Corporate governance Contents

3Promoting good corporate governance

Directors’ duties

25.The key requirements on company directors relating to corporate governance are set out in the Companies Act 2006. To a large extent, the Act served to clarify, or at least, codify, existing rights and responsibilities under the common law. During the passage of the Companies Bill, there was considerable debate about how the interests of shareholders and other stakeholders should best be balanced. The formulation that was arrived at was carefully crafted so as to enshrine the existing doctrine of shareholder primacy whilst also providing some protection to the interests of wider stakeholders. Under section 172 of the Act, a director is required to act “in a way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.”39 In doing so, directors are required to “have regards to” a number of considerations, including the interests of employees and the likely consequences of any decision in the long term (see Box 1). This formulation provides a compromise around the extent to which the law should intervene on the decisions of companies: in effect it requires consideration of other factors in pursuit of the primary aim of company success, but it does not prescribe any prioritisation of these factors.40

Box 1: Section 172 of the Companies Act 2006

172 Duty to promote the success of the company.

1.A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to—

a)the likely consequences of any decision in the long term,

b)the interests of the company’s employees,

c)the need to foster the company’s business relationships with suppliers, customers and others,

d)the impact of the company’s operations on the community and the environment,

e)the desirability of the company maintaining a reputation for high standards of business conduct, and

f)the need to act fairly as between members of the company.

2.Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, subsection (1) has effect as if the reference to promoting the success of the company for the benefit of its members were to achieving those purposes.

3.The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.

26.The vast majority of the evidence we received was supportive of the existing legislation. Professional bodies and lawyers in particular argued that the legislation was well understood, at least in the listed sector,41 worked well in practice and, according to the Institute of Directors (IoD), was “largely fit for purpose”.42 It was argued that good boards would naturally consider and balance the interests of different stakeholders: company success depended upon it. Witnesses warned of potential unintended consequences of any changes in terms of the accountability of directors to shareholders and the impact on the attractiveness of the UK as a place to invest.43 Also cited was the difficulty in finding a legal formulation that actually added clarity.44

27.Some witnesses were more critical of the wording of section 172, arguing that, in the absence of clarity, the interests of shareholders could in practice be pursued without regard to those of other stakeholders.45 Provided directors acted “in good faith” (or it could not be proved that they did not), they were free to do so, according to Professor Andrew Keay from Leeds University School of Law. He argued that it would not be easy for the courts to question the motives of directors and noted that the courts have been cautious in granting shareholders permission to take action against a company.46 We heard that there have been no reported cases of shareholders bringing actions against directors in respect of section 172.47 Professor Keay pointed out that promised guidance on how directors should comply with section 172 was never published, leaving directors, shareholders and the courts with little clarity on how the requirement to have regard to a number of factors was to be met.48

28.Janet Williamson, from the Trades Union Congress (TUC), argued that the original wording of section 172 was based on the understanding that there was a convergence between the interests of shareholders, the company and other stakeholders,49 but that the increase in short-term trading had shifted the interests of shareholders to favour short-term share price over the promotion of “long-term organic growth”.50 The TUC argued that section 172 should be amended to require company directors to promote the long-term success of the company as their primary aim and that directors should be required to “have regard to the interests of shareholders, alongside those of employees and the other stakeholder groups already included in section 172”.51 In another proposed move away from shareholder primacy, Helena Morrissey, the then CEO of Newton Investment Management, argued that directors be required to “give equal importance” to all stakeholders.52 Standard Life argued that the legal requirement should relate to reporting, suggesting that companies be required to state more explicitly that directors ‘must consider and report’ on how they have considered other stakeholder interests.53

29.We do not believe that weaknesses in corporate governance arise primarily from the wording of the Companies Act, in particular section 172. We nonetheless recognise that the requirement for directors to “have regard to” other stakeholders and considerations is lacking in clarity and strength and is not realistically enforceable by shareholders in the courts, even if they were minded to take action against their own company directors.54 However, with negotiations on leaving the EU about to begin, now is not the time to introduce uncertainty to UK markets by seeking to reframe the law.

30.We have some sympathy with the argument that there are insufficient incentives for directors to consider seriously the interests of other stakeholders, such as employees, supply chains and pension fund members. This point was illustrated by the finding in 2016 by the Grocery Code Adjudicator that Tesco had seriously breached the code governing the grocery market by deliberately delaying payments to boost its profits. This might be considered a failure in compliance with section 172(c), namely the duty to “have regard to the need to foster the company’s business relationships with suppliers, customers and others.” It is this balancing of different stakeholder interests that section 172 was designed to address, so it is instructive that what looks on the face of it a failure of corporate governance was remedied, not under the Companies Act (which would have required action by shareholders), but by the regulator. A board following the principles of the legislation and the Code would not have allowed this to happen. This is but one example from a growing body of evidence that directors have not paid sufficient attention to the interests of wider stakeholders, whether it be those working for them, the local community or suppliers. Recent examples exposed in the media have included ASOS, JD Sports and IKEA. Improvements in corporate governance can keep issues out of the courts: prevention is better than cure by legal means. We believe that more effective measures are required to ensure that directors demonstrably take seriously their duties to have regard to other stakeholders and the long-term consequences of decisions. This can best be achieved by requiring more specific and accurate reporting, supported by robust enforcement.

