FRC Corporate Governance Code: Our View

The highlights of the Code are:

• More concise with significant new expectation
• Boards will need to spend more time on culture and strengthen quality of information on it
• Major new focus on workforce engagement- implementation will require careful thought
• Diversity- important to look at all aspects and for measures to go beyond NEDs on boards
• Remuneration- useful incremental advances but unlikely to resolve the bigger issues
• FRC in listening mode- changes to chair’s tenure watered down and smaller listed changes reduced
• A world-class code, the challenge now is to get world-class governance in practice

More concise with significant new expectations

‘Less is more’ is a good way of summarising the new UK Corporate Governance Code published today. It is commendably much more concise than the current version and benefits from a complete rewrite including the elimination of supporting principles so that there are now just principles to be applied and related provisions to be adopted on a ‘comply or explain‘ basis. In probably the most extensive rewrites of the code in its quarter of a century life to date, the new code, however, also strengthens expected board practice in a number of areas especially with regards to purpose, culture, workforce engagement, diversity and, the old perennial, remuneration.

Boards will need to spend more time on culture and strengthen quality of information on it

The new code, effective for periods beginning on or after 1 January 2019, now specifically states that successful companies contribute to wider society as well as generating value for shareholders and that their boards should set the corporate purpose, values and strategy and ensure these are aligned with the culture. It goes on to say that the board should assess and monitor culture and where it is not satisfied that they are aligned should seek assurance that management has taken corrective action. Whilst the new code is careful to distinguish between the respective responsibilities of boards and management teams, boards will generally need both to spend more time on corporate culture and to obtain more detailed and higher quality information on the nature of the culture across the business which may come from culture audits, employee engagement surveys, so long as they ask searching questions, customer feedback or in other ways such as from regulatory reports. Given the view, ascribed to Peter Drucker, that culture eats strategy for breakfast additional time spent by the board on corporate culture will be a good investment.

Major new focus on workforce engagement- implementation will require careful thought

Linked to the enhanced focus on culture, the new code also emphasises the importance of wider stakeholder engagement, and in particular ‘workforce’ engagement which it expects to be normally achieved by means of a director appointed from the workforce, a formal workforce advisory panel, a designated non-executive director or a mixture of these. This is welcome as it will bring the boardroom closer to the business, with better two-way dialogue, but if the relevant principle and provisions are to achieve their potential careful implementation will be critical particularly in global businesses where the workforce- and it should be noted this term is deliberately cast wider than employees to include others working in the business- will generally be spread across many different businesses, geographies and levels of seniority. The manner in which the workforce is segmented for consultation purposes and the means used, e.g. surveys, focus groups or an elected or appointed  advisory panel will be likely to influence significantly the quality of information the board obtains and the views it hears.

Diversity- important to look at all aspects and for measures to go beyond NEDs on boards

Diversity has also rightly moved up the board agenda in the new code given considerations of fairness and the importance of ensuring the board and executive team has access to the widest range of talent available to it and avoids group think, with very high risks attached to it in times of major change such as at present. The relevant principle in the new code makes clear that board appointments and succession planning should promote diversity of gender, social and ethnic backgrounds whilst the related provision makes clear the expectation that the board should oversee the development of a diverse pipeline for succession with regards to board and senior management appointments. As a report due out from Cranfield University this week will highlight, much remains to be done on gender diversity with most of the gains being at NED level , and then mainly as board members not chairs, and with a longer climb left in terms of board executive roles. Moreover, we are lot further behind when it comes to addressing ethnic diversity.

Remuneration- useful incremental advances but unlikely to resolve the bigger issues

And then there’s remuneration, with the new code setting out six areas to be addressed when determining executive director remuneration policy and practices- clarity, simplicity, risk, predictability, proportionality and alignment to culture- and as will come as little surprise further disclosures! These are welcome but whether like other incremental change they will lead to an agreed way forward on this thorny issue remains to be seen- a broader dialogue involving investors, board members, civil society and government is probably needed.

FRC in listening mode- changes to chair’s tenure watered down and smaller listed changes reduced

The changing of the proposal from that in the draft on the chair’s tenure is sensible. Until now the chairs have been expected to be independent on appointment but the approach for independent NEDs that there would be a rebuttable presumption that after nine years they would no longer be independent did not apply to them. The draft proposed treating them like independent NEDs. The new code has come up with a workable compromise which still indicates a chair should not be in post for more than nine years from the date of their first appointment to the board but adds that this can be extended for a limited time to facilitate succession planning and the development of a diverse board particularly where the chair was on the board before assuming that role.

It was also proposed to take out any derogations in the existing code for smaller listed companies outside the FTSE350 and whilst the expectation, not unfairly, is now that, excluding the chair, half of the board should be independent they are only expected to have a minimum of two rather than three independent NEDs on the audit and remuneration committees allowing the possibility of smaller boards that fully comply with the new code than would have been the case under the draft proposals. Some leeway has similarly been allowed on external board reviews.

A world-class code, the challenge now is to get world-class governance in practice

In overall terms, the new code with its focus on sustainability and the related issues of purpose, culture and diversity can rightly be considered to be world-class and at the leading edge of developments in the area. The challenge now is for boards across the listed sector to embrace its spirit and to implement it effectively so that we have world-class corporate governance in practice.