Corporate governance Contents

6Composition of boards

Board diversity

117.Boards of directors, made up of executive directors and non-executive directors, are responsible for the governance of their companies, and for providing the right checks and balances within businesses to strengthen decision-making and accountability.230 The job of a board director can be a hard one; as Oliver Parry from the Institute of Directors told us, “they are running global organisations where their decisions from second to second can have lifelong consequences for the business”.231 But they are also individuals working together, interacting with each other, and challenging each other, for the benefit of the company. Our inquiry into BHS highlighted what can happen when individual board members do not act solely for the benefit of the company as a whole, but are unduly influenced by the interests of one dominant director. To mitigate this risk, we stressed the need for strong individual directors, who are prepared to challenge effectively.232

118.To be an effective board, individual directors need different skills, experience, personal attributes and approaches. They need the ability to know when to ask pertinent questions and to ensure all interested groups connected with the company are engaged. All boards need to mitigate the risks of group think. The benefits of diversity on the board are not obviously reflected in their make-up, which remain remarkably uniform. Currently, of 1,087 director positions in FTSE 100 companies, only 26.7% are women. There is one all-male board, Convatec Group plc.233 Statistics are also poor on ethnic diversity: only 8 per cent of executive and non-executive positions in FTSE 100 companies are held by people from BAME backgrounds.234 Describing board directors, the Prime Minister said in October 2016: “Too often the people who are supposed to hold big business accountable are drawn from the same, narrow social and professional circles as the executive team. And too often the scrutiny they provide is not good enough. A change has got to come”.235

119.The Code requires companies to include a description of the board’s policy on diversity, including the gender balance of the board, the measurable objectives that it has set for implementing the policy, and the progress made on achieving these objectives. However, these reporting requirements have not had the intended impact in tackling the homogeneity of board composition. Whilst the UK is a world leader in many facets of corporate governance, that is not the case on board diversity. Nigel Wilson, from the UK’s largest fund manager, told us that there is a huge gap in representation between men and women, between different ethnic groups, and spoke of a lack of constructive engagement with workers.236

Gender diversity

120.There is a growing body of empirical evidence that highlights a positive connection between the gender diversity of boards and board performance, although a causal link is difficult to prove.237 Dr Barnali Choudhury explains that this could be because the output produced by boards is mainly cognitive in nature, directly influencing board tasks and indirectly affecting firm performance.238 Helena Morrissey asserted that it is irrelevant that causality cannot be proved, and the smart companies just are fully aware of the importance of diversity: “There is no data around other forms of diversity but frankly the argument needs to be turned on its head—there is no business case for homogenous boards!”239 Denise Wilson, CEO of the Hampton-Alexander Review into improving gender balance in the FTSE 350 told us that in their discussions with chairmen and board directors “[t]hey said the atmosphere, dynamics and decision-making processes in the boardroom were better than when it was all males. Yet in 2010, I would say around a third of FTSE 100 chairmen were saying, ‘women will not make it; women do not have the skills; they are not quick’.”240

121.Lord Davies’ 2011 review sought to promote gender equality on boards of listed companies and to identify barriers that were preventing more women reaching the boardroom. He made the business case for gender diverse boards, citing: improving performance; accessing the widest pool of talent; being more responsive to the market; and achieving better corporate governance, and set the target of 25 per cent of boardroom positions to be held by women.241 The number of women on boards duly increased from 12.5 per cent in 2010 to 26.1 per cent in October 2015, thereby meeting the target. Figure 10 shows the rise in percentage of women directors on boards from 1999 to this year and illustrates the rapid rise from 2012 onwards, albeit from a very low base.