Reporting

31.Listed companies are subject to a variety of reporting requirements relating to financial reporting and corporate governance, including those set out in the Code itself, Part 16 of the Companies Act 2006 and the Financial Conduct Authority’s Listing Rules and Disclosure and Transparency Rules.55 Premium listed companies are subject to higher standards of disclosure. These requirements have expanded incrementally, so now companies are required to produce a whole range of discrete reports as part of the annual reporting process. By common consent, some of these reports have become increasingly defensive in nature and legalistic in tone, as companies seek to adhere to minimum requirements for reporting. Evidence referred to “boiler-plate” statements that lacked meaning but passed the test of compliance.56 In cases of non-compliance, the quality of explanations have been described as “disappointing” by the FRC.57 The Investor Forum reports that reporting seems “unable to cater for the rise in the importance of a wider stakeholder group”, nor has it adjusted to the increasing tendency of company value to be in the form of intangible assets, such as knowledge and intellectual property rather than physical assets.58 It is clear that many companies are failing to communicate effectively with stakeholders via the reporting process, and are therefore missing an opportunity to enhance public confidence and inform investors.

32.As part of the reporting process, companies are required to provide a high level statement of how the board operates,59 and must include in strategy reports an assessment of the position of the business against a number of specified criteria.60 Companies are not required to explain specifically how they have fulfilled their section 172 duties, including how they have had regard to other considerations and the interests of stakeholders whilst pursuing the success of the company in the interests of its members. As a result, it is very difficult for shareholders to hold directors to account for the fulfilment of their legal duties or understand how they have balanced the interests of various stakeholders over the course of the year. Jonathan Chamberlain of the Employment Lawyers Association told us that

We are all in agreement that, to put it at its lowest, it is very difficult to evaluate the operation of Section 172 in the absence of any real disclosure as to how it is working in practice.

33.Stakeholders have a right to expect higher standards of reporting in respect of section 172 duties: this is essential to securing improved levels and standards of engagement with shareholders. We do not want to add to the volume of meaningless, boiler-plate statements that companies produce in response to requirements.61 Instead, directors should be required to report in an accessible, narrative and bespoke form on how they have complied with their duties under section 172. This will force directors to at least actively consider how they meet these requirements during the year and increase the prominence of these other factors throughout the company and also in the minds of shareholders. The Modern Slavery Act 2016 may provide a useful model, as suggested by the Employment Lawyers Association.62 That Act includes a requirement for companies with an annual turnover of at least £36 million to state what steps they have taken to ensure that their supply chains have not included trafficked people. Whilst such statements are themselves subject to “boiler-plating”—and we note that there was an ostensibly compliant statement published by Sports Direct when two individuals were convicted under that Act of trafficking people from Poland to work there63—they have nonetheless served to raise the profile of the issue and force companies to take their responsibilities seriously. Stricter requirements in relation to section 172 can have a similar effect.

34.We do not underestimate the difficulties of establishing consistent standards of reporting, when compliance is with a duty to “have regard to” a number of factors and is subjective to an extent but it is possible to develop a common understanding of what companies should be required to do by way of informed reporting on how they have balanced different interests. For example, they should explain the rationale behind the allocation of funds between dividends, pension funds, capital investment and other categories. Companies should be required to provide better information on how they have looked after the interests of employees, fostered relations with suppliers and mitigated any environmental impacts. They should also provide an explanation as to the time horizon of decision making, with respect to the duty have regard for the consequences of decisions in the long term. We recommend that the FRC amends the Code to require informative narrative reporting on the fulfilment of section 172 duties. Boards must be required to explain precisely how they have considered each of the different stakeholder interests, including employees, customers and suppliers and how this has been reflected in financial decisions. They should also explain how they have pursued the objectives of the company and had regard to the consequences of their decisions for the long term, however they choose to define this. Where there have been failures to have due regard to any one of these interests, these should be addressed directly and explained.

