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The UK Corporate Governance Code establishes fresh principles on gender diversity, debate in the boardroom, and pay – but the real emphasis is on risk
the background
Since the first code in 1992, there have been six revisions of the document. The latest sees the Combined Code renamed the UK Corporate Governance Code, and a series of additional principles introduced concerning the accountability and performance of corporate boards. The document remains a guide, however, in which the UK’s governance and reporting regulator, the Financial Reporting Council (FRC), sets non-binding ‘principles’ rather than requirements. The new edition of the Code applies to financial years beginning on or after 29 June 2010.
why now?
The FRC places its latest update firmly in the context of the financial crisis, which is cited as the main reason for the original review of the code. While the focus is therefore on risk and long-term sustainability, however, a more general aim of the code is to enhance the influence of shareholders in monitoring the code by giving them a greater say in how businesses are run and promoting better interaction between the boards of listed companies and their shareholders.
risk management
In response to the perceived corporate irresponsibility of banks and other financial institutions leading up to the financial crisis, the new code has recommended that company boards are held responsible ‘for determining the nature and extent of the significant risks [the company] is willing to take’. It also says a clear explanation of the long-term business model should be included in annual reports, adding that shareholders should pay particular attention to these areas.
remuneration
Pay is one of the central sections of the code, and while the 2008 version had stressed the need to link pay to ‘individual performance’, the emphasis is now, in line with the Code’s concern with risk, more specifically on long-term success. The code now includes a recommendation that executive pay be aligned with the ‘long-term interests of the company and its risk policy and systems’.
accountability
Another new principle is for the annual re-election of FTSE350 directors by shareholders. All directors should be subject to election by shareholders at the first AGM after their appointment and to subsequent re-election at intervals of no more than three years, according to the code.
Requirements are also laid out on the processes to be followed to ensure that shareholders are able to make informed decisions. There has been criticism of the requirement, especially given the cost that is likely to be incurred by its implementation. It is thought the change could result in 3000 directors submitting themselves to a shareholder vote next spring. However, the code says companies should ‘ensure planned and progressive refreshing of the board’.
diversity
The code now requires firms to evaluate directors against ‘external’ indicators every three years, and in consultation with outside experts. It says: ‘The search for board candidates should be conducted, and appointments made, on merit, against objective criteria and with due regard for the benefits of diversity on the board, including gender.’ It adds that a focus should be on achieving a ‘balance’ of experience in the boardroom, not just taking account of the merit of individuals.
Despite the fact that 25 per cent of the UK’s largest companies have no female board representation, some have criticized the move, arguing that it is likely to cause conflict in the boardroom and elsewhere.
Roger Barker, head of corporate governance at the Institute of Directors, said: ‘Our women want to achieve a position on the board through their own merit and own abilities. When this artificial mechanism is used it undermines their own legitimacy. People will now question why they have come to be on a board.’
performance
New to the Code is a section on ‘effectiveness’. Within this are recommendations that FTSE350 chairmen ‘have externally facilitated board effectiveness reviews at least every three years’, and that they conduct regular ‘development reviews’ with directors. There is also a ‘supporting principle’ that the chairmen ‘promote a culture of openness and debate by facilitating the effective contribution of non-executive directors in particular’.
the background
Since the first code in 1992, there have been six revisions of the document. The latest sees the Combined Code renamed the UK Corporate Governance Code, and a series of additional principles introduced concerning the accountability and performance of corporate boards. The document remains a guide, however, in which the UK’s governance and reporting regulator, the Financial Reporting Council (FRC), sets non-binding ‘principles’ rather than requirements. The new edition of the Code applies to financial years beginning on or after 29 June 2010.
why now?
The FRC places its latest update firmly in the context of the financial crisis, which is cited as the main reason for the original review of the code. While the focus is therefore on risk and long-term sustainability, however, a more general aim of the code is to enhance the influence of shareholders in monitoring the code by giving them a greater say in how businesses are run and promoting better interaction between the boards of listed companies and their shareholders.
risk management
In response to the perceived corporate irresponsibility of banks and other financial institutions leading up to the financial crisis, the new code has recommended that company boards are held responsible ‘for determining the nature and extent of the significant risks [the company] is willing to take’. It also says a clear explanation of the long-term business model should be included in annual reports, adding that shareholders should pay particular attention to these areas.
remuneration
Pay is one of the central sections of the code, and while the 2008 version had stressed the need to link pay to ‘individual performance’, the emphasis is now, in line with the Code’s concern with risk, more specifically on long-term success. The code now includes a recommendation that executive pay be aligned with the ‘long-term interests of the company and its risk policy and systems’.
accountability
Another new principle is for the annual re-election of FTSE350 directors by shareholders. All directors should be subject to election by shareholders at the first AGM after their appointment and to subsequent re-election at intervals of no more than three years, according to the code.
Requirements are also laid out on the processes to be followed to ensure that shareholders are able to make informed decisions. There has been criticism of the requirement, especially given the cost that is likely to be incurred by its implementation. It is thought the change could result in 3000 directors submitting themselves to a shareholder vote next spring. However, the code says companies should ‘ensure planned and progressive refreshing of the board’.
diversity
The code now requires firms to evaluate directors against ‘external’ indicators every three years, and in consultation with outside experts. It says: ‘The search for board candidates should be conducted, and appointments made, on merit, against objective criteria and with due regard for the benefits of diversity on the board, including gender.’ It adds that a focus should be on achieving a ‘balance’ of experience in the boardroom, not just taking account of the merit of individuals.
Despite the fact that 25 per cent of the UK’s largest companies have no female board representation, some have criticized the move, arguing that it is likely to cause conflict in the boardroom and elsewhere.
Roger Barker, head of corporate governance at the Institute of Directors, said: ‘Our women want to achieve a position on the board through their own merit and own abilities. When this artificial mechanism is used it undermines their own legitimacy. People will now question why they have come to be on a board.’
performance
New to the Code is a section on ‘effectiveness’. Within this are recommendations that FTSE350 chairmen ‘have externally facilitated board effectiveness reviews at least every three years’, and that they conduct regular ‘development reviews’ with directors. There is also a ‘supporting principle’ that the chairmen ‘promote a culture of openness and debate by facilitating the effective contribution of non-executive directors in particular’.
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