15 April 2019 by Poppy Harris
Robust corporate governance drives transparency and a distinct, underlying rationale behind every decision a company takes
Until recently, the application of corporate governance codes and transparent reporting on governance infrastructure has focused primarily on public listed companies – ‘governance’ in many respects has remained mainly in the realm of regulated markets and financial services. However, recently the trend has been to extend these corporate reporting obligations to non-regulated sectors with private businesses of all sizes now facing increased similar requirements
to build confidence amongst stakeholders and the wider public.
In June 2018, Parliament published the Companies (Miscellaneous Reporting) Regulations 2018 for accounting periods beginning on or after 1 January 2019. Much of the driving force for this stemmed from several recent corporate failures which propelled corporate governance onto the political agenda.
Thus in 2016 Theresa May opened discussion surrounding ‘boardroom excess’, with the aim of closing the widening gap of trust between the public and business.
Private businesses now need to report how they have applied appropriate governance arrangements, how directors have actively met their duties, and the impact stakeholder concerns have on board decisions and the overarching strategy of the business. Unlike before, private companies now have a set of regulations that they must actively adhere to and the requisite regulation must be reported on in the company’s accounts, or their website. Private businesses which have not prepared may struggle to comply with the new reporting requirements.
At first glance, the changes appear complex, which is why it is of vital importance that all companies make sure they understand all existing regulations and how changes will affect their business, well ahead of reporting time. Which regulations apply to each company will depend on their size, as there are slight nuances between thresholds. Moreover, businesses should remember that if they fall within the thresholds for any of these reporting requirements, they will be presented in the auditable sections of their financial statements, meaning there could be consequences if evidence of declarations are not identifiable to the auditor.
Furthermore, it should also be considered that private businesses span a broad church of different ‘types’, from long-established, family-run companies to large, non-UK based inbound companies, to private equity companies, and each entity type will have specific needs unique to them. For example, a family firm domestically headquartered within the UK may already have very good levels of corporate governance by virtue of its ownership structure and a record of clear purpose, strategy, and values.
Alternatively, overseas inbound companies may lack this solid governance infrastructure as there could be overreliance on the governance apparatus of the parent company. For example, it may not be a requirement to hold regular board meetings - irrespective of size - as it is within the UK. Finally, private equity companies look to balance the success of their portfolio against the short-term success of the company, so considerations surrounding stakeholders may not be the first priority when taking decisions as a board, although this is something that could be soon set to change – Larry Fink, founder and chair of Blackrock, Inc, stressed in his letter to CEOs in 2019 that ‘companies that fulfill their purpose and responsibilities to stakeholders reap rewards over the long-term. Companies that ignore them stumble and fail’.
Despite the range in company types that make navigating regulations complex, there already exists a plethora of impeccable examples of sound corporate governance in each of these categories, and indeed overseas companies increasingly look to the UK code for guidance on their own best practices at home.
Section 172 states that: ‘A director of a company must act in the way he [or she] considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole’ (Companies Act 2006, s.172).
For many companies, a statement must be included in the strategic report, which details how directors have performed their various duties under s.172 of the Companies Act 2006 (the Act). This encompasses a wider regard to (but not limited to) strategy, employee population, suppliers, and the community, and encourages businesses to take a holistic and considered approach to decision-making.
Whilst directors’ duties were codified in the Act, directors must now actively have regard to their duties when making decisions. Reporting must include how directors have regard to their business strategy, employee population, the company’s relationship with its stakeholders (for example customers, suppliers, and the wider community), and how they consider group-wide policies to support compliance. The report must be published in the company’s accounts within the strategic report and on their website. Reference can be made to group wide policies but specific context must be provided to the ‘reporting’ entity.
Directors should always consider whether the decision they are about to take leads to a positive long-term increase in the value of the company for the benefit of the shareholder(s). Directors must ensure they always have regard to the interests of key stakeholders, which could include company employees, the need to foster relationships with suppliers and/or customers, the environment, community, or, indeed, any external party positively or negatively impacted through its business activities.
The most crucial evidence for this will be in the minutes of board meetings. Companies must ensure the minutes state that directors have taken their duties as set out in s.172 into account when making decisions. Management information and material prepared for the board will be critical also. Ensuring senior management understand section 172 and the relevance for directors will be important.
Companies with over 250 employees are now expected to include a statement within their accounts explaining how they engage with their employees, regardless of their financial threshold. Engagement mechanisms could include annual surveys, meet the CEO events or employee AGMs.
When reporting, directors should consider:
Companies defined as ‘large’ under the Act must now summarise how they effectively engage with their stakeholders, which could include customers, suppliers, or the wider community. Most companies of this size will likely carry out stakeholder engagement already, but companies must now identify how such engagements link to the company’s strategic objectives. A recent PwC study found that only 13% of 2018 strategic reports demonstrated strategic relevance in engagement reporting.
Companies should consider their purpose, business model and strategy when defining key stakeholder groups, as well as identifiable risks associated with stakeholder agendas, the relevance of which should be explored on an ongoing basis.
Large companies will be required to publish a governance statement within their accounts and on their website, detailing whether or not they adopt a corporate governance code, and how it is applied within their business. If they do not adopt a code, they must detail what, if any, governance structures are in place. They may consider following the voluntary Wates Principles, which offer guidance and best-practice approaches.
The Wates Principles may be adopted to support any company that falls under the threshold to disclose a corporate governance statement, enabling them to holistically consider their approach to reporting.
The principles are a set of ‘behaviours’ to encourage trust between the company, its stakeholders, and wider society at large.
Developed jointly between the FRC and James Wates, their rationale was to create ‘a tool for large private companies that helps them look themselves in the mirror, to see where they’ve done well, and where they can raise their corporate governance standards to a higher level’ (Wates, 2018).
Whilst each reporting requirement contains general considerations that companies might consider when reporting, policies and processes should be put in place to ensure adoption of best-practice and a thorough approach to decision making and reporting. In some instances creating a UK specific subsidiary governance policy may be appropriate.
As guidance, successful engagement and reporting by the board can be reduced to five considerations.
Governance has evolved in recent years to add value to business, rather than merely a compliance exercise. Businesses should recognise this shift and aim to use good governance as a positive force. Internally, good governance will assist companies in ensuring they are aligned strategically and confident in their overall purpose. Good governance helps to streamline operations, to positively impact cost efficiency.
Businesses should also consider the risks of non-compliance. In the age of instant information processing and social media, reputational damage can occur in an instant. Many possible disasters can be avoided with a governance framework in place. There is a market advantage attached to demonstrably sound corporate governance, particularly with regard to investor confidence and share price.
Finally, non-compliance may carry regulatory risks such as fines and penalties. Business activity could be interrupted, with a negative impact on revenue. Such regulatory breaches can affect a firm’s ability to obtain certain licenses and approvals.
A full and proper understanding of statutory duties, and careful consideration of regulatory requirements is the essential first step to take. Having measures which enhance the reliability and clarity of reporting will hold a company in good stead.