Iain Wright MP, chair of the Business, Energy and Industrial Strategy Committee in his opening keynote speech stressed the relevance of the debate by saying that “people only tend to think about corporate governance when there is a crisis, similar to people only thinking of plumbing when they are knee deep in trouble”. Indeed, according to the last Edelman Trust Barometer, we have reached record-low levels of trust in business: the credibility of corporate CEOs fell to 37%, a 12-point drop from the previous year. In addition to growing inequality the relationship between society and business is souring due to the fact that many of our current global challenges are intrinsically connected with the economy and by extension with business.
Mr Wright emphasised that there is no silver bullet in corporate governance and declared that his committee was working to “put forward meaningful recommendations” to ensure that the standards of corporate behaviour match societal expectations, focusing on the remuneration system of companies, duties and obligations of directors and strengthening stakeholder voice in boardrooms. The rationale behind these measures is to tackle short-term thinking and most importantly, restore public trust and the social license for business to operate in a post-Brexit scenario.
Fair pay for fair play: reforming executive pay
CEO pay in FTSE 100 companies has quadrupled and increased as a ratio of the average pay of full-time employees from 47:1 to 128:1. The use of bonuses linked to the company’s share price has transformed the incentives of executives, and shifted their focus from making investments in long-term success, such as into innovation and human capital, to managing the company’s short-term share price. Another consequence of this realignment is public perception that executives are drawing wages that are too high compared to that of ordinary people. This practice contributes to growing inequality, which gives rise to social dissonance, and in turn to the return of populist politics.
Charles Cotton, Performance and Reward Adviser at CIPD, explained how incentive schemes impact trust and performance within the company. According to him, bonuses and long-term incentives must be simple and understandable and “should not be directed just to a single person, while the rest of the workforce is ignored or their wages cut. Remuneration should reflect purpose for all employees.”
The current design of executive pay schemes is strongly linked to share price. This, combined with the fact that the average shareholding period has dropped to 8 months in the EU, is causing executive pay to skyrocket whilst encouraging a short-term approach to the company’s financials.
In this regard, Charles Cotton stated that evidence from behavioural economics suggests that the way executives are rewarded does not have a positive impact as “people don't value rewards which they don't understand or don't have control over”. Although performance-related pay may be helpful in relation to concrete mechanic tasks, like screwing caps on bottles or plucking chicken feathers, it doesn’t work in knowledge-intensive roles where collaboration and trust are key elements.
In relation to the disconnect between pay and performance, Colin Melvin, Chair of the Social Stock Exchange and former head and chair of Hermes EOS signalled that “remuneration practice needs to move away from a short-term transactional mindset and focus on longer-term relationships in business and finance”. Mr. Melvin’s remarks are supported by the results of a survey of the members of the UK Institute of Directors, which found that a majority of respondents perceive public 'anger over senior levels of executive pay' as the biggest threat to the reputation of business.
Is company law sufficiently clear on the roles of directors and non-executive directors? Are those duties the right ones?
Perhaps the most significant challenge for boards of directors is the question of how they reconcile the often conflicting interests of shareholders versus other stakeholders and versus the interests of the company itself. Even the interests of long-term shareholders often diverge from those of short-term investors. The primary source of UK company law, the Companies Act 2006, stipulates in section 170 that directors owe their duties to the company. This provides a clear guiding principle for boards to resolve conflicts. However, section 172 of the aforementioned act confuses this principle by requiring directors to promote the success of the company for the benefit of the members (meaning shareholders), whilst having regard to a range of other factors, such as long-term consequences, employees, the environment, reputation, suppliers and customers.
In its response to the UK Government Green Paper on corporate governance, the Financial Reporting Council argued that “this duty must be reinvigorated” and is currently reviewing UK Corporate Governance Code to “consider the appropriate balance between the Code’s principles, provisions and guidance”.
Stephen Hockman QC, Head of Chambers at Six Pump Court Chambers identified two problems with section 172. The first of those problems concerns enforcement. Mr Hockman launched the debate by asking “don’t we need some sort of remedy as a result of failure to comply with the section 172 duty?”, and suggested that an option would be to widen the range of situations where directors’ disqualification could take place.
Mr Hockman suggested that section 172 could be clarified by moving the reference to the 'benefit of the members' from the main definition of the duty to the list of factors that directors should have regard to. He pointed out that the interests of shareholders might not always be aligned with the success of the company in the long-term, or even in the short-term, and that there are different types of shareholders, including those who hold shares for long periods and share-traders who have a much more short-term perspective.
George Dallas, Policy Director at the International Corporate Governance Network (ICGN), argued that the interests of different stakeholders, including shareholders, converge in the long-term. He called for more guidance about how section 172 should be effectively implemented in practice and encouraged the use of integrated reporting as “a management tool for companies and boards and as a way for investors to better understand how a company balances its commercial and stakeholder interests.”
As Stefan Stern, Director of the High Pay Centre, and Stephen Hockman, QC both stressed, the best interest of the company is difficult to ascertain but it must be determined on a context-specific basis and it cannot be equated with maximising shareholder value, especially not in the short-term. Directors are free to instead choose to invest in innovation, research and development, employee training, improvements to sustainability or other areas if that will ensure the long-term vitality of the firm.
How can the interests of employees, customers and wider stakeholders be better taken into account at board level in large companies?
UK Prime Minister Theresa May had suggested plans to include employee representation in corporate boards but has since backtracked. Janet Williamson, Senior Policy Officer at the TUC supported that proposal, noting that the rate of investment in R&D doubles in countries with board level employee representation, to which she also added that “worker participation on boards encourages boards to take a long-term approach to decision-making as they have an interest in the long-term success of their company”. George Dallas concurred that companies should seek input from workers for their governance, but he suggested that there are several ways how to they can do it and that board representation might not work well for every company.
Notes to Editors:
Dr. Jeroen Veldman and Prof. Hugh Willmott run the Modern Corporation Project at Cass Business School, ranked amongst the best business schools in the UK and the world. They provide the academic basis for the Purpose of the Corporation Project, an open-source platform led by Frank Bold, a European purpose-driven law firm. The Project brings together leading experts and organisations interested in promoting the long-term health and sustainability of publicly listed corporations in the areas of policy-making and business management.
Between 2014 and 2016, Cass Business School and Frank Bold hosted a global series of roundtables on corporate governance with events held in Brussels, Breukelen (The Netherlands), London, New York, Oslo, Paris and Zurich. The results of the series of events are compiled in the Corporate Governance for a Changing World report.
Amy Ripley, Senior Communications Officer, Cass Business School
Susanna Arus, Communication and Events Officer, Frank Bold