they provide is just not good enough.”

But her main gripe is the widening gap between employee and executive pay, which has more than trebled in the past 18 years while the FTSE is trading at the same level (and 10 percent below its high peak). “There is an irrational, unhealthy and growing gap between what these companies pay their workers and what they pay their bosses,” she said.

And she’s right. According to research released by the High Pay Centre in August, the average FTSE100 CEO pay package was £5.48m in 2015, up from £4.96m in 2014—a rise of around 10 percent (still small change compared to a Fortune 100 CEO in the United States). And in contrast to the generous pay packages awarded to their executives, only a quarter of FTSE 100 companies are accredited by campaign group the Living Wage Foundation for paying the “living wage”—deemed to be the realistic minimum sum that people actually need to cover the cost of running a household and raising a family—to all their U.K.-based staff. Currently, the living wage is £8.25 an hour nationally—rising to £9.40 an hour in London—compared to a maximum of £7.20 per hour for the national minimum wage. 

To curb fat-cat pay deals, May wants to simplify bonus structures, check incentives are aligned with long-term strategy, make shareholder votes on corporate pay binding rather than advisory, and ensure full disclosure of bonus targets and the publication of “pay multiple” data—that is, the ratio between the CEO’s pay and the average company worker’s pay. Presently, no FTSE 100 company publishes its CEO to employee pay ratio, according to the High Pay Centre.

The measures would go further than the changes introduced in 2013 by former business secretary Vince Cable. Those reforms have handed shareholders greater power over companies’ executive pay policies by forcing companies to hold a binding vote on prospective pay policy at least once every three years, and an annual advisory vote on the annual report on remuneration.

The mooted proposals have already had a positive response from several quarters. Fund manager Hermes Investment Management said the prime minister’s package should be “applauded” as a way to get much-needed “restraint” in boardrooms. The IoD believes that shareholders should have more say on boardroom pay—especially as “it is still possible for directors to ignore even substantial shareholder rebellions”—and it also backs moves to put employees on boards, though it would stop short of making it compulsory for firms.

The Trades Union Congress (TUC), the umbrella organisation for the United Kingdom’s trades unions, has long argued for workers to be given seats on company boards and remuneration committees, calling it “a common sense approach” that would “inject a much-needed dose of reality into boardrooms.” Currently, only one FTSE 100 company has employee representatives on the board. TUI, which recently merged with German incorporated TUI AG, has an airline pilot and a travel agent on its supervisory board.

However, not everyone is convinced. Paul Lee, head of corporate governance at fund manager Aberdeen Asset Management, has reservations on binding votes. “If you are saying that shareholders should be able to give a green or red light on pay every year, then we are in danger of treading on the toes of the board and taking control of the pay decision,” he said.

Others believe that other matters are more important—namely what shape Brexit will take, and how it will impact U.K. business and the economy—and that further regulation is unnecessary. “This would appear to be a measurable hike in regulation without any other saving graces,” said Terry Scuoler, chief executive of U.K. manufacturers’ federation EEF.

“Ministers have a history of starting at the top and then working their way down—creating new reporting burdens, compliance regimes, and tensions that affect a broad swath of the business community,” said Adam Marshall, acting director-general of the British Chambers of Commerce, a business lobby group.

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