The Financial Reporting Council has delivered radical revisions of the UK Corporate Governance Code and of the Guidance on Board Effectiveness. The purpose of this note is to bring you the most important headlines.
One of the lessons of the Banking Crisis was that companies that failed frequently had non-executive teams that lacked sufficient know-how, curiosity or character to ask penetrating questions of the executives who were leading them towards a cliff. As Andrew Bailey, now Chief Executive of the Financial Conduct Authority once put it, “Healthy scepticism channelled into intelligent and forceful questioning of the self-confident can be a good thing.”
The FRC has given a strong, systematic emphasis to NED teams having the skills knowledge and experience to understand everything of importance that is going on in their company. It has focused on the importance of so-called 'soft' skills. Crucially it has put ‘Courage’ at the top of a list of desirable personal attributes of NEDs and steered boards towards actively seeking good candidates who are outside the (social) circles of classical head-hunters.
There has been growing political criticism of short-termism and covert asset stripping by those who lead and invest in UK companies. This has been supported by criticism from economists and long term investors. This behaviour is in part a result of Milton Friedman’s ‘Shareholder Value’ philosophy, which has put anything other than shareholder perspectives into ‘second class’ category.
Encouraged by a strong political steer, and despite seemingly coordinated resistance from large corporates, the FRC has now brought “long term sustainable success” to the core of the Code. This philosophy has been reinforced throughout the Code and the Guidance, in which “long term” appears no less than 40 times.
Friedman-ism has been dealt a second blow by forcing boards to listen to the workforce. Political pressure arising from the increasing disparity between C-suite and worker pay is one driver. The second is the recognition that workers often won’t give leaders unwelcome news because they fear the consequences – what we call the ‘Unknown known’ problem.
As regards the unknown known’ problem, the FRC has given renewed emphasis on going beyond ‘whistleblowing’ programmes towards systematising a culture which makes it both routine and safe for the workforce to ‘speak up’ if they feel anything is amiss.
The pay disparity issue has been tackled by a variety of measures. One is to force boards to institutionalise an ‘employee voice’ whether via an employee director, a director designated to listen to and bring workforce views to the board; or a formal workforce advisory panel. Boards are expected to explain to the workforce the relationship between executive pay and wider company pay policies and corporate culture.
Bonuses and other incentives
Finally, the FRC made a promising and well-thought-through attempt to de-risk bonuses and other incentives. Among other measures, the FRC is encouraging simplicity and clarity in their structure and the thinking through of potential unintended consequences.
But they have also taken a stand against the risk of a CEO burnishing present profits (and thus bonuses) by increasing risks ‘after I have gone’. It is often easy, and given the wrong bonus architecture can be tempting, to boost profits (and bonuses) today by cutting back on, for example, maintenance or innovation. Cut maintenance regularly causes costly disasters. And many suspect that investment foregone is an important cause of lacklustre performance at UK companies.
The FRC has tackled this through the best method of which we are aware: by encouraging boards to require executive bonus share awards to be held for “two or three years after leaving the company”. That way retiring CEOs have a huge incentive to leave their company in excellent shape. For if one thing is certain, it is that their successor will have a thorough look for skeletons left by their predecessor before setting the starting point for their own bonus scheme.
You will find the rationale behind most of the FRC's main changes fully explained in "Rethinking Reputational Risk - How to Manage the Risks that can Ruin Your Business, Your Reputation and You" by Anthony Fitzsimmons and the late Derek Atkins.
We have written a more detailed note on this, which you will find here.