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No simple solutions

31 October 2016 by Peter Swabey

Corporate Governance: No simple solutions - read more

The BEIS Select Committee calls for evidence on corporate governance

On 16 September, the Business, Energy and Industrial Strategy Committee (BEIS Committee, formerly known as the BIS Committee) announced an inquiry on corporate governance. It focuses on directors’ duties, executive pay and the composition of boardrooms, including worker representation and gender balance in executive positions.

As befits ICSA: The Governance Institute, we have been giving a great deal of thought to these issues already. This article is intended to give a flavour of the response we have developed, the full text of which is available on our website.

It is easy to see the lens through which the Committee is approaching this issue – its recent inquiry into the failure of BHS – but we believe that, although there have been some high-profile failures in private companies, there is little evidence that the existing governance model for private companies is not working in the majority of cases.

Directors’ duties

We believe that the statutory directors’ duties, set out in sections 171-177 of the Companies Act 2006, are clear and unambiguous. These were considered in some detail when the decision was taken to codify them under the Act.

We believe that they continue to strike an appropriate balance between the rights of shareowners and the rights of other stakeholders. It is important that directors, with the proactive support of their company secretaries, are clear as to whom they owe their duties.

There may be a case for strengthening the statutory duties to have greater regard to the long term and for including a specific duty to have regard to members of defined benefit pension schemes. There may also be a case for reviewing the enforcement of directors’ duties – perhaps creating a role for Government.

One important point that we have made to the Committee is that in a unitary board, all directors should have the same responsibilities. There is no legal difference between an executive director and a non-executive director, and we do not believe that there should be. Nor do we believe that a case for moving away from the unitary board model has been made.

One of the strengths of the law as currently drafted is that it is akin to the principles-based regulation that we see elsewhere in corporate governance, where it is not enough merely to comply with a set of rules; directors must also comply with their spirit.

The Committee went on to ask – again BHS may not have been far from their minds – whether there should be greater alignment between the rules governing public and private companies. We believe that there should be, but that such alignment should be proportionate. The rules applicable to companies, including those relating to the degree of scrutiny and challenge to which their boards should be open, should be dependent on their size and societal impact, rather than their choice of ownership structure.

In the majority of UK companies, managed by the owner, the need for scrutiny and challenge is fundamentally external – the need for those affected by the company’s decisions to be able to challenge them. Shareholders in UK companies have more power over directors than those in many other countries, but it is a power that must be used with discretion.

Shareholders can best be assured that executive directors are subject to appropriate independent challenge by electing non-executive directors in whom they have confidence to provide supportive and constructive challenge. If shareholders do not trust those elected to the board, then they have the ability to vote against their appointment.

A sensible approach would seem to be an obligation on those unlisted or private companies and LLPs with greater societal impact to comply (or explain non-compliance) with an appropriate corporate governance code and to appoint a company secretary to support the board. In both cases, these requirements should be subject to a threshold – for example, that the company is of sufficient size to qualify for external audit or that it must comply with the new regulations regarding publication of information on the gender pay gap. In either event, we would recommend that those private companies which are subsidiaries of others, particularly of quoted companies, be exempt.

For the largest companies, especially those that are publicly quoted, there are additional significant transparency requirements that allow the directors, not only to be held to account by the owners, but, increasingly, in the court of public opinion through the activities of the press and special interest pressure groups. These parties can, and often do, challenge the activities of the company.

Executive pay

We are pleased that the Committee has, in our view, rightly focused on understanding the reasons why executive pay is excessive in some companies before seeking to recommend action. We consider there to be four principal issues driving executive pay:

  • The increasing internationalisation of senior executive recruitment, creating a competitive environment which is not usually replicated at more junior levels
  • Complexity of senior executive pay structures, often driven by a desire to align executive pay more closely with company performance and investor experience in the long term
  • Impact of consultants, who are rarely incentivised to develop lower and simpler pay packages
  • The level of disclosure which, especially with the requirement for publication of a single figure, places executives in a stronger position to compare their pay with that of their peers and, therefore, in a stronger position to demand comparability. 

All that said, the central question about high pay is: who defines ‘too high’ and against what criteria? There is clear evidence of a public perception that there is a level of pay that is too high, regardless of performance, but it is not clear what this level is and how it is defined. In our view, there are three separate elements to this public perception and the issues surrounding them, and the steps that may be taken to address them, differ. These elements are:

  • Pay is disassociated from performance – although this is closely monitored by investors who have the power 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 
  • There is income inequality in our society
  • Some people are simply paid too much.

Both of these latter points are undoubtedly true, but are not really corporate governance issues and will not be addressed solely by a focus on executive pay in public companies. The pay of senior executives in quoted companies is visible to all, but the same cannot be said of the income of those in equivalent positions in private companies, professional firms or private equity and other investment firms, to say nothing of entertainment or sports stars or those who receive income from inherited investment.

There is a whole range of fiscal and other remedies available to Parliament and the Government to address these issues of inequality.

Given that we are still in the first cycle of pay policy implementation following the changes introduced in 2013, and there has been insufficient time to assess its impact, we are not convinced that it is yet necessary to take further action in this area.

Board composition

Finally, on board composition, we firmly believe that as talent is diverse, boards that have taken advantage of that diversity are likely to perform more effectively and so all elements of diversity should be embraced in our society. Companies’ approach to the training and development of staff is crucial and companies must comply with the spirit, as well as the letter, of anti-discrimination laws.

Our report in May this year, undertaken jointly with EY, on the role of the nomination committee provided strong evidence that many of the better nomination committees are making considerable progress in this direction.

As mentioned above, we believe that the unitary board system is effective, but boards cannot function properly when each member is representing a particular constituency. For this reason, we do not support the development of a new ‘class’ of ‘worker director’, although this is not to say that employees should necessarily be excluded from board membership.

We believe that a better approach, and one more likely to address the underlying issues, might be to look at ways in which boards can get a better understanding of the views of stakeholders, in order to have greater regard to their interests.

This might include a further review of the nomination committee process to broaden the range of candidates, including employees; adding ‘advisory’ members to the nomination and remuneration committees; or requiring specific board members to be the primary point of liaison with particular stakeholder groups.

We think that Lord Davies’ initiative to increase women on boards was effective but the momentum now needs to be maintained to increase the number of women in executive positions. We await the outcome of the Hampton-Alexander review, to which we have contributed.

However, it is crucial that the ‘pipeline’ issues are addressed, together with lifestyle policies to facilitate women’s continued participation in the workplace. In our response to the Government Equalities Office consultation on the gender pay gap last year, we suggested what some of these policies might be:

  • Encouragement for young women and those from non-traditional backgrounds to consider the broadest range of careers
  • More initiatives to support parental leave and childcare, which we believe to be at the heart of addressing the imbalance between men and women at senior levels in business
  • More support for carers, in order that older working women and those from certain cultures are able to fulfil their career potential.

These are all important issues which deserve a proper examination. They are not susceptible to simple or knee-jerk solutions and we look forward to working with the Select Committee and responding to the anticipated Government consultation on similar issues over the coming months.

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

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