Charles Martin and Emmie Jones of Macfarlanes LLP trace the development of corporate governance in the UK.
It is timely to remember that widespread interest in corporate governance in the UK dates back to the downturn in the early 1990s and the collapses and scandals that followed it. The string of perceived regulatory failures resulted in Sir Adrian Cadbury being invited to chair a committee whose aims were to investigate the British corporate governance system and to suggest improvements to restore investor confidence in that system. Writing a foreword to Stijn Claessens’ paper, Corporate Governance and Development, some years later, Sir Adrian Cadbury describes the aim of corporate governance as being “to align as nearly as possible the interests of individuals, of corporations, and of society”. That definition very much resonates today.
Although governance standards have been tightened up in a number of ways since then, the global financial crisis and economic recession have arguably combined to throw the interests of individuals, corporations and society out of alignment again.
Against a backdrop of high unemployment, increasing pressure on household budgets and a focus on the role of women in the workplace, the key trends in corporate governance over recent years – being, primarily, executive remuneration and the role of women on boards – are clearly very topical.
Concerns about executive pay are not new but have been given new focus by the perception, articulated by the Secretary of State for Business, that pay and performance are increasingly disconnected. Over the past decade, the pay of chief executive officers has risen faster than the increase in the FTSE100 index, retail prices or average remuneration levels across all employees for the same period. The median total remuneration of FTSE100 chief executive officers rose annually by 13.6 per cent on average between 1999 and 2010. By comparison, an average annual increase of 1.7 per cent in the FTSE index was observed across the same period. Statistics such as these fuel an ongoing debate in the public arena about who was responsible for the economic situation in which we now find ourselves and whether the impact of that economic situation is being felt equally amongst all strata of society.
The emotional terms in which this debate is often framed might suggest to those unfamiliar with executive remuneration law and practice that the current arrangements are largely unregulated. In fact, this is far from the case. There are various interconnected legal topics that have an impact on executive pay: disclosure to shareholders; controls on the duration of contracts; scrutiny of board performance; and the terms linking individual performance with remuneration. These legal topics exist within a common law, statutory and regulatory matrix and are further influenced (at least in the case of listed companies) by the UK Corporate Governance Code (hereafter known simply as “the Code”), which invites companies voluntarily to promote strong corporate governance, and the guidance issued by institutional investor bodies.
A good example is the executive remuneration guidelines published by the Association of British Insurers (ABI), a highly influential investor body. The ABI’s revised Principles of Remuneration reflect the belief of ABI members that non-executive directors have a key role to play in determining appropriate remuneration and that shareholders should be actively involved without micromanaging companies. In brief, the Principles suggest that company boards should: support appropriate reward for exceptional performance; strongly resist any payment for failure; understand that excessive or undeserved remuneration undermines the efficient operation of the company; and not engage in “crude benchmarking” when seeking to justify increases. The ABI has also recently written to companies regarding uncapped incentive plans and executive directors’ salaries, saying that “it can no longer be business as usual for this remuneration round”.
Other important guidelines are those issued by the National Association of Pension Funds (NAPF) (the Corporate Governance and Voting Guidelines 2011) and the Pensions Investment Research Consultants (PIRC) (the UK Shareholder Voting Guidelines 2012), both of which are updated annually. The NAPF Guidelines largely reinforce the Code provisions on remuneration, stating specifically that NAPF supports the Code “in its entirety and wishes to add minimal requirements to that body of work”. Both the NAPF Guidelines and the PIRC Guidelines set out what is, and is not, acceptable for their members and circumstances in which their members may want to vote against certain resolutions.
Notwithstanding the keen interest taken by these investor bodies in the issue of executive remuneration, the Department for Business, Innovation and Skills (BIS) believes that further regulation is required. In January 2012, the Secretary of State for Business, Innovation and Skills announced a package of measures to address “failings” in the corporate governance framework for executive remuneration. This included: greater transparency in directors’ remuneration reports; empowering shareholders and promoting shareholder engagement through enhanced voting rights; increasing the diversity of boards and remuneration committees; encouraging employees to be more engaged; and working with investors and business to promote best practice on pay-setting. In March 2012, BIS published a further consultation paper seeking responses to the proposal to give shareholders greater influence on the issue of executive remuneration.
Interestingly, as can be seen from one of the package of measures announced by BIS in January and referred to above, there is increasingly an alignment of the debate on diversity of board membership with the remuneration discussion. The NAPF Guidelines require boards, in the context of their succession and refreshment policies, to explain in detail how they will approach diversity, bearing in mind the need to develop the right skills and experience amongst the directors. The ABI has also recently published a report on board effectiveness, which looks at board diversity as well as succession planning and board performance evaluation. It recommends, among other things, that companies should make achieving diversity of perspective a key objective in board appointments and should discuss openly the issues and challenges that they face in achieving diversity in their annual reports.
In February 2011, Lord Davies of Abersoch produced a report into the lack of female representation in boardrooms. Two-thirds of those questioned believed there were too few female directors in big businesses. Of FTSE100 board members, only 12.5 per cent were represented by women. At the current rate of change, 70 years would pass before an even split was achieved. A progress report commissioned by the European Commission showed only a small increase in the average number of female board members, a reduction in number of female chairs and a gap in the approach of member states to improving gender balance. While the Davies Report recommended that this imbalance be addressed, it fell short of recommending mandatory quotas. Norway, France and Spain have, however, introduced quotas and the EC is itself currently considering mandatory targets, launching a public consultation seeking views on possible action.
The Financial Reporting Council issued a consultation document seeking views on whether the Code should be revised following the Davies Report. It questioned whether boards should have an annual reporting requirement about their diversity policy, including any measurable objectives they had set themselves, and what steps they were taking to comply with the policy and objectives. As a result, the Code will be amended in 2012 to promote greater gender diversity at board level and those new provisions will apply to financial years beginning on or after 1 October 2012.
Notwithstanding the ongoing challenges, it would seem that developments in corporate governance systems and procedures are largely positive. As an anecdotal indicator of this, in 2010 PIRC recommended support for approximately 77 per cent of management proposals at UK companies for which PIRC issued voting advice whereas in 2009 it had supported only 65 per cent of such proposals. It is clear, however, that the importance of corporate governance to British business, policymakers and society more widely will continue to grow as those dictating or influencing the development of corporate governance continue to grapple with the issue of how best to “align as nearly as possible the interests of individuals, of corporations and of society”.