Figure 10: History 1999–2017 FTSE 100: % women directors

Source: Professional Boards Forum BoardWatch

Data provided by BoardEx and The Female FTSE Board Report.242

122.However, this welcome rise in the number of women on boards is deceptive: it combines both executive and non-executive directorship roles. In the FTSE 100, only 10.4 per cent of executive director positions are currently held by women, compared with 33.7 per cent of non-executive directors. Even more strikingly, the number of female CEOs has actually declined during the past three years: there were nine women CEOs in 2014; in March 2017 there were only six. In February 2016, the Hampton-Alexander Review was set up, headed by Sir Philip Hampton, chairman of GlaxoSmithKine, and Dame Helen Alexander, chairman of UBM, to continue with the work started by the Davies Review, focusing on improving the representation of women in the executive roles of FTSE 350 companies, with the target of having women hold 33 per cent of executive positions on boards by 2020. In hindsight, there might have been more merit in having the Hampton-Alexander Review before the Davies Review, to improve first the pool of executive senior managers. It is crucial that opportunities for women to progress through an organisation into executive positions are fully available and promoted.

123.Current legislation requires companies to disclose the gender balance among directors, senior managers and employees within companies’ Annual Strategic Report, but the term ‘senior manager’ does not carry across companies easily, which makes it hard to assess progress on gender diversity. The Hampton-Alexander review highlights this point; that it is hard to quantify what it means to be a senior manager, and therefore hard to assess the gender diversity of senior managers. Once the definition of ‘senior manager’ is more uniform, it will be easier for companies to disclose the gender balances of their Executive Committees, which is another Hampton-Alexander recommendation that we support. Furthermore, we agree with the Equality and Human Rights Commission’s Chair, David Isaacs, who last year called for the Hampton-Alexander’s aims to be set higher, proposing a new national target that half of all new appointments to senior and executive management level positions in the FTSE 350 and all listed companies should be women. As the EHRC states, “this will guarantee a strong pipeline of women for the top jobs”.243

124.Much has been achieved in increasing the number of women directors on boards since Lord Davies’ recommendations in 2011. However, there is still one board in the FTSE 100 that has no women directors, and the increase in women that has occurred has been primarily in non-executive roles. The number of women executive directors is still very low, with only six women CEOs in the FTSE 100. We support the current work by the Hampton-Alexander Review, especially its recommendation that the Government should, in consultation with business, consider how best to clarify or supplement the definition of ‘senior managers’ to have a more consistent, meaningful metric, based on the Executive Committee or its nearest equivalent in each company.

125.Companies need to ensure that women are encouraged from early on in their careers, through mentoring, meaningful work experience, and proper flexible working, to ensure they are equipped to progress to executive director posts. Firms also need to communicate how they are approaching the encouragement and engagement of women throughout the organisation. The FRC should take this into account as part of its rating system.

126.Also we support the Hampton-Alexander Review’s recommendation that the FRC should amend the UK Corporate Governance Code, so that all FTSE 350 listed companies are required to disclose in their annual report the gender balance on the Executive Committee and direct reports to the Executive Committee.

127.We believe that the aims and targets of the Hampton-Alexander Review should go further and, in support of the Equality and Human Rights Commission’s objective, we recommend that 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. Companies should explain in their annual report the reasons why they have failed to meet this target, and what steps they are taking to rectify the gender inequality on their Executive Committees.

Ethnic diversity

128.The Corporate Governance Code has five references to gender, but only one to race (and that reference is in the preface).244 The statistics relating to the ethnic diversity of boards are startling: in FTSE 100 companies, only 8 per cent of positions are held by directors of colour, of which 1.5 per cent are UK citizens (despite that fact that 14 per cent of the total UK population is from a non-white ethnic group). Only 1 in 16 top management positions are held by a person from a BME background, and only 73 directors in FTSE 150 companies have a black, Asian or minority ethnic (BAME) background, and only 1.6 per cent of directors are UK BAME citizens.245

129.Sir John Parker’s review into ethnic diversity on boards, A Report into the Ethnic Diversity of UK Boards, published in November 2016, recommended a target of one in five Directors of FTSE 100 firms being from an ethnic minority background by 2020.246 Baroness McGregor-Smith led a review to complement the Parker review, looking at issues faced by businesses in developing black and minority ethnic talent from when people start work, to executive level. Her report made the following damning comment:

There is discrimination and bias at every stage of an individual’s career, and even before it begins. From networks to recruitment and then in the workforce, it is there. BME people are faced with a distinct lack of role models, they are more likely to perceive the workplace as hostile, they are less likely to apply for and be given promotions and they are more likely to be disciplined or judged harshly.247

