In the great pendulum swing that characterizes the mood toward government oversight of companies and corporate governance, the pendulum in the U.S. has swung against regulation and against mandated governance requirements. However, in the U.K., the pendulum is on the opposite end of the arc, as the current government is moving quickly to adopt new corporate governance requirements.
As discussed in an earlier post (here), the current U.K. governance initiative kicked off with the Prime Minister’s November 2016 Corporate Governance Reform Green Paper, which focused on executive pay, private companies, and workers on boards. The Green Paper solicited comments on its various proposals. The comments have been received and processed and the result is an August 2017 report entitled “Corporate Governance Reform, The Government Response to the Green Paper Consultation” (here). The report sets out a list of governance reform proposals the government intends to put into effect in the coming year.
In its latest report, the Department for Business, Energy & Industrial Strategy notes that the aim of the current initiative, which the government launched with the Green Paper, was “to consider what changes might be appropriate in the corporate governance regime to help ensure that we improve business performance and have an economy that works for everyone.”
Based on the results of the consultation the report sets out nine “headline proposals” across three specific aspects of corporate governance: executive pay; strengthening the employee and customer and supplier voice; and corporate governance in largely privately-held businesses. The aim is to have the various proposals put into place by June 2018.
Executive Pay: After noting that executive pay has “risen faster than corporate performance” and that “a persistent small minority of businesses continue to disregard the views of the shareholders on pay each year,” the paper identifies three sets of proposals with respect to executive pay.
First, paper proposes revisions to the U.K. Corporate Governance Code to be more specific about the steps listed companies should take when encountering significant shareholder opposition to executive pay policies; give remuneration committees a broader responsibility for overseeing pay and incentives across their company and require them to engage with the wider workforce to explain how executive remuneration aligns with wider company pay policy; and extend vesting period for executive share awards from three to five years to encourage companies to focus on longer-term outcomes.
Second, introduce secondary legislation to require listed companies to annually report the ration of CEO pay to the average pay of their UK workforce, along with a narrative explaining year-to-year changes in the ratio; and to provide a clearer explanation of the range of potential outcomes of complex, share-based incentive schemes.
Third, to invite the Investment Association to maintain a public register of listed companies encountering shareholder opposition to pay awards of 20% or greater, along with a record of what these companies say that are doing to address shareholder concerns.
Strengthening Employee, Customer and Stakeholder Voice: As discussed in an August 30, 2017 post on the Cooley PubCo blog about the U.K. governance reforms (here), in the U.S., we follow a “shareholder predominance theory,” under which corporate boards give priority to “maximization of shareholder value.” The U.K.’s corporate law reflects a different theory. Section 172 of the Companies Act of 2006 provides that corporate directors must act in a way most likely to promote the success of the company for the benefit of its shareholders, but also having regard for the interests of employees, customers and suppliers, and the impact of the company’s operations on the community and the environment.
The latest report notes that in the consultation comments, there was “strong support for action to strengthen the stakeholder voice.” Many commentators reportedly thought companies should do more to reflect their “recognition that they have responsibilities to employees, customers and wider society. In order to address these concerns, the paper sets out three proposals.
First, the government will introduce secondary legislation to require all companies (public and private) of a significant size to explain how their directors comply with the requirements of Section 172 to have regard to employee and other interests.
Second, to develop a new Code principle “establishing the importance of strengthening the voice of employees and other non-stakeholder interests at board level as an important component of running a sustainable business.”
Third, to encourage industry-led solutions through a variety of organizations to provide “joint guidance on practical ways in which companies can engage with their employees and other stakeholders.”
Corporate Governance on Large Privately-Held Businesses: The report notes that the consultation comments “revealed broad support for action to encourage high standards of corporate governance in the U.K.’s private companies reflecting the significant impact these companies have on employees, suppliers, customers and others, irrespective of their legal status.” The report sets out three initiatives the government intends to implement.
First, to invite the Financial Reporting Council to work with a variety of industry organizations and associations to develop a voluntary set of corporate governance principles for large private companies.
Second, to introduce secondary legislation to require companies of a significant size to disclose their corporate governance arrangements in their Directors’ Report and on their website, including whether they follow any formal code.
Third, in the ninth and final of the report’s proposals, the report reflects an initiative to clarify the authority of the Financial Reporting Council, which oversees corporate governance.
The U.K. is not alone in moving ahead with corporate governance proposals. As discussed here, in March 2017, the European Parliament approved a new Shareholder Rights Directive that is intended to “sharpen big EU firms’ focus on their long-run performance, by fostering their shareholders’ commitment to it,” according to the legislature’s press release announcing the Directive’s adoption. Both the U.K. initiative and the EU legislation proceed from perceived governance shortcomings and concerns over disproportional corporate focus on short-term results.
As I suggested at the outset of this post, these initiatives stand in significant contrast to the current direction in the U.S., which is against regulation. The White House and Congress, as well as the current SEC leadership, have indicated an interest in rolling back many of the regulatory requirements and initiative adopted in the Dodd-Frank Act and in the wake of the global financial crisis.
Not only does the U.K. initiative contrast with the general regulatory tone in the U.S., the report omits or downplays several points of emphasis that undoubtedly would have been a part of any similar U.S. analysis.
In particular, as an American reading the U.K. report, I found it noteworthy that there was no discussion in the report of the question of how the governance regime would affect domestic companies as they try to compete in a global economy. A recurring concern in the U.S. when governance issues is whether or not rigorous governance requirements will put U.S. companies at a competitive disadvantage in the global marketplace.
By significant contrast, the U.K. report seems to reflect a belief that more rigorous governance is to the competitive advantage of U.K. companies. For example, the report contains an introductory statement from the Teresa May, the U.K. prime minster, in which she states that “our system of corporate governance is rightly envied and emulated around the world,” adding that “we must continue to improve if we are to retain our competitive edge.”
Another observation I had as an American reading the U.K. report is the absence of a consideration that would have been woven through an equivalent report by an American governmental agency – that is, an American report of this type would have been replete with concerns about the cost the various proposed initiatives would impose on the companies involved. A corollary of this concern would have been the related concern whether or not the benefit from the various proposed initiatives would justify the costs they would impose. While I do not believe the authors of the U.K. report are indifferent to the costs their initiatives would impose on companies, it is interesting to me that the concern about costs is not express and does not predominate, as it would have in an equivalent U.S. report.
Another point of interest is the report’s proposal to address governance concerns of private companies. An equivalent U.S. report almost certainly would not address private companies, simply because private companies are regulated at the state level not the federal level. There is also perhaps more of a view in the U.S. that the governance of a private company is more of a concern for the private company’s owners.
The report’s emphasis on the interests of stakeholders other than shareholders is also interesting. This philosophy is already reflected in the U.K. Companies Act, but the contrast of this approach to the U.S. shareholder predominance theory is interesting and striking. The adoption of this view is the source of an entire category of corporate governance expectations in the U.K. that are unlikely to appear on the governance agenda in the U.S.
Despite the differences in philosophy and approach between the U.S. and the U.K., it will nevertheless be interesting for us here in the U.S. to watch the U.K. governance initiative as it is put into practice. The U.K.’s initiatives represent a real world test of the value and benefit of the various proposed governance changes, and the resulting experience will be instructive both in the U.K. and in the U.S.