Business must act on corporate governance, executive pay, and boardroom diversity to address worrying lack of trust, say MPs

While recognising the overall strength of the UK corporate governance system, the report notes the damage caused by high profile failings and a dramatic ratcheting up of executive pay in recent years, at a time of stagnant wage growth for many workers. It recommends a series of actions on executive pay, a new and stronger voluntary code of governance for private companies, better reporting by companies on how directors fulfil their duties and responsibilities and a major 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.

On executive pay, the Committee calls for businesses to simplify the structure of executive pay and put an end to long-term investment plans (LTIPs), which lack transparency and which can distort decision-making. The Committee also suggests workers be represented on remuneration committees and for the chairs of remuneration committees to be expected to resign if shareholders fail to approve the company’s pay policy. The report calls for companies to explain their pay policies better, including by publishing pay-ratios annually. On gender diversity, the Committee calls for the Government to set a target that from May 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, and for companies to explain if they fail to achieve this ambition.

Iain Wright MP, Chair of the Business Innovation and Skills Committee, 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.

“The rise of "ownerless companies", where no single investor has a sufficiently large stake in the business to act as a responsible owner, checking performance and behaviour, provides a significant challenge to sound corporate governance. Successful, productive and profitable companies cannot be disconnected from society. Businesses have wider responsibilities than short-term profits; they have a responsibility to their employees, their suppliers, and to the communities in which they operate.

Executive pay has been ratcheted up so high that it is impossible to see a credible link between remuneration and performance. Pay must be reformed and simplified to incentivise decision-making for the long term success of the business and to pursue wider company objectives than share value.”

“The collapse of BHS highlighted the flaws in 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.”

Executive pay – votes on pay & Remco Chairs The report rejects annual binding votes on pay but calls for the FRC to revise the Code to include a requirement for a binding vote on executive pay awards, held in the following year, in the event of there being a vote against such a vote of over 25 per cent of votes cast [see paragraph 106 of report]. To incentive strong engagement with shareholders, the report also recommends that the Chair of a remuneration committee be expected to resign if their proposals do not receive the backing of 75 per cent of voting shareholders [see paragraph 109].

The Committee recommends the FRC revises the Code to include a requirement for a binding vote on executive pay awards the following year in the event of there being a vote against such a vote of over 25 per cent of votes cast. This requirement should be included in legislation at the next opportunity.

Included in the report are recommendations relating to, among other issues, ethnic and gender diversity in the boardroom, holding company directors to account, a new ‘traffic light’ rating system for companies and their corporate governance, the establishment of stakeholder advisory panels and workers on remuneration committees, non-executive directors, and the publication of pay-ratios:

Holding company directors to account The Committee recommends the Government gives the Financial Reporting Council additional powers to engage and hold to account company directors in respect of the full range of their duties. This includes the FRC reporting publicly to shareholders on any failings of the board collectively or individual members of it or, if companies fail to engage with the FRC, the Committee recommends the FRC be given authority to initiate legal action for breach of section 172 duties.

‘Traffic light’ rating system for companies The report recommends the FRC assess businesses on their corporate governance with a red, amber, green rating-system, which would encourage investors, suppliers, and employees alike to pressure boards into maintaining a good rating [paragraph 40]. The report proposes a series of reforms designed to require directors to take more seriously their duties to comply with the law and the Code relating to corporate governance. These include requirements relating to more specific and accurate reporting, better engagement between boards and shareholders, and more accountable non-executive directors.

Boardrooms – gender diversity, ethnic diversity The report recommends that the aims and targets of the Hampton-Alexander Review should go further, and supports the Equality and Human Rights Commission's principle that the Government should set a target that from May 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.

The Committee calls on the FRC to embed the promotion of the ethnic diversity of boards within its revised Code. The Committee recommends that, at the very least, wherever there is a reference to gender, the FRC should include a reference to ethnicity, so that the issue of ethnic diversity on boards is made explicit in the revised Code, and is given as much prominence as gender diversity.

In accordance with the recommendation in the Parker Report, the Committee also recommend that the Government should legislate to ensure that all FTSE 100 companies and businesses publish their workforce data, broken down by ethnicity and by pay band.

Iain Wright MP, Chair of the Business Innovation and Skills Committee, said: “Too often in the wake of corporate failures we discover that directors, especially non-executives, have failed to provide sufficient challenge. Too often these individuals seem to be drawn from the same cosy club. We do not recommend tokenism, but we strongly believe a diverse board both better reflects the society in which the firm operates and provides greater challenge to the strategy and decisions taken, which should improve company performance and profitability.  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.”

Workers on remuneration committees & stakeholder advisory panels The report welcomes the progress made on some aspects of diversity and believes it can be improved by the appointment of workers on boards as a means of having strong employee engagement, although it does not recommend the latter be made compulsory. The Committee calls for workers to be represented on remuneration committees, which would represent a powerful signal on company culture and commitment to fair pay. The report also recommends companies consider establishing stakeholder advisory panels, including workers, consumers, and suppliers, to help collaboration and dialogue.

Non-executive directors – serving on multiple boards The report calls for the effectiveness of NEDs to be considered carefully in annual director reviews, and also in the external board review required every three years. The Committee also calls on NEDs to be required to demonstrate more convincingly that they are able to devote sufficient time to each company when they serve on multiple boards.

Publish pay ratios – companies and public sector The Committee calls for companies to publish pay ratios between the CEO and both senior executives and all UK employees. The report also recommends the Government requires that equivalent pay ratios should be published by public sector and third sector bodies.