130.Perhaps the most shocking statistic is that only nine people from ethnic backgrounds hold the position of Chair or CEO in this country, and 53 out of the FTSE 100 companies do not have any BAME directors. Out of 1087 UK citizen director positions in the FSE 100 boards, only 1.5 per cent are BAME. Seven companies account for over 40 per cent of the directors with ethnic backgrounds, and five out of the seven companies have headquarters historically located outside the UK.248

131.The arguments for greater diversity, including ethnic diversity, often conflate the argument of social justice with competitive advantage. Ken Olisa, deputy Chairman of the Institute of Directors, told us that a diverse board gives competitive advantage because if the directors and non-executive directors do not look like the different stakeholders, “the people whom they are trying to employ, trying to sell to, trying to buy goods from and being regulated by, then those people in the supply chain are less likely to be empathetic to the needs and requirements of the company”.249

132.For companies seeking a competitive advantage, the directors and non-executives running them, and those setting the strategic context in which they operate, should be empathetic to the needs and requirements of all those involved, including employees, workers, suppliers and customers. It makes business sense to recruit directors from as broad a base as possible, across the demographic of the UK. We recommend that the FRC embeds the promotion of the ethnic diversity of boards within its revised Code. At the very least, we recommend that wherever there is a reference to gender, the FRC should include a reference to ethnicity, so that the issue of ethnic diversity on boards is made explicit in the revised Code, and is given as much prominence as gender diversity.

133.In accordance with the spirit of the McGregor Smith review, we recommend that the Government should legislate to ensure that all FTSE 100 companies and businesses publish their workforce data, broken down by ethnicity and by pay band.

Cognitive diversity, including social diversity

134.The update to the preface of the UK Corporate Governance Code in 2014 widened the definition of what the FRC would expect diversity to cover, in terms of the board:

Essential to the effective functioning of any board is dialogue which is both constructive and challenging. The problems arising from ‘groupthink’ have been exposed in particular as a result of the financial crisis. One of the ways in which constructive debate can be encouraged is through having sufficient diversity on the board. This includes, but is not limited to, gender and ethnicity. Diverse board composition in these respects is not on its own a guarantee. Diversity is as much about differences of approach and experience, and it is very important in ensuring effective engagement with key stakeholders and in order to deliver the business strategy.250

135.Many respondents to our inquiry argued that diversity should be viewed in its broadest sense, with intellectual diversity and experience being as important factors as ethnicity and gender.251 Rowena Ironside, founder and Chair of Women on Boards UK, told us “Diversity is the grit in the oyster”.252 The Institute of Directors’ evidence states that more diverse boards perform better over the long term, and that fielding a team of top executives and board directors with varied cultural backgrounds and life experiences can broaden a company’s strategic perspective. In practice, there is likely to be considerable overlap between securing a cognitively diverse board and one that is diverse in terms of gender, ethnicity, and background.

136.The more similar that individual directors think, act, and look, the more likely it is that they are not going to challenge each other, or innovate, or think imaginatively. Directors should not be appointed to the board solely on the basis of one particular background or area of expertise. Greater cognitive diversity promotes more effective challenge and more informed decision-making and we recommend that the FRC works with others to provide improved guidance on this aspect of diversity in the context of board membership.

The Pipeline of talent

137.Directors appointed from within the organisation, working their way through the executive channel, have an intimate experience of the company and are usually also paid less than outsiders brought in to fill directorships.253 Janet Williamson from the TUC and Stephen Haddrill, from the FRC, both told us that nurturing people within companies can result in a more diverse group of people reaching the top of the corporate sector, and include people who are more likely to be focussed on the longer-term strength of the business.254 There is also evidence to suggest that CEOs appointed from within the company add more value than those recruited from the outside, and at a lower cost.255

138.We support measures to enhance the executive pipeline, ensuring that talented people within an organisation are encouraged and supported at an early stage of their careers, and beyond, into middle and senior management.