35.There is no intrinsic need for these new reporting requirements to be part of the already voluminous documentation contained in annual reports. At a time when companies are taking advantage of new technology to communicate in ever more sophisticated ways with their customers, the annual publication of large reports seems an increasingly old fashioned and unhelpful way of communicating. Baroness Hogg was among the witnesses who advocated better use of technology to improve reporting and engagement.64 The FRC should encourage companies to be more imaginative and agile in communicating digitally with stakeholders throughout the year and should actively push back on the use of boiler-plate statements in annual reports, using wider powers which we argue for in the next section.

Enforcement

36.Existing requirements relating to corporate governance are currently enforced via the comply or explain regime governed by the FRC, backed up by a legal framework that includes, for the most serious offences, punishments such as the disqualification of directors.65 It is important to make a distinction between two objectives: advancing best practice and improving transparency, primarily via the Code; and the taking of effective action in cases where minimum standards have been breached by individual companies. There are improvements to be made on both fronts.

37.The evidence presented to us was overwhelmingly supportive of the comply or explain principle underpinning the Code. There was almost no support for supplanting this approach with more regulation. Witnesses argued that further regulation would do little to influence individual behaviour and noted that not all company failures were the result of poor corporate governance: some boards simply made legitimate decisions that turned out to be poor.66 More significantly, it was argued that greater regulation would shift the culture towards a rules-based, compliance one, encouraging a tick-box mentality, rather than seeking to embed high standards and cultural change across the board as a self-evidently desirable objective for companies.67 Some witnesses, notably from legal practices, argued against any change at all, maintaining that the existing legal framework governing company behaviour was sufficient, covering a wide range of areas, including the treatment of employees, consumer protection bribery, pensions provision, health and safety, competition and insolvency.68 But few argued that enforcement could not be improved. The tone of many witness submissions was captured by Sarah Wilson, Chief Executive of the proxy agents, Manifest, who told us

We have a misalignment between all the parties in the system.  Yes, we have very good laws and the UK Companies Act and Governance Code is something to be very proud of. But I am not in favour of new law; I want the existing ones to be enforced correctly.69

38.A minority of witnesses cited the absence of legal action in respect of section 172, as discussed in paragraph 26, as evidence that regulation was not working and advocated the establishment of a new independent supervisory body to monitor compliance and take action where necessary.70 Most witnesses were content with the current system, and could see the value in the flexibility offered by a system of voluntary codes and guidance, under the auspices of the FRC, with other business organisations helping to drive up standards through advocacy and pressure. We do not see sufficient reason to depart from the comply or explain principle, which is well understood and widely emulated around the world. Nor do we believe that it is necessary for the Government to establish a new regulatory body.

A stronger enforcement body

39.However, we believe that enforcement is currently not strong enough. More pressure could and should be applied to companies to ensure they comply with their legal responsibilities, and those under the Code, relating to corporate governance. There are some encouraging recent developments. In 2016 the Institute of Directors published a ranking of the FTSE 100 companies according to a set of corporate governance metrics.71 The Financial Reporting Council told us that it is currently considering engaging in more direct contact with companies on poor reporting and publicising poor practice.72

40.We welcome the sharper focus being applied by the IoD and FRC on corporate governance. The rigorous, transparent rating exercises should become an integral part of the business landscape, helping shareholders to engage with, and challenge, companies whose standards appear low. In the interests of simplicity and accessibility, this should be a simple red, yellow and green rating system for the FTSE 350. To achieve maximum credibility, it should be developed with the involvement of a regulator as well as business organisations, and to give it prominence and influence companies should be required to include the consequent rating in annual reports. In the first instance, it is logical for the FRC to take this forward, building on the work of the IoD and the CBI. Over time, this enhanced and simple system should incentivise companies to improve performance, assist investors and asset managers in making decisions and explaining them. Poor corporate governance should ultimately have an impact on share price—the most effective deterrent. We recommend that the Financial Reporting Council works with business organisations to develop appropriate metrics to inform an annual rating exercise. This should publicise examples of good and bad practice in an easy to digest red, yellow and green assessment. Companies must be obliged to include reference to this rating in their annual reports.

41.Reporting examples of bad practice is not enough. At present, the FRC has powers to monitor a company’s strategic report and financial statements but not in respect of other aspects of reporting. It can take action against directors only if they happen to be accountants, auditors or actuaries.73 This is because the FRC is, as its name suggests, a regulator of financial standards which has acquired more responsibilities relating to other aspects of corporate governance. The FRC is seeking wider powers, via changes in legislation, to enable it to investigate and pursue potential breaches of existing duties under section 172 by any directors, not just those who happen to be auditors, accountants or actuaries. To do this properly, it will need new powers to secure information in order to take action directly with the companies. The frequent use of investigatory powers by other regulators, such as the Care Quality Commission, could provide a model for the enhanced FRC role. It could conduct a small number of spot checks each year, potentially using a risk based approach. The prospect of investigation by an expanded FRC in respect of section 172 duties is a much more effective deterrent than the remote prospect of legal action by shareholders. Such an enhanced role will no doubt require extra resources, which the FRC should pay for via a small increase in the levy which funds it.

