Government consultation on strengthening the voice of employees and other stakeholders in large companies and improving corporate governance in large unquoted companies

Under proposals put forward by the Government in a Green Paper published at the end of last month, a particular non-executive director could be tasked with representing the interests of one or more groups of stakeholders in board level discussions. In addition, or alternatively, boards may have to consult stakeholder advisory panels on matters such as executive remuneration policy and the annual remuneration report. And large unquoted companies may be encouraged, or possibly even required, to commit publicly to complying with a specially adapted version of the UK Corporate Governance Code.

Although the Green Paper does not mention the names of any particular corporate failures, its proposals are clearly in part a response to concerns about how the owners and managers of BHS and some other large unquoted companies have apparently been able to put the interests of employees, pension scheme members, suppliers and other stakeholders well behind those of shareholders.

Ideas for improving law and practice are floated in three areas:

• Executive pay in quoted companies. These are discussed in a separate Law-Now article.
• Strengthening the voice of employees, customers and other stakeholders in large companies both quoted and unquoted.
• Corporate governance in large unquoted companies.

If the Government decides to take any of the ideas forward, it will need to publish further details for public consultation.

Strengthening the voice of employees, customers and other stakeholders

Designated non-executive director to represent interests of stakeholders

Boards of unquoted companies often include executive directors who are responsible for human resources or customer or supplier relations, and boards of quoted companies occasionally do so. In order to strengthen the voice of these and other stakeholders the Government suggests that one or more of a company’s existing non-executive directors could be designated:

"to provide an independent and clear voice for key interested groups as a formal part of the board structure […]. Each designated NED could chair a board-level committee with the status to ensure that executive decision-making takes appropriate account of employee, supplier or consumer issues. In addition to the NED, the committee might comprise other relevant board members, such as the HR director or an executive director responsible for customer relations. This would mirror the formal boardroom committee structure that already exists in other areas of the business, such as the audit and risk committee which is responsible for assisting the board in its oversight of issues such as financial and business reporting processes, and compliance with legal and regulatory requirements.”

The designated NED might also be a member of the remuneration committee, to help ensure that wider workforce considerations are brought to bear on decisions about executive pay.

A designated NED would need to develop ways of ensuring that they have a good understanding of their stakeholder constituency - whether it be employees, customers, the supply chain or others. One way of doing this would be for the company to create one or more stakeholder advisory panels: see below.

The Government also suggests that each designated NED could set out their objectives each year and report on how they have tackled specific issues identified and generally represented the interests of their stakeholders.

Stakeholder advisory panels

Either separately, or in conjunction with designated NEDs, the Government suggests that companies could create stakeholder advisory panels for directors to hear directly from their key stakeholders:

"These could operate in a number of ways. Company directors (executive or non-executive) could seek the views of the stakeholder advisory panel on particular issues as they arise to be considered later at full board meetings. Advisory panel members could be invited to full board meetings to offer views whenever relevant agenda items are scheduled. A stakeholder advisory panel could also have a role in initiating discussions on topics that they feel are important, perhaps requesting specific executive or non-executive company directors to attend their meetings to answer questions."

"A stakeholder advisory panel could, for example, be consulted on the company’s executive remuneration policy and the annual remuneration report. The non-executive chairman of the company’s remuneration committee could be asked to consult the stakeholder advisory panel during the development of the three year pay policy and the annual remuneration report. Or a stakeholder panel made up of companies in a supply chain could help advise the board, at regular intervals, on relationships with suppliers."

Although most unquoted companies do not have non-executive directors, or a remuneration committee or audit and risk committee, the Government’s proposals relating to designated non-executive directors and stakeholder advisory panels do seem to be intended to apply to all large companies, whether quoted or unquoted.

Appointing stakeholder representatives to company boards

The Government also suggests that companies could choose to appoint a new director to represent the interests of a particular stakeholder group – such as the company’s employees – but, contrary to previous indications, it does not intend to require companies to do so.

Comment

The critical issue here is what it means for a director to “represent” the interests of a particular group of stakeholders. As the Green Paper notes, every director, whether executive or non-executive, has a duty under section 172 of the Companies Act 2006 to:

"act in the way he 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 —
(a) the likely consequences of any decision in the long term,
(b) the interests of the company's employees,
(c) the need to foster the company's business relationships with suppliers, customers and others,
(d) the impact of the company's operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of business conduct, and
(f) the need to act fairly as between members of the company."

All directors are therefore required by law to have regard to, broadly, the interests of the company’s various stakeholders. (Sometimes the interests of one group of stakeholders will conflict with those of another group.) From a legal perspective, there is therefore no problem with any director acting as the “voice” of a group of stakeholders in board-level discussions provided that, overall, that director acts in the way he considers, in good faith, would be most likely to promote the success of the company. All directors also have legal duties to exercise independent judgement and to avoid conflicts of interest.

