Investors come first in the new corporate governance code

 
Stephen Haddrill

THE latest version of the UK Corporate Governance Code will be launched by the Financial Reporting Council (FRC) this month. Setting the standards for good governance, companies with a premium listing must report on their compliance with the Code, but many others adhere to it to demonstrate to investors their commitment to best practice.

The Code requires boards to take a long-term focus and to look at strategic risks that could affect the company and its long-term viability. For investors, knowing how the board is managing and mitigating risks is an important indicator when judging whether the company will be able to deliver the value that they seek. But it is difficult to talk about trust and communication between businesses and investors without tackling the tricky topic of executive remuneration.

During this year’s AGM season, shareholders were entitled to enhanced voting rights on remuneration, resulting in a few votes being lost and significant levels of dissent in many others. Firms should heed these signals and take care to ensure that they show a clear link between the performance of their directors and the pay they receive.

The level and structure of remuneration can also have an important effect on behaviour, and needs careful thought if it is to create the right incentives. Remuneration and incentives that encourage people to cut corners or prioritise short-term gains over long-term prosperity, or which leave some groups of employees feeling unfairly treated compared to others, can have a destructive effect.

Our recent consultation on changes to the Code suggested that directors’ remuneration should be designed to promote the long-term success of the business. Performance-related elements should be stretching and rigorous, and firms should have suitable claw-back arrangements in place. We also proposed a provision for companies to explain when publishing general meeting results how they intend to engage with shareholders when a significant percentage of them have voted against any resolution.

Investors are attracted to demonstrably well-run companies. If they are to commit investment over the long term, they deserve good quality information and evidence of effective governance. In 2011, we commissioned Lord Sharman to consider the quality of information that firms provide on their financial health and their ability to withstand stresses over time. As a result of his recommendations, boards will have to assess and report on whether risks give rise to material uncertainties in relation to the going concern basis of accounting. This technical “going concern” statement affirms that a company can operate as a going concern over the next year.

The Code consultation proposed introducing a new type of viability assessment separate to this narrow accounting valuation, which will give investors an improved and broader integrated assessment of solvency and liquidity. Boards would specify the period covered by this statement – which we expect will be significantly longer than 12 months – and why they consider it appropriate. Directors would make the new statement in the Strategic Report, which means that they can benefit from safe harbour.

Some have questioned whether we are asking companies to stare into a crystal ball. I say we are asking them to do what they should have already been doing: making their shareholders’ needs a priority in their reporting.

The FRC will continue to ensure that the UK maintains its position as the leading proponent of high quality corporate governance.

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