42.We recommend that the Government brings forward legislation to give the Financial Reporting Council the additional powers it needs to engage and hold to account company directors in respect of the full range of their duties. Where engagement is unsuccessful, we would support the FRC in reporting publicly to shareholders on any failings of the board collectively or individual members of it. If companies were not to respond satisfactorily to engagement with the FRC, we recommend that the FRC be given authority to initiate legal action for breach of section 172 duties. Given the broader powers we have recommended in this Report, the Government should consider re-establishing, renaming and resourcing appropriately the FRC to better reflect its expanded remit and powers.

43.In cases of potentially serious bad practice or corruption, there are other tools available. Under the Companies Act 1985 the Secretary of State has a range of powers to send in inspectors to investigate the affairs of a company, where for example, the circumstances suggest grounds for suspicion of fraud, misconduct, conduct unfairly prejudicial to shareholders or of failure to supply shareholders with information they may reasonably expect.74 Inspectors may also be sent in at the request of a specified percentage of shareholders and to investigate the membership of any company in order to determine for certain those financially interested in the success or failure of a company or able to control it. These powers have been used in respect of the Insolvency Services’ ongoing inquiry into BHS, and should be exercised aggressively when there are grounds to do so. Rather than seek to introduce any new legislation, we would urge the Secretary of State to be more prepared than is presently the case to use existing powers where there is any suspicion of serious wrongdoing that may be in breach of the law. A public statement by Ministers to the effect of being considerably more pro-active in this areas may also have a welcome deterrent effect.

Investor and company engagement

The objectives

44.Good engagement by investors with company management is essential to improving standards of corporate governance as well as company performance. Effective engagement allows shareholders to better judge the effectiveness of board members, to understand their long-term strategy and to assess whether they are fulfilling their duties with regard to all stakeholders, as required by law. Engagement is supported and promoted through the FRC’s Stewardship Code. This has served to drive improvements by requiring signatories to report on their stewardship activities, such as engagement with companies not just on pay, but on strategy, risk, culture and environmental issues.75 There are a variety of forms of engagement, ranging upwards from private conversations with board members, through to more formal and collaborative engagement through the Investment Association or Investor Forum, with the ultimate possibility of voting against the re-appointment of directors or specific resolutions at annual general meetings (AGMs).

45.Shareholders will of course have diverse objectives and may not necessarily be expected to engage proactively, nor to press for any other objectives than increasing share prices. However, we believe that greater transparency and accountability throughout the investment chain is the best way to improve the quality of the dialogue between shareholders and company boards and ultimately serve to improve public trust and company performance. Ultimately, it is pension holders and individual savers who are—through a number of intermediaries usually—supporting the board in its decisions. The public relies on the stewards of its money to exercise judgement on its behalf. Institutional asset owners, such as insurance companies and pensions funds, must be required to explain their approach to stewardship and asset managers should similarly be required to account for the way in which their engagement with companies, through voting and less formal means, has been in line with this mandate. The aim should be for standards of both corporate governance and investor stewardship to become an ever sharper focus of attention and even competition, which will drive up standards and help embed a culture of excellence.

The practice

46.There were considerable concerns about the quality of shareholder engagement in the evidence we received. Ken Olisa, Deputy Chairman at the IoD, told us that in his experience “shareholder engagement is extremely poor”76 and that the press did a better job of applying pressure to companies than shareholders.77 The Chief Executive of ShareAction, Catherine Howarth, argued that while directors’ duties are clearly set out in law, there were no corresponding requirements on shareholders. She argued that a lack of transparency around conflicts of interest and voting by institutional investors had been major stewardship failings.78

47.On the other hand, Andrew Ninian, from the Investment Association, defended shareholders, asserting that they spent a lot of time engaging with companies and argued that engagement was becoming increasingly prevalent.79 In recent years there has been a welcome increase in attention on the stewardship duties of investors, both internationally and domestically. The OECD has developed principles on engagement. At a European level, the Shareholder Rights Directive, which relies on the UK comply or explain model, is moving towards implementation. In the UK, the FRC reports regularly on compliance with its Stewardship Code,80 flagging up examples of best practice, and has now begun a tiering exercise to differentiate the performance of different asset managers according to an assessment of their performance.81 The Investment Association argued for enhanced stewardship in its 2016 Productivity Action Plan and is engaged in a number of activities promoting better engagement.82 The establishment of the Investor Forum is a positive development and has helped to provide a space for such co-ordinated engagement to take place.83 It reports that it now has 33 members with UK equity investments representing some 35 per cent of the value of the FTSE share index,84 although it has so far limited its engagement to only the most serious cases.85 The Forum is a welcome initiative but it has the potential to develop much further. We recommend that the Investor Forum seeks to become a more pro-active facilitator of a dialogue between boards and investors by engaging in regular routine dialogue in order to pick up on any widespread concerns, for example those identified by the new FRC rating system.

