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The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver long-term success for a company. It’s the system by which companies are directed and controlled. And it provides a measure for shareholders to satisfy themselves that their company has an appropriate governance structure.
Therefore, a cornerstone of the Corporate Governance Code is the principle of ‘comply or explain’. Premium-listed companies must report each year how they have applied the principles of the Code, so that investors can evaluate the actions taken.
The FRC have just issued a revised version of the Corporate Governance Code for consultation. The new Code will apply to financial years from 1 January 2019 onwards, so 2020 reports will need to include the ‘comply or explain’ statement for this new Code. There will be no transition period.
Many companies seek to include a full compliance statement, and will no doubt want to continue this under the new Code too. This obviously demonstrates good corporate governance, and is also used by proxy advisers in their voting recommendations. But it may be tricky for companies to comply fully with the new Code, at least as soon as 2019 or perhaps for longer, because of some of its new requirements.
For example, the Code proposes three employee engagement methods (an employee director, a formal workforce advisory panel, or a designated non-executive director). Companies are likely to need some time to work out which method would suit their business and workforce best and then implement this method. As there are no transitional provisions, such companies may be non-compliant in the first year or so of the new Code. Would this lead to negative voting recommendations from some proxy advisors? If so, the company could suffer substantial shareholder dissent. What if a company decides that a totally different method of engaging with its workforce is far more appropriate? They would need to ‘explain’ rather than ‘comply’ continuously. But ironically, a company which takes time to work out the best way to strengthen its workforce’s voice in the boardroom should be lauded.
Companies may also wish to integrate this with another new Code requirement, to strengthen the voice of other non-shareholder stakeholders at board level. This is likely to add to the time investment needed to come up with the best way to achieve these twin requirements.
To prevent a substantial shareholder vote against resolutions, remuneration committees may need to spend more time explaining their position on employee/stakeholder engagement directly to their shareholders. This would add to the already increased burden on committees, possibly unnecessarily.
We will shortly have the public register of substantial shareholder discontent for any resolution with over 20% opposition (to be set up by the Investment Association by the end of 2017). It would be a shame if companies end up on the register simply because they were understandably taking time to work out how best to comply with the Code.
It’s clear that ‘one size fits all’ does not apply in the business environment. The new Code aims at a change in culture, to restore trust in business. Perhaps what we also need is a change in attitude to the rigid ‘comply or explain’ principle, so that a convincing explanation (of a departure from the Code) can be just as acceptable to proxy advisers, stakeholders and shareholders.
13 December 2017
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