Features
Liz Loxton 7 Apr 2017 10:00am

Why corporate governance is about more than executive pay

The government’s green paper has shone the spotlight on pay, engagement and the private company sector. But is more regulation needed? Liz Loxton reports

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Caption: Photography: Catherine Hyland

Following Theresa May’s stated aim to make business more responsible, the UK government’s green paper on corporate governance has attracted a good deal of debate. The paper has drawn criticism, largely over whether renewed legislative activity is necessary given the standing of the UK’s corporate governance regime internationally, but the prime minister’s overall purpose has been held up as a laudable one.

In the 25 years since the Cadbury Report and the nine years since the introduction of the Combined Code, adherence to the main tenets of good governance – accountability and transparency on pay, directors’ duties and engagement with stakeholders – continues to ebb and flow. In January the world’s largest fund manager, Black Rock, stepped up rhetoric on executive pay, writing to Britain’s biggest listed companies to call for an end to pay awards and pension contributions that outpace those of ordinary employees. The collapse of BHS in 2016, which exposed a pension fund painfully in the red, revived concerns about the lack of checks and balances on the private company sector.

These examples are not the only evidence that corporate life, once examined, can be found wanting. Last year’s review of the conduct of the large company sector from Grant Thornton’s Governance Institute found positive results: 62% of the FTSE 350 fully comply with the UK Corporate Governance Code, up from 57% the previous year.

However, only 20% provide good or detailed discussion on organisational culture – a factor at which the finger of blame is often pointed after a scandal.

There is a virtuous circle, says Simon Lowe, head of Grant Thornton’s large corporate practice and chairman of its governance institute. “Externally, good governance creates trust in business. Internally, it enables measured risk taking, which gives management the confidence they can deliver on value.”

So what does the green paper add to the corporate governance mix? The main areas of focus – executive pay, the wider stakeholder voice and the conduct and transparency of the UK’s privately held businesses – are absolutely the right places to focus the debate on corporate conduct, says Oliver Parry, head of corporate governance at the Institute of Directors. With some executives paid more than 120 times more than the median worker in their company, with widely varying standards and regulations across the private company sector and a general sense of mounting concern about business’s disconnect from public opinion, the green paper, he believes, rightly draws attention to issues that go to the heart of the role of business in society. “There is a disconnect between the top and bottom of organisations and a concern about standards of corporate governance in the private company sector. It’s absolutely time that they look into these issues,” he says.

Executive pay

Naturally enough, the paper’s key emphasis on executive pay represents one of its most attention-seeking features.

It is an issue that is never far from the eye of the storm. Soon after becoming prime minister in the summer, May spoke of her desire to make binding shareholder votes on the remuneration report an annual affair, as opposed to the current situation, where they occur every three years with advisory votes taking place for the years in between. The green paper rows back on that position, stating that while the binding vote could apply to the full remuneration report, it alternatively might apply only to variable elements such as bonuses, long-term incentive plans or pay rises.

Elizabeth Richards, head of corporate governance in the technical strategy department at ICAEW, says highlighting this area was not unexpected. However, the Institute believes that companies need flexibility in this area. “We feel that the discussion should move on from ‘no one should be massively paid for failure’,” she says.

When it comes to votes, ICAEW’s position is that the current situation should be seen in action for a bit longer; 2017 will mark the second occasion that shareholders have had a binding vote on executive pay, she points out, with almost half of Britain’s largest listed companies facing a binding vote in 2017. “Some opposition votes have occurred so it seems too soon to look to amend the legislation,” she says.

Lawrence Green, consultant in Squire Patton Boggs’s tax strategy and benefits practice, agrees that we lack genuine need to change voting arrangements and frequency. “Shareholders already have the tools; it’s just that it takes time. If shareholders were to have this process they’d be voting against companies all the time. There needs to be a carrot as well as a stick, with shareholders saying what they want to see and companies being able to respond.”

The issue of pay ratios similarly appears to have been subject to negotiation ahead of the green paper’s publication. As ICAEW says in its response to a Department for Business Energy and Industrial Strategy consultation, setting limits on the multiples that executives can be paid compared to junior employees may have unintended consequences. Companies with large numbers of low-paid employees could be encouraged to outsource, with the knock on effect that they may then not enjoy the same kind of benefits of their equivalents who have in-house roles elsewhere. Green agrees: “Human nature being what it is, you can’t be sure that the reaction isn’t going to be that the lower paid are outsourced more frequently. And your terms and conditions are much more likely to be in your favour if you work for the company directly.”

That’s not to say that we won’t see some form of pay ratio disclosures in the future. Francis Kean, executive director at Willis Towers Watson, says he would not be surprised to see some version of pay ratios become mandatory. “The government is,” he says “responding to a number of different themes and pressures and in particular here to the question: Is there adequate transparency
on pay and how it relates to performance.”

Engagement

Theresa May’s vision of employee engagement and worker directors is also an area that has been somewhat watered down within the green paper. It is touched on but it is clear that worker directors will not become a compulsory part of the corporate landscape. That has been perceived as a retreat, and yet it is an idea that has a degree of support. “We have gone out publically and said there is value in worker directors and that the views of the workforce should inform board-level decisions. If the board chooses not to appoint worker directors then the directors should have to explain how they are going to take account of workforce views,” says Richards.

“Since the Companies Act (S172) there has been an obligation on board members that in making business decisions they need to take into account employee views, on environmental issues especially. This is not new but what is not apparent is whether that obligation has made any difference to decisions,” says Kean. Having a non-executive director champion employee views is likely to capture the imagination during the consultation process but would require extra consideration as it brings additional duties for non-execs, he argues.

Giving stakeholders more of a voice in a broader sense – from investors to employees to customers and suppliers – is an area that also has support, but it comes with practical issues around implementation. “You’re talking about quite different groups. Employees are hard-wired into the business in a way that customers aren’t, for instance,” says Richards.

Privately held companies

Britain’s privately held companies vary widely in scope and make up, but the recent and very public scandal at BHS, for example, has had the effect of concentrating attention on this sector.
Kean says the time may have come where we will see more requirements such as those on executive pay and wider engagement extended to private companies. While the British Venture Capital Association already provides guidance, it seems likely that disclosures that go beyond the financial health of the business will be encouraged, he argues.

Not everyone believes additional legislative rounds are necessary at all. Clive Stevens, Kreston Reeves’ chairman, thinks we need balance between greater regulation and good conduct. “I’m not sure business needs greater regulation, but it does need people to take responsibility,” he says.

And there may be a competition point for the UK in the corporate governance debate as we head towards Brexit. “Our regulatory regime is an asset,” he says. “People will want to come here for our regulatory and legal framework. I’m not sure it needs to be more severe, but individuals certainly need to be held accountable.”

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