UK inquiry into corporate governance closely watched

Given the increasing convergence of governance frameworks globally, the UK inquiry into corporate governance currently underway is being closely watched by market participants and regulators around the world.

The inquiry arises from the Prime Minister Theresa May’s comments that she intended to overhaul corporate governance, as well as the UK parliamentary Business, Innovation, and Skills Committee’s recent inquiries into corporate collapses that highlighted corporate governance failures. The Prime Minister had noted in her speech that ‘Better governance will help companies to take better decisions, for their own long-term benefit and that of the economy overall’.

The inquiry is focusing on executive remuneration, directors’ duties, and the composition of boards, including employee representation in boardrooms and gender balance in executive positions.

On the issue of directors’ duties, the inquiry will focus on whether company law is sufficiently clear on the roles of directors and non-executive directors, and whether those duties are the right ones. The terms of reference ask if those duties should be amended, if found not to be the right ones. The terms of reference also ask whether the duty to promote the long-term success of the company is clear and enforceable as well as how the interests of shareholders, current and former employees are best balanced.

The decisions of boards and how they should best be scrutinised and open to challenge is also on the agenda, as is the question of whether there should be greater alignment between the rules governing public and private companies, and what the consequences of such an alignment would be. The terms of reference also ask whether there should be additional duties placed on companies to promote greater transparency, for example, in regards to the roles of advisers. If so, what should be published and why, and what would the impact of this be on business behaviour and costs to business?

The inquiry will also ask how effectively the provisions of the 1992 Cadbury report have been embedded, including how best shareholders can have confidence that the executive team is subject to independent challenge. The final issue to be explored in relation to boards is whether the government should regulate or rely on guidance and professional bodies to ensure that directors fulfil their duties effectively.

On the issue of executive remuneration, the inquiry will look at what factors have influenced the steep rise in executive pay over the past 30 years relative to the salaries of more junior employees, and whether executive compensation should reflect the value added by executives to companies relative to more junior employees. US companies will be required to disclose from 1 January 2017 the ratio of pay of a CEO's annual total remuneration to the median annual total remuneration of all company employees. CEOs in the US are paid around 300 times the median employee wage, while in the UK the ratio is roughly 183:1.

The inquiry will also assess if there is evidence that executive remuneration is too high and to what degree government should seek to influence or control it. It will consider how executive remuneration should take account of companies’ long-term performance and whether recent high-profile shareholder actions demonstrate that the current framework for controlling executive remuneration is effective and whether shareholders should have a greater role.

In relation to board composition, the inquiry will focus on whether there is evidence that more diverse company boards perform better and how greater diversity of board membership should be achieved. It will assess whether the criterial for diversity should include gender, ethnicity, age, sexuality, disability, experience, and socio-economic background. The question of what can be done to increase the number of women in executive positions on boards is also open for discussion.

Following on Theresa May’s speech prior to the election calling for employee representation on company boards, the inquiry will also consider if this should happen and examine what this might look like in practice, how it would work, and how employees would be selected. The question of whether employees should be represented on remuneration committees forms part of this.

Announcing the inquiry, the chair of the committee noted that ‘Good corporate governance shouldn't be a hindrance to business; it can contribute to companies' long-term prosperity and performance as well as showing to the world that a business is transparent, accountable and responsible’. Considerable interest in responding to the inquiry as well as its final report is expected.

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