The Governance Report: An article not about the election or Brexit!

Posted on: May 9th, 2017

With all that is going on, it may have passed you by that at the end of March the Business, Energy and Industrial Strategy Committee (BEIS) released its report on corporate governance. While it may not sound like the most thrilling of reports, it comes at an important time for British business as we begin to prepare for life outside the European Union.

As part of the exit process, it is important that we continue to attract companies to our shores; and our rules governing corporate behaviour will have a big effect on our ability to do that. The report provides an important insight into parliamentary thinking on how corporations should behave and why it thinks that recent failures may have occurred.

The report arrives after a year in which Sports Direct, BHS, Tesco and Southern Rail hit the headlines for, in BEIS’s own words, “serious failings”. Failings which, it believes, are directly attributable to those in charge.

An important balance needs to be struck between the need to create a framework which gives freedom to set up and undertake business, but regulates business to protect all stakeholders, from suppliers and employees to consumers.

A lack of trust

A major focus of the report is the public’s perception of British business.

According to the Edelman Trust Barometer 2017, citied in the report, in the UK levels of trust of businesses are at the point where the prevailing attitude is that of active distrust. This is in marked contrast to countries such as the Netherlands and China, where the attitude is predominantly positive. In fact, the UK ranks well below many others and is one of the worst on the scale.

BEIS believes this lack of trust has been fuelled by the recent high profile examples of bad practice, such as those listed above, but also due to the levels of executive pay being “so high that it is impossible to see a credible link between remuneration and performance.”

Further concerns

Beyond trust, the report focuses heavily on stakeholder engagement. Much is made of the fact that in the last half century there has been a fall in the period for which shares are held and the proportion of those held directly by individuals. There has also been a decrease in the number of large individual shareholders which, BEIS believes, means that directors have less accountability, and no obvious source of pressure. According to Ken Olisa, Deputy Chairman at the IoD, this has meant the press doing “a better job of applying pressure to companies than shareholders.”

Beyond shareholder involvement, the report focuses on a concern that other stakeholder groups, such as employees, suppliers, and customers, also not being given the due consideration at board level which they should be, something that feeds into a lack of director accountability.

BEIS’s concern with director accountability is tied to a belief that there is too much short term thinking at the executive board level. It argues that current payment structures continue to reward short term behaviour over long term development, which has a direct effect on the British economy at large, specifically the low levels of investment in both infrastructure and research and development.

The recommendations

The report’s recommendations are legislation light. Rather than proposing that the Government adds to, or changes, what is already in place, BEIS takes the approach that the mechanisms are there, but they are just not being used in the right way or to the fullest extent.

Expect to see further, more general, reporting requirements relating to directors’ duties that will be similar to those brought in under the Modern Slavery Act and in relation to gender pay gaps. Also expect to see requirements imposed on large private companies to report more fully and in a way that is already familiar to listed companies. There is clear concern that private companies are less transparent than those which are publicly listed.

Among the report’s other, more specific, recommendations:

  • to combat the current perceived issue of directors taking a short term outlook, the phasing out of directors’ long-term incentive plans as soon as possible with no new ones agreed from the start of 2018;
  • in support of increased diversity, that the Government targets May 2020 as a date for when at least half of all new appointments to senior and executive management positions in all listed companies should be women;
  • to increase stakeholder engagement, the establishment of stakeholder advisory panels by companies and for future annual reports to include details on how companies are conducting engagement with stakeholders.

Cautious change

These reforms are not intended to create onerous new requirements, but to establish arrangements to ensure the better enforcement of the Companies Act 2006, to improve the voice of other stakeholders, including employees, and to require companies to engage in a more open and transparent manner with the public. Their aim is to ingrain permanently the values and behaviours of excellent corporate governance into the culture of British business.

As mentioned, the report does not favour the introduction of a raft of new legislation and BEIS makes it very clear that, despite the criticisms raised, the system is not broken. It is emphasised that the UK’s current corporate governance system is a “considerable asset” and that a small number of corporate failures, though damaging, should not mean “a hasty and disproportionate response”.

Do not, then, expect to see much in the way of radical change over the next few years. The emphasis in this report is to suggest that change should come internally from companies rather than through government pressure. There is likely to be the introduction of further reporting requirements for both public and private companies, and expect this to slowly trickle down from the large multinationals to the SMEs as well. The bigger concerns for companies and their directors, for now, should be the media coverage and the public pressure that will come as more information becomes available and more is demanded.

The full report can be found here.