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Corporate governance: impact on boards

Proposed legislation and new regulations will step up pressure on companies and directors to show that they are making a positive contribution to society.

Proposed legislation and new regulations will step up pressure on companies and directors to show that they are making a positive contribution to society.

Just before she became Prime Minister, Theresa May said that she wanted to “get tough on irresponsible behaviour in big business”. One result of this promise is the revised UK Corporate Governance Code which the FRC published in draft late last year. Legislation is also expected to introduce new reporting and governance obligations for large UK companies including subsidiaries within groups.

In March 2018, the Government launched a further consultation regarding corporate governance in pre-insolvency situations.

The proposals set out in the draft code are not as stringent as Mrs May’s language might have suggested, but there are still some significant shifts of emphasis:

The Government is not proposing to amend s.172, but it would like to nudge companies towards being more receptive to the concerns of employees and wider stakeholders.

Key Points

There is increasing pressure on directors/their companies to make a positive contribution to society. This comes from institutional investors as well as from the UK Government – for example, in March 2018, the Prime Minister declared that housebuilding companies “should do their duty for Britain and build the houses our country needs”.

The idea that companies owe a duty to a country is, for the moment, only political rhetoric. But the draft revised UK Corporate Governance Code has taken up this theme. It begins with a new expanded principle:“A successful company is led by an effective and entrepreneurial board, whose function is to promote the long-term sustainable success of the company, generate value for shareholders and contribute to wider society. The board should establish the company’s purpose, strategy and values, and satisfy itself that these and its culture are aligned.” Principle A

For the most part, there should be no conflict or tension between s.172 duties (see panel) and the sentiments set out in the proposed Principle A. Enlightened shareholder value theory says that doing the right things by community, customers and other shareholders will usually deliver the best shareholder returns, so there is no conflict. But this is not always the case. Take a takeover situation or other strategic turning point, for instance, where shareholders have the opportunity for immediate returns that would not be possible if the directors continued to pursue a longer-term strategy. In such a case, directors need to make finally balanced judgments but their duty is always to the company, not specific shareholders or stakeholders.

The Government is not proposing to amend s.172, but it would like to nudge companies towards being more receptive to the concerns of employees and wider stakeholders. Both the Code and new legislation (applicable to larger companies) will require disclosure on how stakeholder interests have been taken into account in decision-making. So on the one hand nothing has changed in terms of the legal duties directors owe, but as we have seen with gender pay reporting, the very act of reporting can cause greater awareness and discussion of issues at board and management level. It will be interesting to see whether the obligation to describe engagement with stakeholders and its effect on decisions will make tangible differences to business outcomes or simply introduce further boilerplate text into annual reports.

Possibly one of the most contentious proposals in the draft code is that the chair must be independent at all times, not just on appointment. That means any chairs in situ for nine years or more will fall foul of this requirement. If the proposal comes into effect, it may put longer-serving chairs into an awkward position. Pressure from proxy advisers and investors to comply with the code’s independence provisions is likely to lead to faster turnover of chairs, potentially depriving boards of valuable wisdom and experience. There could also be reduced retention of independent NEDs on the basis that an individual who has been a NED for a number of years would not be regarded as independent throughout a reasonable term of office as chair – instead potential chairs may choose to start afresh at a different company.

Other proposed changes will require that a majority of the board, including rather than excluding the chair, should be independent. (Under the current rules only half the board needs to be independent). In a company with eight directors, for example, where four NEDs plus the chair, are considered independent, the new provision would be met. If the chair is not, however, considered independent, the provision won’t be met.

Some may feel that the result of the changes as a whole is more work on succession planning but no better governance overall.

Summary

Issues for boards to consider: Assuming that the proposed changes to the UK Corporate Governance Code come into effect, companies which are affected should consider

One

Whether the need to disclose the impact of stakeholder matters on their principal decisions will affect their decision-making processes and whether they need to document or record decisions differently.

Two

How they can make disclosures that are not merely about standard processes and that demonstrate that their business judgments have genuinely balanced all relevant factors, avoiding the risk of unjustified criticism that they have not made decisions in a proper way.

Three

Which of the draft code’s recommended models of engagement with the workforce they should employ, or how to justify a different model.

Four

The new independence rules – will there be an impact?  Will they accelerate succession planning?