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BEIS Select Committee report on Corporate Governance

The Government is expected to publish its response to the Green Paper, “Corporate Governance Reform” in the early summer.  In the meantime, the BEIS Select Committee published its report on Corporate Governance yesterday.  The headline recommendations are:

  • Abolition of long-term incentive plans – move to simple pay structures with base salary and long-term (non-performance) share awards.

  • Annual publication of the pay ratio between Chief Executive, Senior Executives and the median of all UK employees.

  • No proposal for an annual binding vote on pay but a lower 75 per cent threshold to trigger a binding vote.

  • Employee representation on the Remuneration Committee to form part of the UK Corporate Governance Code.

  • Call for a new Governance Code for the largest private companies.

  • Recommendation for Government to introduce a new target that at least half of all new appointments to senior and executive management level positions by listed companies should be women.

  • Legislation to ensure all FTSE 100 companies and businesses publish workforce data broken down by ethnicity and pay band .

The Report seeks to address a perceived lack of public trust in business, with a focus on improving governance and process rather than suggesting a new set of onerous reporting requirements.  The Committee proposes to action its recommendations by calling on the Financial Reporting Council to amend the UK Corporate Governance Code. Whilst we broadly welcome the report, some recommendations, such as abolishing LTIPs, are too prescriptive. A summary of the main points is set out below. Executive pay The Report found an “overwhelming majority” of its respondents to be in favour of reform as executive remuneration packages were perceived to have become too complex and far removed from those of other employees. The Select Committee agrees with the Prime Minister that “high and unwarranted executive pay is an issue that needs to be addressed” and believes this is best resolved through better corporate governance rather than Government intervention.  The Report finds that greater controls need to be exerted on executive pay and favours “a move away from a heavy reliance on incentive pay back towards basic salary”. Long-Term Incentive Plans (LTIPs) The Report highlights LTIPs as being complex and unpredictable and concludes that long-term incentive plans should be phased out as soon as possible.  A preference is stated for non-performance share awards with vesting over a five year period. Kepler comment: This would clearly represent a significant change for UK plc and many companies seeking to replace LTIPs with Restricted Shares in this AGM season have received resistance from institutional shareholders and proxy advisors such as the IA and ISS (with some companies even pulling their resolutions before the AGM).  We believe that long-term incentives remain an effective tool for some companies as they provide a link between executive pay and long-term company performance – something that both shareholder and executives continue to believe is important.  However, LTIPs need to be carefully designed with measures and time horizons appropriately tailored to ensure that we reward the “right” performance and behaviours that support company strategy.  We agree that the ‘one size fits all’ approach does not work. Short-Term Bonuses The use of short-term bonuses should be limited and objectives should be stretching and align with broader corporate responsibilities. Kepler comment: This was the basis on which bonuses were originally introduced. If an LTIP is not in place, a Balanced Scorecard would be required to capture internal / external perspectives, lead / lag measures of performance and different stakeholder interests.

Shareholder engagement The Report acknowledges that increased engagement is required over executive pay.  However, in isolation, this may not be enough to tackle restraint.  It recommends that the combined impact of wider stakeholder involvement, increased transparency, better reporting and tougher enforcement should foster more responsible shareholder engagement.  Whilst annual binding votes are not being proposed, there is a recommendation to lower the threshold that triggers a binding vote whereby a vote against a pay resolution of 25 per cent or more in one year would force a binding vote on policy in the following year. Kepler comment: Requiring a binding policy vote the next year should not be too onerous as the most it will mean is pulling the next Policy vote forward by one year Remuneration Committees The Report calls for employee representation on Remuneration Committees to send a clear signal on the commitment to fair pay.  The Report also recommends that the Chair of any Remuneration Committee “be expected to resign if their proposals do not receive the backing of 75 per cent of voting shareholders”. Kepler comment: This suggestion will need to be balanced against considerations of how to attract the best people to take on this difficult and important role Publication of pay ratios It is recommended that companies publish the pay ratios between the CEO and both the senior executive team and the median of all UK employees. In the interest of providing greater context, equivalent ratios should also be published by public sector and third sector organisations above a specified size. Mercer Kepler comment: We note the suggestion that the ratio be applied to senior and UK employees as opposed to just all employees, but this is still fraught with difficulty, e.g. the risk of incentivising off-shoring low paid roles and companies will need to be very thoughtful about how the data is presented.  We would also continue to support calculating average pay, rather than median, which will be more transparent and less onerous for companies. As an alternative, we advocate that companies are instead encouraged to compare both CEO pay and employee pay to the National Living Wage – rather than with one another.

Reporting on broader stakeholder interests The Report’s findings indicate that companies should be required to state more explicitly how they have considered broader stakeholder interests beyond their shareholders - such as employees, suppliers and customers - and for the FRC to have “authority to initiate legal action for breach of [these] duties” where companies fail to reach the required reporting standard. The recommendation is to require directors to report in an “accessible, narrative and bespoke form” on how they have met these requirements during the year by explaining how different stakeholder interests have been met, how this has been reflected in financial decisions and giving regard to the long term consequences of these decisions.  It is also recommended that in order to strengthen the enforcement of the reporting standards, the FRC should work alongside business organisations to develop appropriate metrics to inform an annual rating exercise. Kepler comment: We believe that this is a sensible approach and probably in the interests of shareholders as well as broader stakeholders Private companies There are recommendations to develop a new Code for larger private companies in order to raise standards and improve public trust.  The Code would be voluntary for a period of 3 years but may be replaced with a mandatory regime if there are high levels of non-compliance. Kepler comment:  A new corporate governance code for private companies could help to promote a strong and healthy business culture that contributes to longer-term business success.  By being distinct from the UK Corporate Governance Code, it will be possible to ensure any such code is neither overly onerous nor prescriptive, as well as being sufficiently flexible to accommodate the diversity of organizational structures within the privately-held businesses in the UK. Transparency and role of advisors The Report acknowledges the role of various relationships between intermediaries and external advisors to the various parts of the business (including lawyers, investment bankers, pay advisors etc.) and evidence presented to BEIS has suggested that whilst these participants are integral to the business, the Committee recommends that the Government consults upon new requirements to provide fuller information on advisers engaged in transactions above a reasonable threshold. Kepler comment: advisers bring expertise and a perspective of the broader market which can be helpful to companies in guiding decision-making. In this context we welcome the Report’s conclusions that advisers “help all parties to obtain proper information and advice on the legal and financial implications of activity and assist in evaluating the risks” together with recognition that they monitor and enforce professional standards in their respective fields. The increased transparency proposed will improve public perceptions. Board diversity The Committee calls for the Government to set a target that from May 2020 at least half of all new appointments to senior and executive management level positions in the FTSE 350 and all listed companies should be women. Failure to achieve this diversity should be explained in the annual report and what steps are being taken to rectify gender inequality. Kepler comment:  We support the view that diversity in all its dimensions should be encouraged, and that steps should be taken to increase the Board’s accountability for developing and maintaining a strong healthy corporate culture. While a diversity target may help achieve this goal, we note and support the suggestion that companies be given the opportunity to “comply or explain” to allow sufficient time to embed appropriate programmes for cultural change (where required), and review succession planning.

This briefing is for general guidance and does not necessarily cover all areas of the topics included in this briefing. It is not designed to give legal or other professional advice.

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