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Corporate governance has been on the political agenda for years, but in recent months it has been in the headlines even more than usual, thanks to the demise of BHS and to Theresa May’s comments concerning the representation of consumers and employees on company boards. At the end of November 2016, the government duly published a substantial consultation paper ominously entitled ‘Corporate governance reform’.
The consultation paper, which is open for comment until 17 February 2017, is something of a mixed bag in terms of its scope, for it addresses three areas: directors’ pay, stakeholder representation and corporate governance beyond the listed company sector. It is also a mixed bag in terms of the ambition of the reforms which are under consideration. On the one hand, a suggestion that large private companies should be subject to a corporate governance code is a sensible and proportionate innovation. On the other hand, the options for reform concerning directors’ pay and stakeholder representation do not address the root cause of the perceived problems in those areas, which is that shareholders have not shown themselves to be particularly inclined to defend stakeholders’ interests.
The consultation paper – directors’ pay
The legal underpinnings of the rules governing directors’ pay are to be found in companies’ articles of association and in the Companies Act 2006. The question of how much directors should be paid is, fundamentally, one for the company’s shareholders, but it is common for the articles to provide for this power to be delegated to the board, either in relation to the pay of all of the directors or in relation to the pay of only the executive directors. The risk that the directors will misuse that power is, to some extent, addressed by the fact that, in setting their own pay, directors are obliged to act in accordance with their statutory duties, including their core duty of loyalty under section 172. The Act also contains specific provisions designed to mitigate the risk. Shareholder approval is required in relation to certain long-term service contracts (section 188) and certain payments to directors for loss of office (sections 217 – 219), and shareholders of quoted companies have further protection in the form of a binding vote on the company’s remuneration policy (section 439A) and an advisory vote on the actual sums paid to individual directors (section 439).
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The consultation paper (‘Corporate Governance Reform – Green Paper’, Department for Business, Energy & Industrial Strategy, November 2016) notes that the requirement for shareholders of quoted companies to be given a vote on the policy and on actual pay was introduced just a few years ago. It also notes, however, that shareholders have not demonstrated any great inclination to strike down pay arrangements – as of October 2016, only one company had lost a vote on its policy and only six had lost a vote on actual pay – and suggests that the public at large may find current levels of pay unacceptable. Accordingly, it seeks views on whether a ‘further refinement’ of the regime may be warranted. Amongst the numerous options for reform which it sets out are the following:
the extension of the binding vote to the actual sums paid to individual directors
the introduction of a requirement for the policy to set an upper limit for total pay, and for any proposal to breach that limit to be subject to shareholder approval
the introduction of measures to facilitate voting by individual, as opposed to institutional, shareholders
the introduction of a requirement for companies to disclose how the chief executive officer’s pay compares with pay elsewhere in the company (so-called pay ratio reporting)
an enhancement of the requirement to disclose the performance targets which trigger bonuses.
The consultation paper – stakeholder representation
Section 172 of the Companies Act 2006 imposes on directors a duty to promote the success of the company for the benefit of its shareholders, and, in doing so, to have regard to (amongst other matters) the interests of company’s employees, the company’s relationships with its suppliers and the impact of the company’s activities on the environment. The duty embodies the notion of ‘enlightened shareholder value’, which holds that sustainable success is bound up in treating the company’s stakeholders fairly.
The consultation paper notes, without naming names, that there have been some examples of companies failing to pay sufficient attention to stakeholders’ interests, and suggests that more may need to be done to ensure that stakeholders’ views are heard at board level, such that directors can comply fully with their duty under section 172. It sets out four possible ways in which change may be brought about:
by the appointment of stakeholder representatives to the board
by the establishment of stakeholder advisory panels which would feed stakeholders’ views to the board
by assigning to individual non-executive directors the task of ensuring that the board hears the views of particular groups of stakeholders
by strengthening companies’ reporting obligations, such that the directors’ compliance with section 172 can be assessed properly.
The enhancement of reporting obligations could, presumably, involve the introduction of detailed legislative requirements, but in general the government appears to favour a less prescriptive approach to implementing any reforms in this area. It had been thought at one stage that the Prime Minister wanted to require companies to have employee representatives on their boards, but the consultation paper confirms expressly that the government does not intend to introduce any such mandatory obligation. Instead, it suggests that companies could be made subject (either through legislation or through other means) to a general principle that they should take proper account of stakeholder interests, and it would be for individual companies to determine what specific mechanisms for absorbing stakeholder views are best suited to their circumstances.
