The government is getting tough on fat cats, they announced with fanfare over the weekend, introducing new regulations to force large companies to publish the ratio between the pay of the CEO and the average employee.
Leaving aside whether or not this will have much effect on remuneration, either at the top or bottom, what was perhaps strangest about the Business Department’s press release and the subsequent media coverage was that it made barely any mention of much more significant reforms that are also coming this week.
Corporate governance may not be beating Love Island on Google’s current search rankings, but don’t reforming company boards was part of Theresa May’s pitch for leader of the Conservative Party. And one of the hottest topics among governance geeks at the moment is the way in which boards consider the impact of their decisions on a wide range of people connected to the business.
And that is where the real news was this weekend. From now on, the Government will require companies above a certain size to report on their compliance with section 172 of the 2006 Companies Act.
Put simply, this is the legal duty placed on directors to promote the success of the company for the benefit of its members – that is, the shareholders. So far so unsurprising. Where it gets a bit unwieldy is the next part, which specifies that in doing so, a director must also have regard to a number of other groups, including employees, customers and suppliers.
Why does this new reporting requirement matter? Traditionally, most boards have worked on the assumption that the responsibility to shareholders trumps the interests of any other group.
If the interests of these disparate groups are all in line, then the duties under section 172 need not be too difficult to uphold, but when the priorities and needs of these groups are out of sync, things become trickier.
Think of Carillion, the UK’s second largest construction firm which collapses earlier this year, which continued to pay dividends while the pension deficit widened and payment terms on supplies were lengthened.
The change means that companies matching two of three size criteria (turnover of more than £36m, a balance sheet of more than £18m or 250 or more employees), will have to show how they are pulling off this balancing act. In part, the Government has been influenced by watching cases like Carillion, and before it BHS. In the former case, shareholders began pulling out months before the final collapse, in the latter, the holding company offloaded a subsidiary, only to see it go under a short while later. In both cases, employees and suppliers we left to carry the can.
We will have to wait to see the impact of this new disclosure, which will largely be dictated by the appetite of individual boards and directors to engage with the issue. What is clear, however, is that it is only part of a broader drive by the Government to increase transparency about how boardroom decisions are made.
The same motivation exists in the new governance code for large unlisted companies, something which the IoD has advocated for some time. Private limited companies comprise over 96 per cent of UK companies, powering the economy, providing jobs and driving wealth creation. Most are very small, with a handful of employees at most, and clearly don’t need any major governance apparatus.
But there are some private companies with large employee numbers and significant supply chains that currently operate without having to reveal their governance arrangements to anywhere near the degree seen at companies who list on the stock market.
No longer, says the Government and, come January 1, the very largest private companies in the UK (some 1,750 or so) will be required to say whether they follow any governance code, and what happens if their directors depart from it. To fall under the scope of this change, companies will need to have either over 2,000 employees or a turnover of more than £200m and a balance sheet of more than £2bn.
In order to prepare for this new light to be shone into the boardrooms of the nation’s largest private firms, the IoD has been helping the Financial Reporting Council to create a set of relevant corporate governance principles. The intention of these principles is to give companies the option of reporting against a more bespoke option for private firms than found in the UK Corporate Governance Code which is geared to publicly listed companies.
Naturally, it is likely there will be reservations from some in business, who may see the changes described above as an imposition on private enterprise. For the majority of businesses, however, both of these measures should merely formalise existing arrangements and be an opportunity to publicly display their existence.
For those companies where this is not the case, this is a good opportunity for the board to investigate whether a stronger focus on governance could improve their performance. Ultimately, this all comes down to individual directors. Directorship has long been seen as the domain of the gifted amateur, but while we will always need mavericks and risk-takers driving innovation, we also need professional directors who are fully aware of their responsibilities.
More than any headline-grabbing pay ratio, a genuine effort to drive up standards of transparency and governance is the way to secure growth for the long-term.