by Laurie Fitzjohn-Sykes, director of research, Tomorrow's Comapny Read the original article here. It is now 25 years since Tiny...
Tomorrow’s Company welcomes the government’s green paper on corporate governance, which puts forward many sensible policies, some of which have been advocated by Tomorrow’s Company. The most meaningful of these are shareholder nomination committees and stakeholder advisory panels. However, it is also lacking in some areas. It seeks to address the already small number of scandals, rather than tackling the much more damaging issue of risk aversion in many boardrooms and consequent lack of investment. It also narrowly focuses on the executives and the boardroom, without sufficient focus on the role of shareholders and the investment chain. Put simply, action on executive pay and scandals is not enough without tackling short-termism and getting companies investing again.
On executive pay, increased voting power to shareholders is a helpful step. However, currently only 3% of companies lose their advisory vote on pay, therefore the impact of binding votes may not be that great. Improved disclosure on executive pay would also be helpful. While pay-ratios are a crude instrument that are not always comparable, they would prompt companies to fully explain why a certain pay ratio was appropriate for their organisation.
The green paper rightly considers the role of remuneration committees, and how they should consult employees. Tomorrow’s Company would go further than this and broaden the remit of the remuneration committee to consider the pay and incentives for all employees. This would encourage the committee to consider if the pay structure and differentials were supporting the company’s culture and strategy, rather than discussing executive pay in isolation. This idea was also mentioned by the FRC in its submission to the BEIS Select Committee inquiry on corporate governance.
Under the heading of executive pay the green paper suggests the introduction of shareholder nomination committees, as exist in Scandinavia. Tomorrow’s Company supports this idea, as argued in this report Bridging the UK engagement gap through Swedish-style nomination committees. However, its benefits and implications go far beyond executive pay. It can help improve the engagement between a board and its largest shareholders. This is potentially the most significant reform suggested in the paper.
Stakeholder advisory panels
Tomorrow’s Company is supportive of the combination of stakeholder advisory panels, designated NEDs and improved reporting. This is close to reforms Tomorrow’s Company recently advocated in Bringing employee voice into the boardroom. Increasing the voice of stakeholders can improve boardroom decisions and hold boards to account to their wider duties under Section 172 of the 2006 Companies Act.
Private company governance
Improved governance for large private companies is also sensible. The number of listed companies is in decline and there are an increasing number of private companies of a similar size to large listed companies. A private company governance code would help increase the accountability of these companies to their key stakeholders. Indeed, many large private companies already choose to comply with the governance code.
But reforms also need to tackle short-termism
These policies are mostly sensible steps forward, but the green paper in some ways has the wrong focus. The government rightly points out that the UK is a leader in corporate governance, with overall high standards of corporate behaviour. Scandals, such as BHS, are a very small minority. Despite this there are a number of worrying trends, as highlighted in the report UK Business: What’s Wrong? What’s Next? – business investment is low, employee engagement is low, real wage growth is stagnating, public trust in business is low and the irony is that shareholder returns have also been poor.
Further reducing the number of scandals will not address these trends. Instead we need to encourage UK business to take more risks and increase investment. The lack of investment has now reached a damaging level – dividends from non-financial companies have risen to £120bn, 13% of gross value add, up from 8-9% in the early 1990s. This is contributing to companies now being net savers to the tune of £127bn or 8% of GDP, up from 3-4% in the early 1990s. Despite falling interest rates and tax rates, companies are forgoing profitable investment opportunities in order to pay dividends to shareholders. This places a far greater cost on the UK economy and society, than the small number of scandals.
Encouraging business to take risks and invest will also prove a more effective means of restoring public trust than tackling a few bad apples. People need to be inspired by companies that invest in pursuit of a purpose that delivers value to society. There are currently too few business leaders who have the courage to show this sort of leadership.
The other key omission from the green paper is the narrow focus on executives and the boardroom, with little mention of shareholders and the broader role of capital allocation within the investment chain. To be effective boardrooms need supportive long-term shareholders, which is in turn conditional on action across the investment chain from asset managers to pension trustees and investment consultants. The government should consider how it can support the creation of a base of long-term shareholders in UK companies.
Overall, the green paper suggests some sensible policies. Of these, shareholder nomination committees and stakeholder advisory panels would have the most meaningful impact. As such, Tomorrow’s Company is very supportive of the governments work in this area. However, the paper also ignores two important issues – the low level of investment and the need for a supportive base of long-term shareholders. Lack of trust in business will not be solved by focusing solely on executive pay and scandals, but instead by encouraging companies to start investing again.
 The Big Innovation Centre, The Purposeful Company – Interim Executive Remuneration Report, November 2016.
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