66.In our joint inquiry with the Work and Pensions Committee into the collapse of BHS, we reported on how weak corporate governance enabled Sir Philip Green to use a network of private companies to channel profits to a family business located offshore. This was apparently legal, but without the transparency required of listed companies, it was difficult to follow the money and understand why the pension fund fell into substantial deficit. In the light of the alarming evidence we took from board members of Sir Philip’s companies (where the chair of the board was not even invited to the meeting that determined the sale of BHS), we undertook to consider further whether private companies should be subject to more stringent requirements regarding corporate governance and reporting. The Government’s Green Paper on Corporate Governance sought views on whether the corporate governance framework should be strengthened for the largest privately-held businesses, and if so, how?124
67.Whilst the legal duties of directors are the same, regardless of company status, private companies are not subject to the same reporting requirements of public companies, nor listed companies. Instead, there are minimal requirements to report basic information regarding directors and to file accounts with Companies House. There are currently some 2,600 private companies in the UK with over 1000 employees. Trends over the last 20 years indicate a drop in the number of listed companies.125 Explanations offered include the suggestion that some companies are delisting in order to avoid the additional scrutiny associated with listed companies, although the increasing availability of funds from sources other than equity markets may be more significant.
68.Much of the evidence we received agreed with the different treatment for corporate governance purposes of private companies and many argued that the imposition of greater regulatory burdens was not warranted. Witnesses argued that for most private companies there is little separation between ownership and control, so the company would in effect be reporting to itself about itself on governance principles that did not apply.126 Furthermore, it was argued that the sheer variety of private companies would make it difficult for a single Governance Code to be applicable to all.
69.The arguments in favour of greater transparency and accountability for private companies are based on the premise that those with a significant presence in the community have wider social responsibilities too and should be required to report on non-financial matters for the benefit of employees and other stakeholders.127 They should be subject to minimum standards of corporate social responsibility. Most of those who made this case acknowledged the potentially disproportionate nature of new requirements and argued that only those companies above a certain size should be subject to new requirements. The FRC proposed that qualifying companies should be based upon a minimum turnover or number of employees.128
Figure 5: Number of new listing and delistings between 1999 and 2012 for the UK
Source: From Purposeful Company, Interim Report, May 2016 p 71 (Julian Franks and Colin Mayer (2016) based on data from the London Stock Exchange)
70.The trend in the number of UK businesses, particularly micro-businesses employing fewer than ten staff, is upwards and that of listed companies downward.129 Regardless of whether these trends continue, we believe that large privately-owned companies with a significant footprint in society should be required to demonstrate that they adhere to certain minimum standards, not only to mitigate the risks of failure, but to increase engagement with, and the confidence of, the communities from which they draw their workforce and in which they seek to sell their goods and services. No law or governance code can eradicate the risk of serious failings of corporate governance, risks that are higher where there are small boards and dominant personalities involved, but a Code can serve to raise awareness of good practice and, over time, help to improve of standards of corporate governance in private companies, large and small.
71.It would not be sensible to simply apply the existing Governance Code to private companies for the reasons cited in paragraph 64.130 An alternative is required and there are many models from which to choose. The IoD has developed guidance for unlisted companies;131 the big four accountancy firms have agreed on a voluntary basis to an FRC Code for audit firms; there is also a Code published by European Confederation of Directors’ Associations.132 The private equity industry established a new association (the Private Equity Reporting Group) in 2008 to monitor and report annually on industry compliance with guidelines covering disclosure of information.133 Annual reports by the independent association have indicated that compliance rates have generally been as high as those for listed companies, although there have been fluctuations. Whilst these annual reports are based on a sample of companies and do not tend to name companies failing to comply, the model itself appears to be an effective regulatory solution.
72.A new regime for private companies should aim to build public trust by improving transparency and confidence in private companies. It should serve to drive up standards of corporate governance and provide a mechanism for any potential failings to be flagged up and pursued with the company concerned. Our preference is for new requirements to be consistent with the existing comply or explain approach for listed companies and that they should be both proportionate and flexible, to reflect the diversity of companies potentially covered. New requirements to publish bulky annual reports are not the best way forward and we would not want to see large private companies burdened with additional onerous regulation. Instead, we favour the development of a new voluntary Code for large private companies. Depending on the number of companies covered, enforcement may be difficult for any organisation, as was pointed out by the IoD, who suggested that some form of sampling might be the most that could be expected.134 That seems reasonable.
73.We advocate a light touch approach based on providing specified information, but potentially covering revenues, compliance with section 172 of the Companies Act 2006, company structure, executive pay, numbers of employees and pension scheme contributions. This information might best be provided on websites, rather than contained in published annual reports. It should be provided on a comply or explain basis, like the existing Code for listed companies. The FRC has offered to develop and oversee a Code for private companies.135
74.In terms of the threshold for companies to participate, we would envisage starting with the largest employers, say those with over 2,000 employees.136 This threshold may be lowered over time as the Code gains credibility and becomes something that private companies actively want to comply with for reputational reasons. High standards of corporate governance thereby become publicly linked to public confidence and company value. We would leave it to existing interested organisations to develop the details of the proposed Code, but it should be broadly in line with the existing Code in respect of reporting duties on section 172, but sufficiently flexible to provide meaningful requirements for the diverse range of large private companies. Depending on the numbers of companies involved, compliance might be monitored on the basis of a risk-assessed sample. Reporting on compliance by the new regulatory body should include the naming of companies if behaviour is particularly poor. We recommend that the Financial Reporting Council, Institute of Directors and Institute for Family Business develop, with private equity and venture capital interests, an appropriate Code with which the largest privately-held companies would be expected to comply. They should contribute to the establishment of a new body to oversee and report on compliance with the Code. We further recommend that the new Code includes a complaint mechanism, under which the overseeing body could pursue with the company any complaints raised about compliance with the Code. The scheme should be funded by a small levy on members. Should this voluntary regime fail to raise standards after a three year period, or reveal high rates of unacceptable non-compliance, then a mandatory regulatory regime should be introduced.
125 See figure 5 below
129 There are nearly 10,000 private companies in the UK with more than 250 employees.
131 Institute of Directors, Corporate Governance Guidance and Principles for Unlisted Companies in the UK
132 Corporate Governance Reform Green Paper p46; Q108
133 The guidelines were drawn up following a review by Sir David Walker of private equity in 2007.
135 FRC, Letter to the Committee, 30 November 2016
136 Accurate statistics are not available, but this figure may cover up to around 100 companies.
4 April 2017