If the UK Corporate Governance Code for quoted companies were to be amended, and/or a corporate governance code for unquoted companies were to be developed (see below), to designate a particular director to represent the views, or act as the “voice”, of a particular group of stakeholders, in order to be consistent with section 172 the code would need to make clear that, overall, the director is still expected to act in the way he considers, in good faith, would be most likely to promote the success of the company. Both the designated director and the rest of the board would also need to satisfy themselves, on an ongoing basis, that the designated director retains sufficient independence of mind to discharge their other duties as a director.

By contrast, there should be fewer difficulties from a legal perspective with establishing stakeholder panels to “advise” the board on the actual or expected impact of particular proposals on a body of stakeholders. In practice, some companies already operate such arrangements voluntarily, either on a formal or informal basis. However, making such arrangements mandatory would inevitably result in additional cost and process for many companies, and could have a negative impact on the competitiveness of UK companies generally and their ability to attract investment and executives.

Corporate governance in large unquoted companies

With the exception of a few large UK portfolio companies owned by private equity firms, which have to comply with the Walker Guidelines, UK companies that do not have shares admitted to a stock market are not currently required to comply with any particular corporate governance code. This is the case irrespective of their size in terms of turnover, number of employees, number of investors or their economic significance.

Various reasons account for this. In particular, the relationship between the investors/owners and the directors/managers is often much closer than with quoted companies, so it is less important that the directors follow an industry standard model of corporate governance; and practically speaking it is very difficult to draw up a single code that is suitable for all unquoted companies - which differ enormously in terms of their size, complexity, stage of development and the relationships between their owners and managers.

By contrast, UK companies with shares admitted to the premium segment of the Main Market are required by the Listing Rules to “comply or explain” against the UK Corporate Governance Code (UKCGC) published by the Financial Reporting Council (FRC). AIM companies are required to comply or explain against a corporate governance code of their choosing, and in practice many report against the Corporate Governance Code for Small and Mid-Size Quoted Companies published by the Quoted Companies Alliance, which is based on the UKCGC. The UKCGC and the “comply or explain” model are much admired and imitated around the world.

The Government proposes that large unquoted companies should have to comply with some form of corporate governance code. However, it recognises that the UKCGC is designed primarily for premium segment companies, so if unquoted companies were to report against it they would probably end up “explaining” why they did not comply with lots of its provisions. This could devalue the whole exercise.

Alternatively, the Government could invite the FRC or a business organisation such as the Institute of Directors to develop a separate governance code, which could be based on the various existing codes but tailored specifically to large unquoted companies. In fact, as the Green Paper notes, the IoD has previously published Corporate Governance Guidance and Principles for Unlisted Companies in the UK, which sets out a number of voluntary principles, some of which are applicable to all unlisted companies and others to only larger or more complex unlisted companies, so this could be used as the basis.

In terms of ensuring compliance, the Green Paper seems to favour a voluntary approach under which large unquoted companies would be “encouraged” to comply or explain against an industry standard code (or perhaps a code tailored for companies of a particular size or nature):

"Such an approach could have considerable force. Encouraging better business behaviour through a voluntary approach has led to significant success over the past decade. For example, the Davies Review succeeded in doubling the representation of women on the boards of the FTSE 100 through exhortation and by encouraging companies to disclose the steps they were taking to increase female representation.”

Comment

It seems likely that the Government will indeed invite the FRC and/or IoD to develop a corporate governance code, or perhaps several codes, that are tailored specifically to large unquoted companies. The relevant body is likely to create a working party to develop a draft that can be put out for consultation, perhaps next year. We would expect the draft to be based on the IoD’s Corporate Governance Guidance and Principles for Unlisted Companies in the UK but to incorporate those recent refinements to the UKCGC that can sensibly be applied to unquoted companies.

A key part of the “comply or explain” model, though, is that shareholders must be prepared to challenge the company’s board over any non-compliance that is not satisfactorily explained. Such challenges can take various forms. At one end of the spectrum, a shareholder can have a “quiet word” with the chairman or the senior non-executive director; at the other end of the spectrum a shareholder with a large enough holding has the “nuclear” option of putting forward resolutions to remove some or all of the board. Both of these paths are available to shareholders in private companies, as well as quoted companies. In between these two ends of the spectrum is the option of voting against company-sponsored AGM resolutions – for example, resolutions to approve the re-election of all, or at least a third, of the directors and, for Main Market companies, the remuneration report - which can also attract negative publicity for the company. However, because private companies usually do not hold an AGM unless they are forced to do so by a sufficient proportion of shareholders, it will be harder for minority shareholders in private companies to use this means to express their dissatisfaction with the company’s corporate governance.

Whether unquoted companies will voluntarily agree to report against the new code or codes will therefore depend on a number of factors, including the wishes of their key shareholders and lenders, the costs of compliance and the extent to which a particular company considers it important to have a reputation for high standards of corporate governance.