The consultation paper – corporate governance beyond the listed company sector
One of the most vexed questions in the field of corporate governance is also the most fundamental: what does ‘corporate governance’ actually mean? In its simplest form, it may be taken to mean something along the lines of ‘the way in which a company is run’, and in that sense it is just as important for the smallest private company to have good corporate governance systems in place as it is for the largest multinationals. In practice, however, the corporate governance regime directs its attention mainly towards the affairs of listed companies, on the grounds that the proper running of a company is of particular importance where (a) it has a widely dispersed shareholder base, such that the owners of the company may not easily be able to act together to control the directors; and (b) the company’s scale is such that its activities – and its success or failure – affect not just its shareholders, but also, potentially, thousands of employees and suppliers, millions of customers, the environment, the communities in which it operates and even the national economy.
The question arises as to whether the efforts of government and regulators to ensure that companies are run properly should extend to those private companies which, although they may have a narrow shareholder base, are comparable in terms of the scale of their operations to listed companies. The consultation paper makes the interesting point that around 2,500 private companies have more than 1,000 employees, and it notes that there seems to a trend in favour of running large businesses through private companies. Against this background, it suggests that it may be appropriate for large private companies to be made subject to the same type of corporate governance standards as listed companies. In particular, it asks for views as to whether they should be made subject to a corporate governance code (whether the UK Corporate Governance Code or an alternative bespoke corporate governance code for private companies), and whether corporate governance reporting requirements should apply based on a company’s size rather than on whether it is listed or privately held.
At the heart of the corporate governance regime is a dilemma.
On the one hand, one of the aims of the regime is to ensure that companies do not ride roughshod over the interests of stakeholders, and the underlying theme of the consultation paper is the need to encourage companies to behave responsibly. In her introduction to the paper, the Prime Minister comments that ‘for people to retain faith in capitalism and free markets, big business must earn and keep the trust and confidence of their customers, employees and the wider public’. Elsewhere in the paper, the point is made that ‘society has a legitimate expectation that companies will be run responsibly in return for the privilege of limited liability’.
On the other hand, English law has always taken the view that it is for the shareholders, as the owners, to decide how their company should be run.
The problem is that shareholders’ interests and stakeholders’ interests do not always coincide. Or, at least, shareholders do not always seem to be as eager to ensure that stakeholders’ interests are protected as the government would like. This divergence can be seen in the seemingly endless debate over directors’ pay. The consultation paper suggests that there is public dissatisfaction about the level of directors’ pay, and it is difficult to argue with that assessment of the mood in the country. Shareholders, however, do not appear to be unduly concerned about this issue. For one thing, it is in their power to choose not to delegate to the directors the power to set their own pay in the first place. What’s more, the regime’s attempt to encourage them to restrain pay levels by giving them a vote on policy and actual pay has not been a resounding success. As the consultation paper acknowledges, they have tended to vote heavily in favour of pay arrangements, and in fact a significant proportion of them have not even bothered to exercise their vote.
How is this dilemma to be resolved? If the government is truly determined to protect stakeholders’ interests, it may have to bite the bullet and take a more interventionist stance, curtailing the traditional freedom given to shareholders to run their companies as they please. One option would be to impose on directors a duty to act in stakeholders’ interests, and to give stakeholders the right to enforce that duty. However, such an innovation would be fraught with difficulties. For one thing, it would raise the spectre of a flood of litigation against directors by everyone from employees to customers, suppliers and even representatives of the local community. Another option would be to make more focused interventions. In relation to directors’ pay, for example, legislation could impose an upper limit on pay levels, whether by specifying an actual figure or by setting out a formula based on the company’s performance. Similarly, in relation to ensuring that stakeholder views are fully aired at board level, companies could, after all, be required to have employee or other stakeholder representatives on their boards.
Any such interventions would, of course, be extremely controversial, and a great deal of thought would need to go into their detailed workings. However, the question for the government to consider is whether its current approach, which seeks to introduce cultural reforms by gentle encouragement, is working at all and, if it is, whether it is working quickly enough. The view may be taken that, on balance, it is working reasonably well, and certainly the consultation paper contains some sensible ideas, amongst them the suggestion that large private companies may need to be brought into the corporate governance regime’s fold. We may, though, be approaching the stage at which, in some areas at least, serious reform requires a bolder approach.