Following the evidence that this Committee found in 2016 of major corporate governance failings at BHS and Sports Direct, we welcome the Prime Minister’s commitment to improving behaviour by big business, as demonstrated by the publication of its Green Paper containing options for reform.
In looking more broadly at this issue, we have found that, 25 years after the Cadbury Report, the UK retains a strong system of corporate governance. However, the environment has changed since then, with new business models, technological developments and growing expectations from stakeholders. The changing ownership structure of British business in a globalised economy has contributed to increased pressures on companies to deliver short-term financial gains for shareholders, rather than invest for their long-term benefit. A worrying lack of trust in business by the general public has been fuelled by recent high profile examples of bad practice, as well as pay levels being ratcheted up to levels so high that it is impossible to see a credible link between remuneration and performance. In this context, these developments demand that our existing framework be improved to keep the UK in the lead globally on corporate governance.
Whilst supporting the current comply or explain basis of the UK Corporate Governance Code, we propose a series of reforms designed to require directors to take more seriously their duties to comply with the law and the Code relating to corporate governance. These include requirements relating to more specific and accurate reporting, better engagement between boards and shareholders, and more accountable non-executive directors. Crucially, to combat what are currently very weak enforcement mechanisms, we recommend a wide expansion in the role and powers of the Financial Reporting Council, to enable it to call out poor practice and engage with companies to improve performance.
Given the increasing number of major private companies, which are subject to weaker reporting requirements, we recommend that a new governance Code for the largest private companies be developed. Compliance with this Code would be examined by an expanded FRC, funded by a small levy on businesses, able to pursue complaints relating to compliance with the Code.
In relation to high levels of executive pay, we agree with the Prime Minister that this is an issue which needs to be addressed for the benefits of society as a whole and in line with her vision of an economy that works for everyone. Whilst there are some encouraging signs that shareholders are beginning to exert some pressure on high executive pay, there are structural problems that need to be addressed. We recommend the abolition of long-term incentive plans, which have become too complex and are liable to create perverse incentives and short-term decisions. Instead, we recommend a more simple pay structure, comprising salary, bonus relating to stretching targets, including those relating to wider performance criteria, and payment by means of equity over the long term.
We also propose measures to improve engagement, including with employees, on pay, and to incentivise better stewardship through more transparency and better reporting. This should include the annual publication of pay ratios.
On board diversity, we fully support the recommendations of recent reviews on gender and ethnic diversity. Whilst progress is being made, we recommend further measures to ensure that diversity is promoted at all stages of careers to broaden the pool of talent at the executive level. To this end, the Government should set a target that from May 2020 at least half of all new appointments to senior and executive management level positions in the FTSE 350 and all listed companies should be women.
We also believe that diversity can be improved by the appointment of workers on boards. This model has worked for some companies, here and abroad, and can help provide both challenge and a different perspective on the board.
We believe that our recommendations will make a strong contribution towards embedding the behaviours of good corporate governance in the culture and values of British businesses, to the benefit of both business and society as a whole.
4 April 2017