Section 172 and stakeholder reporting
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Section 172 and stakeholder reporting
Understanding what is required and preparing to meet the requirements.
“Large” (as defined by the Companies Act) UK companies are required to include a ‘Section 172(1) statement’ in their Strategic Report under Section 414CZA of the Companies Act 2006. This technical publication sets out an overview of the requirements and considers the practicalities of preparing a Section 172(1) statement.
Scope of this technical publication
This technical publication provides an overview of the requirements of section 414CZA of the Companies Act 2006 (the "Regulations") for preparing a Section 172(1) statement and the practical matters that companies may wish to consider when preparing their statements. The legislation does not mandate a specific set format or structure for a Section 172(1) statement though it does effectively prescribe its title and location within the report.
This technical publication is intended to provide a useful tool for directors when preparing their Section 172(1) statement.
Why were the s172 reporting requirements introduced?
The intention of the Regulations was to encourage boards to be more structured and systematic about their approach to directors’ duties and to show how broader matters were taken into account in directors’ decisions during the year. The approach has been referred to as “Enlightened Shareholder Value”.
Overview of the requirements
Why is a Section 172(1) statement required?
Section 414CZA of the Companies Act 2006 requires companies to explain how the directors of a company have had regard to the matters set out in Section 172(1) (a) to (f) when performing their duty under Section 172 of the Companies Act 2006.
Section 172 of The Companies Act 2006 states that “a director of a company must act in the way he/she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to:
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Practical matters to consider when preparing the Section 172(1) statement:
- Start early. Preparing a Section 172(1) statement requires time and resource to ensure the statement meets the applicable requirements and presents the directors’ duty in a balanced and fair manner and can be supported by evidence if required;
- Identify and consult the key business partners, such as investor relations, customer services and regulatory engagements. Report preparers should ask key business partners, who are responsible for maintaining relationships with key stakeholders, about their interactions with the Board and Executive Committee;
- Check board minutes. The company’s board minutes should indicate, for each principal decision, when and how broader stakeholder interests were taken into account, and;
- Board oversight. Describe how the Board oversees the stakeholder engagements.
The following sections provide further detail about the requirements, how directors can seek to prepare their statements, including what information should be included, and what practical issues and considerations may be applicable.
Determining which companies need to apply the requirements
| Large companies are required to include a Section 172(1) statement in their annual reports. Large companies are those which meet two of the following three thresholds in a financial year: | ||
| Turnover of more than £36 million | Balance sheet total of more than £18 million | More than 250 employees |
or are ineligible for small or medium exemptions due to being, for instance, a bank, insurer or plc.
For a parent company, these figures should reflect the aggregate results of the parent and all its subsidiaries whether or not the company produces consolidated accounts. The requirements apply to each individual company and therefore a Section 172(1) statement is needed for each company within a group, including the parent entity and each of its subsidiaries, that meets the applicability threshold. There is no group exemption.
What should a Section 172(1) statement discuss?
The Section 172(1) statement must discuss how the directors of a company have acted in the relevant accounting period in order to promote the success of the company, both in the short and long-term, for the benefit of all the company’s members (i.e. shareholders, whether majority or minority), by giving specific regard to a range of broader matters. These broader matters include: considering the consequences of decisions for the long-term, building and fostering relationships with key stakeholders, maintaining the company’s reputation for good business conduct and needing to act fairly for all shareholders of the company.
The statement should therefore explain how the directors have had regard to other stakeholders while acting in the interests of shareholders as a whole.
The statement should indicate the issues, factors and stakeholders the directors consider are material to their duty under Section 172, specifying:
- key stakeholders and why they are important;
- how the directors have engaged with stakeholders; discussing, for example, the main methods of communication, who has been included and what feedback has been received, and;
- for each principal decision taken by the directors during the reporting period, how they took the interests and feedback of the key stakeholders impacted into account when making those decisions.
Implementation
Where should the Section 172(1) statement be presented?
The Section 172(1) statement should be a separate statement set out in the Strategic Report. It must also be made available on the company’s website (where the entire annual report is not already made available). Though there is an overlap, particularly for companies applying the corporate governance code, with stakeholder engagement elements of governance there is no option in the legislation to move the statement outside the Strategic Report.
