Jessica Fino 5 Apr 2017 12:34pm

BEIS urges crackdown on executive pay to restore trust in business

UK companies should abolish long-term inventive plans (LTIPs) and act on boardroom diversity in a bid to restore trust, according to the Business, Energy and Industrial Strategy (BEIS) committee

In its corporate governance report, the committee set out a list of recommendations in a bid to rebuild trust in the UK’s corporate governance system following the scandals at Sports Direct and BHS.

The committee argued that LTIPs have become “too complex” and are liable to create “perverse incentives and short-term decisions”. Instead, it recommended a more simple pay structure, comprising salary, bonus relating to stretching targets, including those relating to wider performance criteria, and payment by means of equity over the long term. 

However, the Confederation of British Industry (CBI) pointed out that banning LTIPs outright could reduce the flexibility for companies to reward their senior leaders.

On Wednesday, the BEIS committee urged the government to introduce a new voluntary code of governance for private companies, as well as better reporting by companies on how directors fulfil their duties and responsibilities.

It also called for an expansion of the role and powers of the Financial Reporting Council (FRC), with a new rating system for companies to be assessed for their corporate governance performance, and the promotion of the ethnic diversity of boards within its revised code.

BEIS committee chair Iain Wright said, "The UK corporate governance system is recognised throughout the world as of high quality. However, recent scandals and the issue of executive pay have undermined public trust in corporate culture.

“That, together with rising stakeholder expectations, changing business models and technology, means that corporate governance needs to evolve to provide assurance to investors and wider society.”

Wright added, “The collapse of BHS highlighted the damage which private companies can do. A new code for private companies will help to ensure that high standards of corporate behaviour are observed by our leading firms, improving their public reputation and making them more attractive to investment."

As a result, the report called on the FRC to revise the governance code to include a requirement for a binding vote on executive pay awards if more than 25% of shareholders vote against the awards. Moreover, it recommended that the chair of a remuneration committee should resign if their proposals do not receive the backing of 75% of voting shareholders.

We need greater diversity in our boardrooms, better training for directors, and more measures to enhance the executive pipeline (BEIS committee chair Iain Wright)

The FRC welcomed the report, saying that the committee’s proposals “pick up many of the FRC’s recommendations” to help restore trust in business and showed the need for the system to evolve with changing circumstances.

“The depth and breadth of the recommendations, if fully adopted, will have significant implications for the FRC’s remit, resources and funding,” the regulator added.

Meanwhile, the report also made recommendations on gender diversity in boardrooms, supporting the Equality and Human Rights Commission's principle that the government should set a target that, from 2020, at least half of all new appointments to senior and executive management level positions in the FTSE 350 and all listed companies should be women.

Companies should explain in their annual report the reasons why they have failed to meet this target, and what steps they are taking to rectify the gender inequality on their executive committees, it added.

Wright said, “We need greater diversity in our boardrooms, better training for directors, and more measures to enhance the executive pipeline, ensuring that talented people within an organisation are encouraged and supported at an early stage of their careers, and beyond, into middle and senior management."

The BEIS committee also called on the government to ensure that all FTSE 100 companies and businesses publish their workforce data, broken down by ethnicity and pay band.

The FRC’s revised code should have the issue of board diversity as a key priority, the committee argued, as well as a public explanation of the reasons why members are part of the board.

Bosses could be forced to include in their annual reports information about the diversity on their boards and in the workforce, covering diversity of gender, ethnicity, social mobility, and diversity of perspective. They should also include a narrative on the current position and targets.

Carolyn Fairbairn, director-general at the CBI, said, “Business-led initiatives to increase gender diversity on boards have made a real difference since 2010, though there is still much to do. Companies recognise that they must extend their focus to improve gender diversity in management positions, but also ethnic diversity at senior levels.

“In the short term, improving voluntary transparency and reporting on these two areas – with clear targets set by businesses themselves - should be our first priority. At this time, legal options are not likely to be the best tool to achieve good progress.”

Furthermore, the committee suggested workers should be represented on remuneration committees.

Trades Union Congress general secretary Frances O’Grady said, “We welcome the committee’s recognition of the value of workers on boards, bringing a broader boardroom perspective and strengthening long-term focus. But it’s unlikely to become ‘the norm’, as the committee hopes, unless there is a legal requirement.

"We encourage the prime minister to stick with her original promise to require companies to put workers on boards.

“The TUC strongly backs the proposal to give the FRC the power to take legal action when companies fail in their duties to workers and stakeholders. This would make a big difference in holding firms to account for their failures. Representation on the FRC’s board should also be expanded to include key stakeholder groups, including workers.”

However the CBI’s Carolyn Fairbairn disagreed, arguing that “mandating a single idea risks stifling the approaches companies already have in place or are considering”.

While not recommending the compulsory requirement of companies over a certain size to include a worker on a firm's board, the committee said this still should be encouraged.

Last month, Sports Direct announced it was beginning the process of electing a workers’ representative to attend its board meetings after promising to do so in September last year. Other companies like John Lewis, First Group, and the NHS Foundation Trust Boards have already adopted the measure in the past.

Meanwhile, Elizabeth Richards, head of corporate governance at ICAEW warned that some companies “will find the proposals challenging”.

“Others will see logic in summarising in a new ratio the pay information they report and will already have directors who welcome regular reviews of their personal performance. Also, many companies regard their employees as their greatest asset and some are backing this up today by including them in decision-making.

“There is no doubt that the issue which really ignites public opinion is executive pay, and the report’s reference to government intervention is a strong statement that the current situation should not be allowed to continue.

“The committee’s recommendations certainly have the potential to bridge the growing divide between the public and business. But whether this is the beginning of a new relationship will depend upon whether companies embrace change or whether they wait to see if new requirements are imposed and then do the minimum to comply.”

In November last year, the government released its Green Paper on corporate governance, where it revealed measures that could result in the most radical shake-up in corporate culture for at least a decade.

The FRC then called on the government to extend its enforcement powers so that it is able to call company directors to account, and not just auditors, accountants and actuaries.

A BEIS spokesperson said, “As this report sets out, the UK is already a world-leader in corporate governance which makes this country an attractive destination to invest and do business.

“The Corporate Governance Green Paper published last year seeks to build on that reputation and consulted on options to further strengthen corporate governance.

“We are considering the responses to this consultation and will respond in due course.”