139.The revised Code should have the issue of board diversity as a key priority and there should be a public explanation of the reasons why members are part of the board. The Code should require boards to cover in their annual reports information diversity on their boards and in the workforce, covering diversity of gender, ethnicity, social mobility, and diversity of perspective. Annual reports should be required to include a narrative on the current position, and an emphasis on what steps the company has taken, and will continue to take to enhance the diversity of the executive pipeline, with agreed targets. This narrative should include how accurately the board mirrors the diversity of both the workforce and the customer base.

140.The detailed narrative of board diversity in annual reports should be a working document throughout the year, informing the board, the Nomination Committee, middle and senior managers, and the workforce and other stakeholders, about the seriousness that companies are taking diversity and succession issues. The revised Code should make this requirement explicit.

Worker representatives on boards

141.In July 2016, the Prime Minister said that the Government would publish plans to have consumers and workers represented on company boards. By November 2016, in her speech at the CBI conference, the Prime Minister had apparently watered down her views, with the resulting statement in the Green Paper: “As the Prime Minister has made clear, we are therefore not proposing to mandate the direct appointment of employees or other interested parties to company boards”.256 The Green Paper lists several obstacles against appointing a worker director: real decision making moving from the boardroom to less formal channels; a risk of tokenism; the difficulties of choosing a worker representative; the worker representative being constrained by the common directors’ duty to promote the success of the company and by the confidentiality of board discussions.257 Witnesses argued that boards should be cohesive governing bodies rather than forums for representatives of different interests to resolve their varied approaches.

142.There is mixed evidence on the impact that workers on boards have on a company. Some evidence shows that greater representation reduces long-term firm value.258 Professor Alex Edmans believes that mandating worker representation sends the wrong message: “It suggests that ‘consulting workers is bad for firm value, so we must pass a law to achieve it’.”259 Others disagree with this view, saying that a worker representative would be a director in his or her own right, chosen from the workforce, but not a conduit for representing its views.

143.The IoD and the FRC are both in favour of worker representation in principle, but Stephen Hadrill told us it would require primary legislation to implement the change; changes to the Code would not be sufficient.260 He went on to suggest that a worker representative need not be an employee of the company, but a director elected by employees of the company: “In Holland, they often elect people from elsewhere. Someone might stand for election because of their empathy with the worker community but they might have great skills that are relevant to the business”.261

144.The TUC argued strongly in favour of workers on boards: “Workers’ voice is the missing element of the UK corporate governance”.262 They state that workers’ interests are best protected by company success, and the natural inter-dependency between workers and the companies they work for makes workers a natural group to participate in corporate governance.263 They cite evidence from Europe, with 19 out of 29 European countries having some provision for workers’ representation on company boards. We heard on our visit to Sweden how workers on boards had helped overcome a period of difficult industrial relations and was now taken for granted.

145.Having a single worker on a board will not address the fundamental issue of the company’s engagement with the workforce, and could risk being seen as a token nod towards employee participation at board level. However, we believe that employees can bring a different perspective and challenge to the board, and are more likely to encourage a long-term perspective. This issue needs to be seen in the context of recognising where success and value are created in an organisation, such as its staff, and having an HR function that is explicitly aligned with a firm’s strategic direction and has sufficient influence at the highest level.

146.We recommend that companies should be recruiting non-executive and executive directors from the widest possible net of suitable candidates, which should include recruiting internally. Successful companies, both here and abroad, have shown that this can work for the benefit of the company as a whole, and we encourage more companies to appoint workers on boards. We believe that, just as the drive for women directors has overcome initial doubts, it should become the norm for workers to serve on boards.

147.We are not minded to recommend the compulsory requirement for companies over a certain size to include a worker on board. There are numerous difficulties to overcome including, for example, how the term ‘worker’ is defined and how the post would be filled. However, there is nothing in law that prevents workers serving on boards, and the diversity of board members, including workers on boards, should be encouraged. There are already long-established boards where this is the norm, for example John Lewis, First Group, and the NHS Foundation Trust Boards. They do not appear to have suffered from some of the disadvantages that sceptics have suggested. Employees appointed to boards should be directors in their own right, with the necessary skills and aptitudes to play a part as a full board member rather than a representative of the workforce. They would not be a delegate, but would provide the same strategic evaluation and challenge that every director should bring.