48.There are valid reasons why engagement remains a challenge, given the different objectives of the different players in the investment chain and the highly dispersed nature of share ownership and the trend towards passive rather than managed funds.86 Given diversification of stock portfolios, few investors have sufficient “skin in the game” to justify the high costs of engagement. Effective engagement and monitoring of management actions and boardroom decisions can be a resource intensive activity. It may make more economic sense to be a “free rider”, relying on a small number of activist investors to monitor the board. One major institutional investor went so far as to claim that the high costs meant there was a market failure on engagement that warranted the imposition of a Government levy on business in order to fund it.87 For index fund managers and for other passive investors, particularly those with relatively small shareholdings, there is little or no incentive to engage. For institutional shareholders as well as individuals, a decision to sell may be a more rational and immediate approach to securing value than expensive and unpredictable engagement.

49.In these circumstances, there are no easy answers to securing better engagement. Peer pressure, greater exposure of poor practice and leading by example are a start: reputational damage can be a powerful influence. There are signs that some of the major investment companies are flexing their muscles, particularly in respect of executive pay. In January 2017 the US investment fund, Blackrock, reportedly wrote to 300 UK companies warning that they would be taking a tough stance on excessive pay increases, particularly those not linked to long-term performance.88 ShareSoc and UK Shareholders’ Association sought to present a resolution at the next RBS AGM to establish a Shareholder Committee. In response, the bank is proposing the establishment of stakeholder engagement panels.89 There are signs that in the US there is an increasing focus on governance issues, with the publication of two Governance codes recently, which include stewardship responsibilities as well as company-related best practice.90 These developments are encouraging although as yet unproven in terms of results.

50.It could be argued that provided there are some responsible active investors to exercise stewardship functions, a degree of “rational apathy” may not only be the right approach for many but also the most efficient use of resources, for both companies and investors. Too much engagement serves the interests of no-one. This model may be an acceptable goal, provided that there is an effective and accessible forum for active shareholders to explain their activities to other shareholders as necessary. This is a potential role for the Investor Forum, as outlined above, but in an increasingly complex investor environment with proxy voting agencies and foreign investors more to the fore,91 it will require a considerable amount of work to co-ordinate activity, and to develop the necessary degrees of trust and quality communication.

51.It is ultimately the responsibility of the asset owners—including the pension funds and insurance companies—to secure high quality engagement by those managing their investments as part of the mandate agreed between asset owner and manager. This point was stressed by the Executive Director of the International Corporate Governance Network, Kerrie Waring, in respect of agreeing environmental, social and governance (ESG) issues, 92 although other witnesses maintained that some asset managers were reluctant to take on board these concepts.93 The institutional investors need to articulate and justify their approach to engagement94 and greater transparency is required on the role of asset managers and proxy agents in order to demonstrate how they are taking stewardship seriously.

52.There are a number of models for enshrining and promoting better engagement. The appointment of one board member with specific responsibilities for stakeholder engagement would be another approach, as cited in the Green Paper. Several witnesses highlighted the potential better use of more sophisticated, digital engagement via online forums.95 We agree with the witnesses who emphasised that it is not about quantity but quality,96 so simple requirements relating to number of meetings are not necessarily productive, and may tend toward the compliance mentality that can be the lazy alternative to genuine cultural change.

Stakeholder advisory panel

53.We heard strong support for the idea of stakeholder advisory panels, from the TUC, Tomorrow’s Company and Blackrock amongst others.97 An advisory panel would provide a more formal framework for directors to seek the views of stakeholders on specific issues, such as the company’s executive remuneration policy and its strategy. This consultative body would not simply be a meeting at the end of the process, to endorse the decisions of the remuneration committee, but would be a forum for meaningful dialogue during the development of policies. It would generate greater trust, by offering more depth to the relationship between the board and its stakeholders, including employees, and, more important, help to alert the board to potential problems. We do not believe that such a panel, if handled correctly, would be a threat to the concept of the unitary board, which we strongly support.

