The UK Corporate Governance Code July 2018, which applies to accounting periods beginning on or after 1 January 2019 and has been adopted early in whole or in part by some companies, is a key pillar of the push to restore public trust in business. It is ‘shorter and sharper’, with fewer provisions than previously and recognises the shared interests of boards, shareholders, employees and wider stakeholders. Critically, it also focuses on how a company applies its main principles (not just how it will ‘comply or explain’ them). In other words, it is asking for meaningful reporting rather than just a tick-box approach.
With the new code, the FRC and FCA are raising standards expected of investors and challenging them to devote more resources to evaluating the quality of company disclosures. They want to see a greater focus on shareholder engagement and on the importance of ‘stewardship’, which is widely defined as acceptance or assignment of responsibility, the way in which something is organised or controlled and safeguarded.
So what can we tell about the way the new code is being embraced, by the early adopters? Last October, the FRC published its Annual Review of Corporate Reporting 2018/2019, which provides their assessment of the standard of corporate reporting. Announcing the publication, the FRC noted that: “The FRC expects companies to improve the quality reporting of forward-looking information, the potential impact of emerging risks on future business strategy, the carrying value of assets and the recognition of liabilities. Failure to report on these crucial areas undermines trust in business and can lead to the conclusion that management is either unaware of their potential impact, is being opaque, or is not managing them effectively.”
The FRC found that only half of the 207 company annual and interim reports it reviewed address the issue of purpose – why they exist beyond simply generating profits for shareholders, while very few appear to have grasped the importance of looking beyond short-term performance to their long-term success. In fact, just 10% of statements provide any insight into the types of metric investors need to assess long-term viability such as key risks, scenario analysis, mitigations, etc.
In terms of forward-looking reporting, 72% of companies talk about strategy, but only 17% provide any sort of timetable for implementation. One area of successes is risk reporting, with 78% of statements providing good disclosures that are increasingly linked to strategy.
However, an area of risk that companies largely continue to ignore is succession planning. It’s worrying that only 17% of statements mention anything about Board succession and only 13% touch on internal management progression. And, when it comes to looking at how far directors’ skills are relevant in the context of strategy and regulatory change, the figure is a mere 2%. So there remains much work to be done in this area.
Companies are also dragging their feet when it comes to meeting the Code’s stipulation that the maximum tenure of a Board chair should be nine years. In fact, 84 FTSE350 chairs have exceeded this suggested limit (that represents almost a quarter of FTSE350 companies) and a further 20 will soon reach it.
In terms of diversity, although gender diversity reporting is at all-time high and 94% of companies mention other kinds of diversity such as ethnicity (42%) and social background (34%), policy and practice are still far apart. This is illustrated by the fact that there are still just 25 female chairs in the FTSE350 and only 59 Senior Independent Directors are female (just 17%).
Finally, the Code requires the remuneration committee to examine six factors when setting the policy for executive director remuneration: clarity, simplicity, risk, predictability, proportionality and alignment to culture. It also asks for a description, with examples, of how the remuneration committee has addressed these factors – a stipulation met by only 5% of companies. Moreover, while most companies are still using only financial metrics to explain director remuneration, the Code stipulates that they explain how executive remuneration aligns with wider company pay policy, what discretion has been applied to remuneration outcomes and the reasons why.
As we start to see the publication of the first annual reports for the 31st December 2019 year end, it will be interesting to see how these differ from the early adopters. Our own experience in conversations with Chairs, CEOs and other board members, is of more discussion around engaging broader stakeholders, a greater focus on diversity and succession planning and a recognition of the need to succession plans in to the skills required to deliver on longer term strategy and meet a purpose beyond the bottom line.