Nomination committees and diversity

148.Normally headed by the Chair of the company, the Nomination Committee’s responsibilities include board succession. The Code stipulates that the company’s annual report should describe the work of the Nomination Committee, including the process it has used when deciding on board appointments: “The search for board candidates should be conducted, and appointments made, on merit, against objective criteria and with due regard to the benefits of diversity on the board, including gender”.264 It should include a description of the board’s policy on diversity, any measurable objectives it has set for implementing the policy, and progress on achieving the objectives, and an explanation if it has not used open advertising or an external search consultancy.265 Oliver Parry from the IoD said the head-hunters churn out the same names, and instead should be encouraged “to think about a more diverse portfolio of individuals, with different backgrounds, different cultures and different understandings of the business environment”, and gave the example of the current need for non-executive directors with cyber-security understanding and experience.266

149.The Code requires that, at least every three years, an external facilitator should review the effectiveness of the nomination committee, including the process it has set for implementing the policy, and progress on achieving the objectives.267 If done properly, this can highlight issues relating to group think, and to diversity of thinking.268 Edward Speed, from Spencer Stuart, recommended oversight of the external facilitator by the FRC to ensure minimum standards and consistency across companies. We agree with his proposal.269

150.Tomorrow’s Company advocates reform of the director nomination process, which it states is a closed process and has little connection between directors and the shareholders who elect them, and highlighted the Swedish nomination committee structure, where major shareholders come together to have a greater say in the nomination of directors. It is also a recommendation put forward in a recent report by Chris Philp MP.270 This proposal would produce stronger shareholder engagement and more diverse and challenging boardrooms.271

151.The Nomination Committee is responsible for finding and appointing board directors based on merit, and against objective criteria. Given those responsibilities, it also has a crucial role in ensuring board diversity. We recommend that the revised Code states explicitly that the procedure for the appointment of new directors to the board should be by open advertising, and by an external search consultancy, and detailed explanations should be given if one or both of these requirements is not met.

152.Currently, the Code requires that, at least every three years, an external facilitator should review the effectiveness of the board, which should check on poor habits, such as group think and complacency. We recommend that the FRC should be given the extra role of overseeing the rigour of the evaluation process to ensure that it is genuinely independent, thorough and consistent across companies. The FRC should highlight best and worst practice among Nomination Committees.

231 Q30

232 BHS, First Report of the Work and Pensions Committee and Fourth Report of the Business, Innovation and Skills Committee, Session 2016–17, HC54; Business, Innovation and Skills Committee, Third Report of Session 2016–17, paras 131 and 135

234 A Report into the Ethnic Diversity of UK Boards Sir John Parker, the Parker Review Committee, November 2016, page 5.

235 The Prime Minister, keynote speech, Conservative party conference, 5 October 2016.

236 Q315

237 McKinsey, CSFB, Citibank, Citibank, SocGen are examples of analyses, showing a correlation between gender diversity and company performance, based on global, Australian and European companies. Written evidence from the Campaign for Merit in Business [0008] claims that there is a causal link between women board members and corporate financial decline.

238 Dr Barnali Choudhury (CGV0160)

239 Helena Morrisey (CGVO0017)

240 Q267

241 Women on Boards, February 2011.

243 Equality and Human Rights Commission (CGV0152)

245 Spencer Stuart, 2016 UK Board Index

249 Q420

250 Para 3

251 For example, ACCA (CGV00), CBI CGV00)

252 Rowena Ironside [Q297]

253 Q30 [Stephen Haddrill]

254 Q37 [Janet Williamson] [Stephen Haddrill]

258 Gorton and Schmid (2004), cited in Professor Alex Edmans’ written submission [006]

259 As above

260 Q31

261 Q34

262 TUC (CGV0156 Para 4.12)

263 TUC (CGV0156 Para 4.13)

266 Q36

268 Q290 [Edward Speed]

269 Q290

4 April 2017