On July 16th, the Financial Reporting Council released the revised UK Corporate Governance Code,[1] which will take effect on 1 January 2019. The new Code focuses on the relationship between companies, their shareholders, stakeholders and corporate culture. It is shorter and sharper and sets higher standards of corporate governance.
The 2018 Code retains the “comply or explain” approach and emphasis on high-quality reporting. More specifically, companies will have to avoid a “tick-box” approach and use explanations as an opportunity to communicate with their shareholders and stakeholders.
More engagement with shareholders and workforce
The revised Code calls on companies to engage more with their shareholders and workforce. When more than 20% of votes have been cast against a resolution, companies will have to explain the actions they intend to take, to consult shareholders, and publish an update no later than six months after such a vote. The companies should also provide a final summary in the annual report and, if applicable, in the explanatory notes to resolutions at the next shareholder meeting, on what impact the feedback has had on the decisions the board has taken and any actions or resolutions proposed.
These provisions encourage dialogue between companies and shareholders and transparency on how companies respond to shareholders’ concerns. The aim is to improve the current market practice of companies usually not disclosing a response to significant dissent on resolutions (other than those related to executive remuneration).
Companies are also encouraged to engage with their workforce through one or a combination of the following options: appointing a director from among employees, instituting a formal workforce advisory panel and designating a non-executive director.
Independence and diversity on the spot
The 2018 UK Corporate Governance Code addresses recent concern over board diversity and asks companies to include in their annual report a diversity policy with objectives and the progress made on achieving the objectives.
The new Code also looks at the Chairman’s independence and recommends that the Chairman not remain in the post beyond nine years from the date of his/her first appointment to the board. However, this period can be extended for a limited time.
Directors’ overboarding (i.e., sitting on multiple boards) is also scrutinized by the revised Code, which recommends that the non-executive directors should have sufficient time to meet their board responsibilities. Prior to appointment, significant commitments should be disclosed with an indication of the time involved. Additional external appointment should not be undertaken without prior approval of the board, with the reasons for permitting significant appointment explained in the annual report.
Stringent rules for remuneration
The new Code has more demanding criteria for remuneration policies and practices. It recommends that remuneration policies and practices should support and be clearly linked to the successful delivery of the company’s long-term strategy. When setting directors’ remuneration, the remuneration committee should also consider workforce remuneration policies and practices, exercise discretion when authorizing remuneration outcomes and explain the rationale. The 2018 Code also clearly indicates that no director should be involved in deciding their own remuneration. Furthermore, the remuneration committee Chairman should have served on a remuneration committee for at least 12 months.
What should investors expect to see from companies?
The new Code paves the way for communication and transparency, with the aim of restoring declining trust in businesses shaken by boardroom battles and controversies related to excessive executive pay. The investors’ voice should be better heard and, most importantly, taken into consideration for future developments. Based on companies’ improved reporting, investors should be able to assess how good corporate governance contributes to companies’ long-term sustainable success and helps achieve wider objectives. Investors can also evaluate companies’ explanations when then deviate from the Code principles by considering individual circumstances.
The 2018 UK Corporate Governance Code recommends higher quality standards and companies should step up to meet them. Nevertheless, investors should not expect to see companies improving their corporate governance overnight. This is a process that takes time. What investors should expect to see is that companies will be more open, will reach out to them and will start making improvements.
[1] The UK Corporate Governance Code recommends standards of good practice related to board leadership and effectiveness, audit, risk and internal control, remuneration, accountability and relations with shareholders. Companies listed on London Stock Exchange are required under the listing rules to report in their annual report how they have applied the Code principles.
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