1 December 2017

Companies need to embrace corporate governance reform for the good of capitalism in the UK

Next week we're expecting to see the next component of the UK’s overhaul of corporate governance with publication for consultation of a new UK Corporate Governance Code. There should be no surprises, as the outline of what to expect has been well-trailed, including:

• A shorter, simpler code based on fewer principles and more commercial outcomes

• A strong stakeholder focus, including the expectation for boards to establish a robust mechanism for ensuring employee voice is heard in the boardroom

• A broadened remit for remuneration committees to oversee pay policy throughout the company

• Increased focus on independence and the roles of Chairman and SID

• Lengthened timeframe of five years for long-term incentive plans

The Financial Reporting Council’s review of the UK Corporate Governance Code is just one of multiple corporate governance changes affecting companies and investors over the coming months, which will also include:

• More specific regulatory requirements on boards to explain how they are fulfilling their duty to have regard to broader stakeholders under s172 of the Companies Act

• Mandatory requirement to report CEO-employee pay ratio, with associated narrative disclosure on the company’s approach to pay fairness

• Enhanced reporting on intangible and non-financial factors in the Strategic Report

• An updated Stewardship Code, emphasising the obligations of all investment chain participants to support long-term value in UK listed companies

These different elements of soft and hard regulation are coming forward in a slightly disjointed manner but have at their core two common beliefs:

• There is a need to encourage business to take a longer-term view of value creation in order to address the UK’s productivity problem

• In order to rebuild trust in business, and indeed in capitalism, business needs to do more to demonstrate that stakeholders, and in particular employees, are being treated fairly in business decision-making

This is an agenda whose momentum seems only likely to build in the face of the forces affecting the UK economy, workforce, and politics. Rather than viewing these in a piecemeal matter, companies and boards need to consider their overall response to these challenges in an integrated way, all linked to fulfilment of directors' fundamental duties under Section 172 of the Companies Act. This means developing a deep understanding of the company’s purpose and role in society, and translating that into tangible policies for the board's agenda, committee remits, and how stakeholders are engaged, their interests considered, and trade-offs made in coming to business decisions.

Fairness is a politically loaded term, and can be hijacked by special interests and narrow perspectives, as we're already seeing in the debate on pay ratios. But it's an issue we need to grapple with and make sense of, in a way that supports rather than inhibits long-term value creation, on which our prosperity depends.

Companies need to make a concerted effort to show that the enlightened shareholder value model enshrined in Section 172 means something beyond window dressing. Otherwise political pressure for more radical options will become irresistible.