54.The diversity of businesses militates against the imposition of a single route for conducting engagement, so we would not wish to see one particular model mandated. However, the establishment of a stakeholder advisory panel would provide useful, more formal, feedback for boards and would potentially be a powerful demonstration of a company culture that values broad engagement and a collaborative approach. All businesses should be required to facilitate engagement, by whatever means suits best, and to report on the steps they have taken. Failure to engage adequately would be subject to further investigation by the FRC. Stakeholder advisory panels can be a useful forum in which meaningful collaboration, consultation and dialogue with all stakeholders can take place. We urge companies to consider establishing such bodies. We recommend that the Code should be revised to require a section in annual reports detailing how companies are conducting engagement with stakeholders.

55.A similar approach should be applied to stewardship. ShareAction produces a public ranking, assessing investors’ performance in providing oversight on behalf of those that invest through them. The FRC’s annual report on stewardship provides useful information on levels of compliance, but as a tool of enforcement, it is pretty limp. It highlights those companies doing a good job, and lists those that have been subject to significant minority votes at AGMs, but it does not single out specific companies for poor practices in a way which is capable of attracting attention and influencing behaviour. A more aggressive approach is required. To be effective, the Code also needs sharpening up. The principles it includes are worthy and unarguable, but too high level to be capable of effective enforcement in all but the most blatant cases. Investors must be required to explain how they have exercised their stewardship functions. We believe that stewardship—like other aspects of corporate governance—should be seen as an avenue for competition, which over time will help to drive up standards.98 We welcome the assessments made and published relating to the performance of institutional investors in terms of their stewardship functions but believe that further action is required. We recommend that the FRC reviews its Stewardship Code with a view to providing: more explicit guidelines on what high quality engagement would entail; a greater level of detail in terms of requirements; and an undertaking to call out poor performance on an annual basis.

Transparency and the role of advisors

56.The relationship between investor and companies is complicated by a number of different intermediaries and advisors. The board will have advisors covering different aspects of company performance; the executive team will have advisors; individual directors may have their own advisors, for example on pay; the Remuneration Committee will take advice; fund managers will also have a network of advisors; proxy agents acting on behalf of investors may also have their own advisors. The complexity of the investment chain provides work for armies of lawyers, investment bankers, auditors, analysts and public relations advisors. In his review of the equity markets, Professor Kay sought to promote trust and a culture of stewardship throughout the investment chain by establishing good practice statements by participants. We have not seen evidence that these good practice statements have been effective, or even been taken much notice of, nor that the degree of cultural change that he sought has been achieved.

57.In evidence to us, many companies providing advice pointed to existing requirements around transparency, such as requirements in the Code to disclose the use of external consultants for the purposes of recruitment, external board evaluations and audit.99 Some did not recognise a need for further transparency, as it was directors who ultimately made decisions.100 Others suggested that the Takeover Code provided sufficient transparency requirements. It was also suggested that imposing more transparency may be counterproductive, as boards may be dissuaded from taking critical advice101 and that too much disclosure may make it harder “to see the wood for the trees”.102 Further concerns expressed were that more transparency might give a false impression that directors were transferring responsibility to advisors for their decisions,103 and that disclosure of advisers’ fees might be misleading.104

58.Others took a different view on the need for greater transparency. Business organisations generally expressed support for greater transparency and openness. From the perspective of the investor, the Investment Association said that while global figures for pay to listed advisors may not add much useful information. They had long argued in favour of more transparency on the fees paid to advisors in individual transactions, and the basis for those fees: for example, whether they are on a contingency basis (success fees) or whether the timing and amount payment depends upon other conditions.105 Standard Life said

We believe that there are too many intermediaries involved in the stewardship chain. The use of advisors has become too commonplace and the incentives of many of these advisors are not aligned with good outcomes for companies, shareholders, employees or broader society. We are concerned that the use of advisors can be detrimental to clear communication and engagement between companies and their shareholders.106

Other investors agreed that greater transparency, particularly in terms of mergers and acquisitions, would serve the interests of protecting long-term value.107 The IoD and FRC suggested that new requirements relating to disclosure around transactions should have some size threshold, to avoid undue burdens.108

59.Advisors are an essential and inevitable part of the investment chain. They help all parties to obtain proper information and advice on the legal and financial implications of activity and assist in evaluating the risks. As a world leading provider of financial and business services, it is important that the UK takes a lead in establishing the highest possible standards. It is up to professional bodies to monitor and enforce professional standards in their respective fields, but transparency surrounding their involvement in the investment chain and in business transactions fall within the sphere of corporate governance. Transparency is essential to enabling investors to engage fully and, more broadly, to improving public trust. It also serves the interests of diversity: companies should justify the process of appointment, if not by competitive tender. During our inquiry into BHS, a private company, we saw the importance, in reviewing a transaction, of understanding who was being engaged by whom, and on what financial basis. It is of course up to directors to determine which advice to listen to, if any, but equally, those with an interest are entitled to know who has been involved. We recommend that the Government consults upon new requirements on listed and large private companies to provide full information on advisors engaged in transactions above a reasonable threshold, including on the amount and basis of payments and on their method of engagement.

