The FRC issued the UK Corporate Governance Code 2014 without
consulting me on the timing, with the result that, having been out all morning,
I started answering tweets about it before I’d had the chance to read the whole
thing. Now that I have paused to read
the new Code, I feel that I can comment more intelligently.[1]
Before I dive into the new remuneration provisions, which
are obviously the most interesting to me (and, I should imagine, to most people,
given that they are the section that is most changed) I thought I’d report
briefly on some of the other changes that caught my attention.
Some are intriguing.
For example, the preface (para 3) states that “diversity…includes, but
is not limited to, gender and race.” On
the one hand this is great – the treatment of diversity as synonymous with
having women on the board has been irritating me for some time. But it is notable that this preface is the
only place in the Code where race is mentioned.
Reference to gender diversity appears in Principle B2 about board
appointments, and in Principle B6 on board evaluation, but that is the only
diversity embedded in the Code itself.
Likewise, the FRC in its press release refers to “the importance
of the board’s role in establishing the ‘tone from the top’ of the company in
terms of its culture and values”. This is
obviously fundamental to governance, as we have all learned that a box-ticking
approach is frustratingly ineffective.
However, although the phrase ‘tone from the top’ appears in the preface,
other amendments in this area must have been in quite subtle wording changes
that I missed on my necessarily quick reading.
A significant change reflects the revised views of going
concern[2]. In Section C on Accountability, the
requirement in presenting annual and half-yearly reports is for directors to
consider going concern for a period of at least 12 months from the date the
accounts are signed. The sentiment
echoes previous Codes, but the level of direction has increased in line with
regulation. Likewise, the provisions in
Section C regarding risk assessment and internal controls have been extended
considerably, and appropriately. And
there are some interesting, more stylistic, adjustments to wording such as referring
to “principal” risks rather than “significant ones”.
Still in section C, at C.3.4 there is a change of something
I had never noticed before. Previously,
the audit committee had to advise on whether the annual report, as a whole,
fairly provided information for shareholders to assess the company’s
performance, business model and strategy.
That last phrase now reads, “the company’s position and performance,
business model and strategy”. Quite
right too, let’s hear it for the balance sheet.
Let’s now move on to the main act…
Directors’
remuneration
The Code’s wording on executive directors’ remuneration
(Section D and Schedule A) has changed dramatically. Gone is the requirement
(introduced in the 1995 report of the Greenbury Study Group) for it to be, “sufficient to
attract, retain and motivate directors of the quality required to run the
company successfully”, whilst avoiding the dangers of “paying more than is
necessary for this purpose”. From a purely
selfish point of view, that’s a shame.
Not because that wording was so good, but because I had a whole lecture segment
asking people to try to explain how the holy trinity of ‘attract, retain and
motivate’ could possibly be achieved, and now that lecture will have to
go. Worse still, everything I’ve ever
written on ‘the Goldilocks number’, which is sufficient but not excessive, will
now have to be rethought![3]
Another big change
in the provisions regarding remuneration is the removal of the phrase “A substantial
proportion of executive directors’ remuneration should be structured so as to
link rewards to corporate and individual performance”.[4] This is a good thing. Although the original intention was sound –
trying to ensure that executives did not receive undue reward for poor
performance – the resultant layers of performance-based pay have had the
unfortunate consequence of increasing overall remuneration significantly. Furthermore, the phrase sits uneasily in a
post-crash environment, given the role that high bonuses for bankers appear to
have played in encouraging risk-taking. As
regulations now limit the level of bonuses in the banking firms, it was inappropriate
that the 2012 Code still encouraged them, and good that the wording has been
retired.
So that’s what’s gone. What do we
have in its place?
The main principle has become:
Executive directors’ remuneration should be designed to promote the long-term
success of the company. Performance-related elements should be
transparent, stretching and rigorously applied.
It is worthwhile also setting out the supporting principles:
The remuneration committee should judge where to
position their company relative to other companies. But they should use such
comparisons with caution, in view of the risk of an upward ratchet of
remuneration levels with no corresponding improvement in corporate and individual
performance, and should avoid paying more than is necessary.
They should also be sensitive to pay and employment
conditions elsewhere in the group, especially when determining annual salary
increases.
I rather like
that. Sure, I can foresee a lot of
complications ahead, but in a principles-based governance system, it says what
it means, which is useful.
And in Schedule A,
which fills out more detail about the remuneration, I am joyful that the sub-section
on balance gives the outline of a 2x2 matrix, the bedrock of any business
school. It requires the remuneration
committee to determine an appropriate balance between fixed and variable
remuneration (the horizontal axis of my matrix) and immediate and deferred remuneration
(my vertical). I’m looking forward to
populating these with examples…
Schedule A carries
over some provisions from the 2012 Code, and revises some others. In summary, it all seems sensible:
·
Executive share options should (generally) not be
offered at a discount
·
Traditional share option schemes should be weighed
against other types of long-term incentive scheme (ltis)
·
Any proposed new ltis should
o
be approved by shareholders
o
should preferably be a replacement for a previous
scheme (a sort of one-in-one-out process)
o
should not lead to potentially excessive rewards
·
For share-based pay, the committee should consider
making the executives hold a minimum number of shares, and hold the vested shares
for a subsequent period
·
Only basic salary should be pensionable.
Having set out
what the new Code says, my initial impression is that I quite like it, but that
it will be difficult to manage.
In considering the
remuneration provisions, I am struck by the phrase, “should be designed to promote the long-term success of the company”. There is currently an active debate going on
about what corporate ‘success’ means, and whether it refers to the company’s
business or relates to or includes (or indeed only includes) success for shareholders. Leaving that aside, the phrase “long-term” is
slippery in remuneration, as the corporate business cycle might extend beyond the
tenure of any individual executive. Such
circumstances lead to the need (or maybe just the desire) to reward executives
for interim performance… which in turn requires defining appropriate long-term
measures and targets, and short-term measures and targets that sit within them.
I can’t see the Code leading to executive pay becoming much less complex
any time soon. But, given that this blog is a snap reaction to a document that
has been a long time in development, I reserve the right to give a more
considered opinion over the next few weeks or months.
[2]
Reflecting the Sharman Panel of Inquiry into Going concern.
[3] See
Bender, R., The Platonic Remuneration
Committee (March 10, 2011). Available at SSRN: http://ssrn.com/abstract=1782642
[4]
This phrase in its original form was introduced in the Combined Code 1998. The word ‘substantial’ was added to the
phrase in the 2003 Code.
