We are delighted to have submitted a response to the Department for Business, Energy and Industrial Strategy’s Green Paper on corporate governance reform. Our response addresses:
- Executive pay: we believe further reform is necessary to refine the executive pay framework.
- Employee and customer voice: the voice of employees and other stakeholders must be strengthened in the board room.
Read on for our full response…
Is there a need to further reform the executive pay framework?
Yes – we believe further reform is necessary.
We work with boards across the FTSE and we have yet to meet a Remuneration Committee chair who feels comfortable with the divergence of exec and worker pay in Britain: if they felt able to ‘fix’ the problem, they would have.
By extension, investors have long had the power to make their voices heard. So to paraphrase Einstein, we should not leave the system as it is and expect a different outcome.
In our opinion this is where the case for wider employee involvement in Corporate Governance comes in.
Do shareholders need stronger powers to improve their ability to hold companies to account on executive pay and performance?
We support efforts to strengthen the role of shareholders in aligning exec pay with (long term) performance. But at best this only addresses one of the two problems with pay.
The other equally serious and separate issue is the growing gulf between exec and all-employee-pay – as highlighted in para 1.2 of the Department’s Green Paper. Aligning exec pay with performance still reserves the spoils for the executive.
This is a societal issue, not a commercial one. And so it seems unreasonable to expect shareholders to tackle it, especially an increasingly international shareholder base – as per para 1.32 of the Department’s Green Paper. If we want to build a society in which the proceeds of success benefit the workforce and the executive, we can’t expect the shareholder to do this for us. Why should they?
Do steps need to be taken to improve the effectiveness of remuneration committees, in particular to encourage them to engage more effectively with shareholder and employee views before developing pay policies?
We advocate a clearer role for the wider workforce in the setting of exec pay policies and for two reasons.
Firstly, to help broaden the attention of the RemCo which is currently (and understandably) absorbed only by factors that affect the shareholder vote. The growing gulf between exec and all-employee pay is a concern for society and not the shareholder. So unless there is some other force at play to require that this be addressed, it will fall by the wayside.
Secondly, to exert a self-correcting influence on the Executive. Executives would be less inclined to demand such inequitable terms in the first place (relative to their Workforce) knowing that they will be scrutinised and need to be approved by one or more members of that Workforce. It is likely the executives would moderate their demands or extend their proposals to include the Workforce.
(I have often wondered why we even have the concept of ‘exec pay’ and why their pay is dealt with separate from an ‘all employee’ pay policy. As one chairman put it: “The CEO receives too much of the blame when things go wrong. And too much of the credit when things go right”. I am not against a pay differential between the worker and the executive – far from it. But why does the executive receive their upside on a totally separate basis to everyone else?)
Employee and customer voice
Is there a need to strengthen the voice of employees and other stakeholders at board room level in UK companies?
Yes – change is needed. The views of employees and other stakeholders command little air time in the boardroom.
What is our evidence?
We review hundreds of company board packs every year from across the FTSE, giving us extensive (possibly unparalleled) visibility of the status quo in the boardroom.
Stakeholder considerations beyond the shareholder, are conspicuously absent from board papers. Financial and, in some sectors, regulatory considerations dominate to the exclusion of much else. And this in turn, drives a board conversation that is dominated by finance and compliance (evidenced by board minutes).
Why is the situation as it is?
It is not because directors like it this way.
In the course of our work we ask many hundreds of directors (exec and non-exec) about the conversations they would like to be having in the boardroom. And they always say the same thing: they would like to spend more time on strategy, longer-term issues and understanding their firm’s impact on wider stakeholder groups. They recognise the link between healthy stakeholder relationships and commercial success in the long run - and they are on the whole good people who want to do right by both the business and society.
So what’s stopping them? Partly habit and convention: board packs have always been filled with financial information and in turn this has driven the board conversation.
But that isn’t the only reason. Increased shareholder and regulatory pressure has driven a greater focus on financial performance and compliance. And without an equivalent force exerting influence over the board, the focus of board attention is unlikely to widen at any great pace.
What would make the difference?
Each of the options presented in the Green Paper would help to put stakeholder interests more formally on the board agenda.
As the Department’s Green Paper points out, Section 172 of the Companies Act already “enshrines the importance of wider interest groups in corporate governance.” And as we have pointed out above, directors are (typically) supportive for reasons beyond legal duties. But this is evidently insufficient to compete with the other demands on the board and to break well-formed habits. So something more is called for.
How should reform be taken forward? Should a legislative, code-based or voluntary approach be used to drive change?
Under normal (non-Brexit) circumstances we would advocate a change to the Corporate Governance Code, regulation or legislation. Anything less is unlikely to achieve much impact.
But with Brexit on the horizon we are vulnerable to businesses relocating their operations or head-offices away from Britain. The relative flexibility of doing business in Britain is one of the attractions. So the last thing we should be doing right now is weakening the case for staying by introducing a wave of rigid new rules. And yet ‘doing nothing’ leaves the interests of society and business on diverging paths.
This leaves the option of a campaign-led approach which Helena Morrissey and the 30% Club have shown can achieve material and voluntary change.
It is hard to think of other campaigns that have delivered a voluntary change in business practices on such a scale without regulation or legislation, so replicating the success of the Women on Boards campaign cannot be assumed. And as long as shareholders and regulators wield the threat of penalties they will dominate the board’s attention and reduce the likelihood of measures being adopted that are not required by either party.
So to stand a reasonable chance of success a ‘voluntary’ campaign led approach would need the full force of government behind it and the threat of legislation to follow if insufficient progress is made.
If you’re interested in contributing to the corporate governance debate by joining one of our roundtables, or would like to hear more about our wider thought-leadership work, do get in touch.
You can visit the Business, Energy and Industrial Strategy Committee’s Corporate Governance Inquiry page for further information on the Department’s review.