Voting records

60.We heard that disclosure of voting records by fund managers—established in the Stewardship Code as best practice—was not always complied with, and several witnesses called for greater transparency on this front.109 We heard from ShareAction that asset managers are effectively competing against a benchmark on an annual basis.110 They are incentivised accordingly to pursue short-term gains in their investments rather than pursuing long-term value.111 Some have pointed to a disconnect between voting records and stated intentions,112 due in part to the presence of intermediaries.113 Increased transparency and accountability are the best routes to promoting better stewardship, high quality engagement and public trust. We recommend that the FRC includes in its revised Stewardship Code stronger provisions to require the disclosure of voting records by asset managers and undertakes to name those that subsequently do not vote.

Non-executive directors

61.The legal duties of non-executive directors (NEDs) are the same as for executives and they share responsibility for any business failure. In reality, NEDs perform very different functions from executives. The Code sets out as a main principle that “non-executive directors should constructively challenge and help develop proposals on strategy” and sets out in more detail the requirements of the role:

Non-executive directors should scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance. They should satisfy themselves on the integrity of financial information and that financial controls and systems of risk management are robust and defensible. They are responsible for determining appropriate levels of remuneration of executive directors and have a prime role in appointing and, where necessary, removing executive directors, and in succession planning.114

62.The role of NEDs is also affected by an asymmetry of information provision: they will not generally have access to the full range of management information provided to the executive team, nor could they realistically expect to have time to consider it all.115 We heard that companies tend to allocate particular responsibilities to individual directors and the position of a “senior NED” is now well established and advised in the Code,116 but no such distinction exists in legislation. A minority of witnesses, including the IoD, argued that “There should be greater distinction” in law.117 In practice, the courts would be expected to take into account the particular circumstances and role of each director in apportioning responsibility.118

63.Witnesses pointed out that NEDs who tend to challenge may not always be welcome, or be retained on the board.119 A board must be able to be cohesive and supportive as well as genuinely challenging. This is no easy balance to strike; and achieving it is a crucial role for the chair. We saw in our BHS inquiry what can happen if it is not right: the consequences when NEDs do not provide the degree of constructive challenge required, or indeed participate at all in key decisions.120 Investigations into the causes of the banking crisis were highly critical of the challenge provided by inexperienced non-executive directors. The Treasury Select Committee commented “Too often, eminent and highly-regarded individuals failed to act as an effective check on, and challenge to, executive managers, instead operating as members of a ‘cosy club’.”121

64.We are in no doubt about the vital role that NEDs have in company governance and are concerned about the impact of what we heard were ever increasing burdens on their ability to perform their role effectively, particularly if they serve on several boards. We believe that all directors, and particularly NEDs, should be given the training and professional development they need in order to allow them to fulfil their responsibilities with confidence and full effectiveness.122 We heard that while some companies provide comprehensive briefing to new directors and are prepared to pay for professional advice for NEDs, this is not universal practice. It is the responsibility of companies themselves—not Government—to ensure that their board members are well equipped for the role. There are commercial providers already, but there may be a role for the IoD, working with other bodies, to take a lead. We recommend that the FRC includes best practice guidance on professional support for non-executive directors when it updates the Code and that companies include training of board members as part of reporting on their people or human resources policy.

65.We are also concerned that statute law has not kept pace with the evolution of their role, and that the courts are left to interpret the particular dynamics of a boardroom on a case by case basis. The Investment Association was not convinced a change in the law would add more than could be achieved by changes to the Code.123 Any change in the law to recognise the different functions of NEDs would necessarily need widespread prior consultation to consider all the potential legal ramifications. We do not consider that this is necessary at this stage, but we do believe that there is a case for greater certainty, for the benefit of directors and shareholders alike (and in very rare instances, the courts). The effectiveness of NEDs should be considered carefully in annual director reviews, and also in the external board review required every three years. We recommend that the FRC updates the Code to provide guidance on how companies should identify clearly and transparently the roles of non-executive directors where they have particular responsibilities and how they should be held to account for their performance. We further recommend that NEDs should be required to demonstrate more convincingly that they are able to devote sufficient time to each company when they serve on multiple boards.


