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A change in approach

26 September 2016 by Simon Osborne

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It may be necessary to consider more radical reforms, says Simon Osborne

Plans to force companies to publish the ratio between the pay of chief executives and average staff incomes are being fast-tracked by the Government, according to a recent article in The Times, as Prime Minister Theresa May seeks to tackle excessive salaries in the UK.

The pay gap has doubled in the past 10 years for FTSE 100 companies, with the average pay of chief executives hitting £5.48 million in 2015 – up £1.3 million since 2010. Recently Chris Philp MP has produced a report ‘Restoring Responsible Ownership – Ending the ownerless corporation and controlling executive pay’. It was published at the start of September in conjunction with the High Pay Centre and is being looked at by the Downing Street Policy Unit.

Although the disparity in wealth between those at the top and those at the bottom of the corporate ladder undoubtedly merits attention, it is less certain that Mr Philp’s proposal to have annual binding shareholder votes on executive pay will do anything practical or effective to reduce it.

Since 2002, the UK has been pursuing a regulatory approach based on a combination of transparency and voting rights. Despite both elements of this approach having been strengthened since then, it has done little or nothing to prevent an escalation of directors’ salaries and bonuses. It is not self-evident that a further strengthening of the same basic approach will achieve that objective.

Shareholders are seemingly reluctant to use the rights that they already have to hold companies properly to account. The five largest shareholder revolts this AGM season have seen the average vote against the remuneration report hit 54% but the average vote against the chair of the remuneration committee is less than 1.5%. Unless investors become more willing to use the powers they already have, it may be necessary to consider more radical reforms and I have written to the Prime Minister to express these views.

In my letter, I also addressed the issue of governance at larger private companies, something that I touched on in my last column. The boards of larger private companies should aspire to the same standards of governance as those in the listed sector. Arguing that there should be different expectations of 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 first of my recommendations to the Prime Minister, therefore, is that those companies required under the Companies Act to have audited accounts and to produce a directors’ report should be required to disclose in their annual report the extent to which they comply with the UK Corporate Governance Code, issued by the Financial Reporting Council.

The ‘comply or explain’ mechanism means that private companies would have the flexibility to deviate from the Code’s detailed provisions where they feel it is appropriate, as long as they disclose that they have done so. Linking them to the Code will help to ensure that they give the same amount of thought to good corporate governance practices that listed companies do.

My second recommendation concerns the requirement in Part 12 of the Companies Act for public companies to have a company secretary. If we are to expect the same standards of professionalism of the boards of larger private companies as we do of public companies, we should also expect them to seek the same standard of professional advice. The requirement to have a company secretary should therefore be extended to these companies as well.

It remains to be seen what the Government will do as it seeks to reform corporate governance practices in the UK. Yet as the professional body for governance, ICSA: The Governance Institute welcomes the emphasis that is being placed on the need for companies to governed in a way that is in the long-term benefit of both the company and society at large.

Simon Osborne is CEO of ICSA: The Governance Institute

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