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Both opportunity and threat

07 March 2017 by Peter Swabey

Green Paper: Both opportunity and threat - read more

ICSA’s response to the corporate governance Green Paper

On 29 November, the UK Government published its long-awaited Green Paper on corporate governance reform. This is a wide-ranging review of the governance landscape in the UK and represents both a huge opportunity and a huge threat.

It is an opportunity because it enables a review of some of the issues that have created a general lack of trust in business, and a threat as there is a risk that responses will focus on individual poor examples as a basis for change, rather than the good practice of the majority of companies. This could damage the UK corporate governance model, a system which is widely admired and often replicated around the world.

At ICSA, we take very seriously our Royal Charter duty to lead ‘effective governance’. Company secretaries have a key role in leading effective governance in their companies and advising their boards. Our investor members have a similarly key role in investor oversight of that work.

We therefore have a keen interest in the issues raised in the Green Paper and, we believe, an unrivalled position from which to understand those issues through our members’ access to discussions on executive pay and attendance at remuneration committee and board meetings.

The Green Paper focuses on three issues:

  • Executive pay
  • Strengthening the employee, customer and wider stakeholder voice
  • Corporate governance in large privately-held businesses.

Executive pay

Some action needs to be taken about executive pay. But it is essential to be clear about the ill we are seeking to cure, because not all of those who criticise ‘high pay’ are coming from the same viewpoint and the solution to the problem depends very much on what the problem is. Is it that pay is disassociated from performance; that there is income inequality in our society; or that some people are simply paid too much?

Each of these concerns is a valid one for the Government to address, but they are different and so the appropriate solution for each of them will also differ. There are a raft of legal and regulatory powers open to the Government and it is important that they pick the right ones to address the ill they are seeking to resolve.

“There is a socially unsustainable gap between the highest and lowest paid in society”

In terms of the linkage of pay to performance, there has been a great deal of effective work done in relation to public companies to address this issue. This has primarily been led by shareholders, who have reviewed and approved, or not as the case may be, executive pay policies that are designed to align executive and shareholder interests, and which recognise, where appropriate, the need to reflect the international talent pool from which some companies must seek senior executives.

Shareholders have powers to reject pay policies of which they disapprove and to indicate to boards that they do not agree with the manner in which a policy has been implemented.

If the central issue is that of income inequality in society, that is not just a corporate governance issue and so not one for companies and shareholders to address in isolation. There is a considerable and socially unsustainable gap between the highest and lowest paid in society, but there are a whole range of fiscal and other remedies, including raising minimum pay and giving greater employment rights to temporary workers, available to the Government to address these issues of inequality.

Similar arguments apply to quantum – the idea that there is a figure above which it is unreasonable for anyone to be paid. But executives of listed companies are not the only high-income earners in our society.

For good reason, their pay is highly visible, but that does not make them the highest paid in our society, compared with, for example, some of those in equivalent positions in private companies or professional firms, to say nothing of entertainment or sports stars or those with income from inherited wealth.

The Government may legislate to restrict the quantum of pay if it wishes, but the argument for limiting such restrictions only to the employees of quoted companies has yet to be made and doing so will address only a small proportion of high incomes.

We do not believe shareholders need stronger powers over executive pay at this time. Executive pay in UK companies has never been more regulated and only a small minority of companies are the target of shareholder anger.

In our view, the most effective policy intervention would be one that addressed specific areas of abuse, rather than the market as a whole. It would be sensible to evaluate the impact of the 2013 regulations, which gave shareholders a binding vote on pay, before considering changes. A more appropriate time for a review of executive pay regulations would be this autumn, when the results of the 2017 AGM season and, therefore, the results of the 2013 reforms, can better be assessed.

Strengthening the stakeholder voice

Employees and other stakeholders are enormously important to companies, and the experience of our members is that many boards already take their interests into account.

However, the solution that works for one company may not work for others. We believe that guidance will therefore be more effective than any legislative or regulatory solution, and that any legislative or regulatory solution around employee, customer and stakeholder engagement should be dependent on societal impact – by which we mean the impact that company has on the society in which it operates, whether through the number of people it employs, its position in the marketplace, and so on – rather than simply a feature of its ownership structure.

ICSA is working with the Investment Association on a joint project to look at existing good practice and develop guidance in this area.

Large, privately-held businesses

The governance of private companies is a complex issue because they range from those where the owners and directors are the same people, to those where the directors are merely managers. There have been some high-profile failures in private companies, but there is little evidence of a problem in the majority of cases. So any new requirements must be proportionate.

There are two proposals on the table: that companies should comply with a corporate governance code and that they should report on their compliance. There are two problems with these. To whom do such companies report, and by whom is compliance with a code enforced?

“The governance of private companies is an area that could benefit from improvement, most notably in terms of transparency”

Current compliance and reporting requirements are focused on reporting by the users of capital to the providers of capital, and we believe that raising capital from the public should continue to be the main threshold for requiring that governance arrangements be reported.

However, companies with significant impact on the society in which they operate have a responsibility as well – reporting to society on their compliance with corporate governance standards.

Many private companies already comply with much of the UK Corporate Governance Code because it is simply good business to do so, and some larger private companies choose to report on their governance voluntarily. However, the governance of private companies is an area that could benefit from improvement, most notably in terms of transparency.

As we said in a letter to the Prime Minister in August 2016: ‘The fact that a large company may be privately owned does not reduce the public impact when it fails. Arguing that there should be different expectations on the board of directors simply because there is a different ownership structure is a red herring.

‘The Companies Act 2006 already recognises this to be the case, which is why the duties of directors set out in Part 10 of the Act – which include a requirement to consider the long-term consequences of their decisions and the impact on their employees and the community – apply to directors of all companies, not only publicly-quoted ones … the boards of larger private companies should be expected to aspire to the same standards of governance as those in the listed sector.’

The best solution might be for a governance code for private companies to be described as ‘guidance’ and focus on transparency rather than accountability, although the challenge of an effective and proportionate ‘enforcement mechanism’ remains. ICSA would be very willing to work with the FRC to develop such guidance.

The role of the company secretary

The Green Paper also gives respondents an opportunity to put forward their suggestions for improving corporate governance in the UK.

An additional measure to strengthen the corporate governance framework for the largest privately-held businesses would be to require that they have specialist governance support for the board. The company secretary and the chairman are key to governance practices within a company. Larger private companies tend to have a company secretary, but there is no requirement for them to do so. There should be.

Second, to support the independence of the role, we believe the remuneration of the company secretary should be the responsibility of the remuneration committee rather than any executive director. This will have the important benefit of increasing the independence of the board’s principal governance advisor by removing the company secretary’s payfrom the direct influence of other executives.

Finally, we believe that the right to provide a statement of circumstances to shareholders, granted under the Companies Act to an auditor who ceases to hold office, should be extended to a company secretary.

This has been a significant piece of work and we are grateful to all those members and friends who have helped us develop our response. We will continue to liaise with the Government and the FRC on these issues.

Peter Swabey is Policy and Research Director at ICSA: The Governance Institute

Green Paper response

The full ICSA response to the Green Paper can be found on our website.

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