39 Companies Act 2006, s. 172(1)

40 Employment Law Association (CGV0065) para 3.6

41 Q9 [Stephen Haddrill]

42 Q9 [Oliver Parry]

43 British Bankers’ Association (CGV0085)

44 Company Law Committee of the City of London Law Society (CGV0148)

45 Employment Lawyers Association (CGV0065), para 3.8

46 Professor Andrew Keay (CGV010). This provision does not engage the criminal law. Shareholders may apply to the courts to take a derivative action on behalf of the company against the company itself, under section 170(4) of the Act. Some 22 such actions had been instituted by September 2015, according to Professor Keay.

47 Qs 10, 61

48 Professor Andrew Keay (CGV010)

49 As envisaged by the 2001 Company Law Review which led to the 2006 Act. See TUC (CGV0156) para 2.3

50 Q9

51 TUC (CGV0156 para 2.7)

52 Helena Morrissey (CGV0017)

53 Standard Life (CGV0091)

54 Q10

56 IoD (CGV0034),Professor John Kay, (CGV0174), LGIM (CGV0095)

58 The Investor Forum, Review 2015–16, p32

60 These are listed in The Companies Act 2006 (Strategic Report and Directors’ Report) Regulations 2013, made under s.414C of the Companies Act 2006

61 Q154

62 Employment Lawyers Association (CGV065); Q52

64 Q399; Private investor (name withheld) (CGV0105); ICAEW (CVG0116)

65 There have been between 1,034 and 1,453 directors per annum disqualified under the Disqualification of Directors Act 1986 since 2009–10, either as result of a disqualification order or an undertaking.

66 City of London Law Society (CGV0148)

67 Investment Association (CGV0109)

68 Mazars (CGV0134)

69 Q122

70 TUC (CGV0156), Sheffield Institute of Corporate and Commercial Law (CVG037), Professor Andrew Keay (CGV0010)

72 Letter from FRC, 30 November 2016; Q23

73 FRC letter to Committee, 30 November 2016; Q23

74 Part XIV of the Companies Act 1985, as amended by the Companies Act 2006; Companies (Audit, Investigations And Community Enterprise) Act 2004

76 Q417

77 Q442 [Ken Olisa]

78 ShareAction (CVG0124)

79 Investment Association, (CVG0109)

82 Investment Association, Supporting UK productivity with long-term investment, March 2016

83 Engagement is subject to the EU Market Abuse Regulations; Fidelity International (CGV0107)

84 The Investor Forum, Review 2015–16, p7

85 The Forum reports 8 “comprehensive collective engagements” and a further 8 situations that involved discussions but did not lead to full engagement. For example, it helped investors in Sports Direct combine to apply pressure on the owners on issues of governance.

86 See for example, Financial Times, Blackrock cuts ranks of stockpicking fund managers, 28 March 2017

87 Hermes Investment Management (CGV0090)

89 RBS news story on stakeholder engagement, 30 January 2017

90 The battle of the US corporate governance codes, Financial Times, 5 February 2017

91 Q383

92 Q153 [Kerrie Waring]

93 Q122 [Sarah Wilson]

94 Q155

95 ShareSoc (CGV0021); John Davies (CGV0003)

96 Eg Investment Association, Q419; Legal & General Group (CGV098)

97 Bringing employee voice into the Boardroom, November, 2016. BlackRock; TUC (CGV0156)

98 Q92

99 Equality and Human Rights Commission (CGV0152)

100 ICSA: The Governance Institute (CGV0111)

101 Q100

102 Professor Paul Moxey (CGV0041)

103 Association of Chartered and Certified Accountants) (CGV0100)

104 Q102

105 The Investment Association (CGV0109)

106 Standard Life (CGV0091); Q67

107 LGIM (CGV0095)

108 IoD (CGV0034); Q41

109 Mercer (CVG0101); Unite (CGV0094)

110 ShareAction (CGV0124)

111 Q84, Spencer Stuart (CGV0092)

112 For example, ShareAction, Press notice, 18 May 2015

113 Manifest (CVG0062)

114 FRC, UK Corporate Governance Code, April 2016, p9

115 Investment Association (CGV0109); FRC, Corporate Culture and the Role of Boards, Report of Observations, July 2016, p11

116 NJMD Corporate Services (CGV0028); FRC, UK Corporate Governance Code, April 2016, p9; Q31

117 Q32; John Davies (CGV0003)

118 Q33

119 Chris Philp MP (CGV0089)

120 BHS, First Report of the Work and Pensions Committee and Fourth Report of the Business, Innovation and Skills Committee, Session 2016–17, HC54, para 135

121 Prudential Regulation Authority and Financial Conduct Authority, The Failure of HBOS plc, April 2015; Treasury Committee, Ninth Report of Session 2008–09, Banking crisis: reforming corporate governance and pay in the City, HC 519; see also First Flight Non-Executive Directors (CGV0167)

122 This was advocated in the Higgs Report in 2003.

123 Q423




4 April 2017