Practical consideration: Preparation Practical matters to consider when preparing a subsidiary’s Section 172(1) statement:
Furthermore, while certain parent companies may not have their own operating assets or employees, their ability to generate or preserve value is dependent on their subsidiaries’ activities. Accordingly, parent companies should consider how these matters relate to the success of the group they head as a whole. |
Practical consideration: Publication Unquoted companies are not usually required to publish their annual report and therefore they will need to ensure that their Section 172(1) statement is made available on a website. Unquoted companies may choose to publish either: (i) the statement on its own (i.e. as a separate statement); (ii) the Strategic Report (including the statement); or (iii) the annual report as a whole. Where the statement includes cross- references to other parts of the company’s annual report, then these parts will also need to be included on the website if the whole annual report is not made available. The website in question does not need to be the company’s own website; it may be a website maintained on behalf of the company, such as the website of a parent company, provided it identifies the company in question. Quoted and AIM companies are already required to publish their whole annual report on their websites. |
Identifying and understanding stakeholder engagement
The following diagram illustrates how directors may identify and understand their stakeholder engagement and what factors they may wish to consider:
Who | Identify stakeholders/other considerations Key stakeholder relationships and considerations may include: employees, customers, suppliers, creditors, pension schemes, the community and the environment as well as shareholders. The description of the business model in the Strategic Report should indicate the most important relationships and why they are key. The company need not reproduce the entire list specified in s172 if some of these stakeholders are less important. |
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Why | Why is it important to engage? Engagement is important both for the company’s own interests; these stakeholders are, after all, key to its business and long-term success, and to recognise the impact of the company on broader society. A company which visibly takes these impacts into account helps to maintain its licence to operate and may gain useful insights from its stakeholders’ into its own operations or the economic outlook. |
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How | How do directors engage with stakeholders? Directors should report on who they have engaged with and how. This may involve daily business interactions, annual formal communications, surveys with the community, impact assessments on the environment, or other bases appropriate to the stakeholder in question. |
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What | What are the key topics of engagement and what feedback is received? The most important topics of engagement will be specific to each individual company, but it is likely that they will be linked to the company’s business model, as set out in the Strategic Report. Topics could therefore include: the attractiveness of the company’s products to customers, ethical issues on pricing or use of products, impact on employment and remuneration for the workforce, issues of fairness or sustainability of pricing, or balancing interests of shareholders for dividends, security of longer-term creditors and the company’s need for future investment or environmental impacts. |
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| Impact | What is the impact of the engagement? The interests of different stakeholders may not always be aligned. Where there are conflicts, and the interests of one group have been prioritised over another, the statement could consider how those interests were weighed against one another and the factors taken into account in the final decision. |
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Reporting on principal decisions
In meeting the requirements, the directors should consider the decisions during the year. This need not be exhaustive but should cover key decisions. Examples, and the relevant stakeholders, might include:
Business model | A company changing the basis on which it offers its products may consider the effects both on its own long-term profitability and reputation for stability and the effects on customers and/or suppliers of the change. The directors could explain in the statement how they considered the effects of this change on existing and new customers and/or suppliers, as well as how this impacted its reputation and/ or the environment. |
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Capital allocation and dividend policy | A company paying a dividend or making a major capital investment could consider the effects of capital allocation to one party or investment on the security of others such as pensioners, employees or external creditors. The directors could include in the statement, in the case of a dividend, an explanation of how legal requirements of distributability of reserves were considered, that the dividend was in compliance with these requirements and how this and the company’s overall position has avoided prejudicing the position of other creditors to their significant detriment. |
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| Closure of a branch or division | A company may decide that it is necessary for its long-term success to cease production in a particular facility or market. Though this may negatively impact employees and suppliers in that area or existing customers, the directors could legitimately decide the long-term interests of the company outweigh such implications. The directors could therefore explain in the statement how the interests of those negatively affected were mitigated and how the reputation of the company for high standards of conduct was maintained. |
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Culture | How the company interacts with all its stakeholders is hugely important for maintaining the company’s sustainability and longevity. Establishing a culture embedding the company’s values, attitudes and behaviours can help the directors to meet their Section 172 duties for promoting the long-term success of the company. The directors could explain in the statement what are the key attributes of the company’s culture that drive its long-term success, particularly in the context of supporting the company’s desire to maintain high standards of business conduct. |
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Considering existing disclosures within the Strategic Report
The aim of the Section 172(1) statement is to show how directors have taken the broader matters listed in Section 172 into account when performing their duties. The statement should be succinct and avoid cluttering the annual report by not duplicating information that is already provided elsewhere, particularly where there are linkages and overlaps within the information. Companies should endeavour to maintain the cohesion of the narrative contained within the Strategic Report and incorporate information into the statement by cross-referencing where appropriate. Duplicating information should be avoided where possible, however, the requirement for the statement to stand alone, if it is published separately, may require some repetition.
Directors should consider linkages and overlaps of information, specifically in the following areas:
- Principal risks disclosures – The Section 172(1) statement must explain “the likely consequences of any decision in the long term”. Strategic decisions taken by the directors, for example regarding the company’s operations, business model and/or future growth plans, will therefore need to be explained in the context of how the decision is likely to impact on the long-term success of the company. Accordingly, identifying and having regard to these likely consequences may form part of the risk management process within a company, and therefore the disclosures provided in the Strategic Report on principal risks and uncertainties may need to be linked with the information provided in the statement.
- Review of the business – As already discussed, the Section 172(1) statement should set out the principal decisions taken by the directors during the financial period, how regard was had to the Section 172 matters when making decisions and the effect of that regard. Where this is the case, the disclosures provided in the Strategic Report regarding the company’s business review for the period would be expected to be consistent with the information provided in the statement.
FRC guidance
The FRC published Tips on Section 172, Section 172 report summary and Reporting on stakeholders, decisions and Section 172 in 2020 and 2021 which laid out some useful hints for reporting.
Dealing with other practical considerations
- Documentation – For larger and more formally organised companies the board minutes will likely indicate, for each principal decision, when and how broader stakeholder interests were taken into account. In the absence of such information, evidence of how the directors have fulfilled their duties and the effects that any major decisions have had on the interests of employees, customers and suppliers should be documented for reporting purposes. This is not intended to be a purely year-end measure but instead, it should be an action that the directors routinely carry out throughout the reporting period.
- Boilerplate and generic reporting – Companies should avoid boilerplate or generic text such as reiterations of the s172 requirements to reduce clutter and make the disclosures useful and purposeful. Specific and tailored explanations and discussions are more helpful both to shareholders and other key stakeholders, particularly with regard to improving transparency and building trust with investors.
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Narrative reporting
Pressure for greater transparency from shareholders, not only in the financial statements, but in explaining performance in detail and in more forward-looking areas like strategy and plans for the future is not new.