Is corporate governance heading in the right direction?

Legal expert Stephen Foster analyses MPs’ latest report into corporate reform and transparency

The publication of a green paper in November 2016 generated much discussion about the condition of corporate governance in UK business, with scandals at BHS and Sports Direct also pushing the boardroom-to-worker pay gap and trust in management higher up the agenda.

A new report from the House of Commons Business, Energy and Industrial Strategy Committee proposes reforms in areas such as executive pay and governance for large private companies, and highlights the need to include wider interest groups in decisions regarding directors’ pay and bonuses.

These proposed changes echo the opinion of Theresa May, who has expressed her desire for greater employee engagement at boardroom level. The significance of including wider interest groups in corporate governance is mentioned in the Companies Act 2006, and the green paper recommends requiring directors to explain how they considered each of the stakeholder interests and reflected them in their financial decisions, taking into account any long-term consequences of their decisions.

Executive pay

Executive pay continues to present challenges for the government. In particular, the green paper suggests reform for shareholder engagement and voting rights regarding pay.

One of the proposed amendments is a longer timeframe for the evaluation of senior executives’ performance in relation to pay. The hope is that companies can show that they are being democratically governed in the long-term interests of shareholders, employees and customers alike.

By adopting this broader perspective, companies can regain trust and confidence in their stakeholder communities, instead of focusing on short-term financial gain.

Employee voice

When considering employee engagement, it is thought that currently many companies focus on their short-term financial strategy and turn a blind eye to their long-term social purpose. This short-sighted approach to corporate governance is seen as endemic and ignores the voices of key interest groups at board level.

To adopt a more transparent culture, with established links between workers and the board, the green paper suggests that companies set up a ‘stakeholder advisory panel’, which could be consulted before making decisions at board level. It is also recommends that they make a statement in their annual reports setting out how well the company engages with stakeholders.

Another proposal is to include a designated non-executive director who can devote sufficient time to the company to ensure the voices of wider interest groups are considered by the board. This will give interest groups clear representation in the decision-making process and ensure they are included as a focal point in the long-term business strategy. The green paper also suggests that details of board member training are included in the HR policy and people section of annual reports.

Moving forward

Many of the recommendations could play a crucial role in the restructuring of operations and strategy for UK business. They would secure the need for corporate governance to be driven by the needs of the people being governed.

Steps to improve the representation of women at board level are also a focal point. This isn’t surprising given there are still only six female CEOs in the FTSE 100. Recommendations to improve this include developing initiatives to better support women early in their careers, such as encouragement to progress and flexible working.

We must look forward and evolve from top-down corporate governance and establish the importance of stakeholder engagement. The green paper suggests that pay and bonuses become aligned with wider corporate responsibilities and tough objectives with a phasing out of long-term initiative plans – which are often almost a guarantee of payment.

Whether this will lead to the sort of employee engagement and corporate governance we see in countries such as Germany and France, or whether the government will allow companies to adopt such practices and values on a more voluntary basis, is difficult to predict. However, recommendations such as having employee representation on remuneration committees, and a clear policy statement on how the business has invested in and remunerated individuals at all levels of the company – together with gender pay gap reporting – should be a major step forward towards improved corporate governance.

The government is clearly keen to improve reporting procedures and transparency within companies and for directors to be held more responsible for their decisions and actions in relation to the treatment of staff and their business decisions. As we saw with the Modern Slavery Act, directors can no longer simply turn a blind eye or focus solely on profits. Forcing companies to review and publicly declare the steps they have taken will hopefully become an effective method of achieving a cultural change and improved corporate governance.

Stephen Foster is a partner in the employment team at SAS Daniels