UK corporate governance reform continues in 2024 – it needs to facilitate competitiveness and growth and maintain (possibly, restore) faith in ‘comply or explain’

March 26, 2024

2024 will be another significant year for UK corporate governance reform. Last year’s consultation on the UK corporate Governance Code raised a number of issues. In the end, government intervention (or failure to act) resulted in the FRC’s watered-down revision, which, at least, took account of concerns voiced by issuers.

This year is likely to be dominated by a review of the Stewardship Code and, in the run-up to the forthcoming AGM season companies and their remuneration committees will be looking to the implications of the IA’s letter of 23 February updating its Principles of Remuneration. The IA will be updating its Principles in 2024.

Regulators have focused on simplicity, audit and internal controls and avoiding duplication. All reman important aims. The current buzz-word is competitiveness. The competitiveness of the UK capital markets and of London as the market of choice on which to list shares, and the ability (or inability) of UK companies to compete for executive talent, particularly with the US, in terms of executive pay. The London Stock Exchange Group (LSEG) has identified executive pay as being key to improving the UK’s competitiveness. The LSEG and other leading UK companies have recently proposed enhanced CEO packages. Executive pay is, of course, a headline-grabber but it is not the whole story.

Proposals to increase executive pay can be controversial and elicit strong feelings. They put pressure on the fundamental underpinning principle of UK corporate governance; ‘comply or explain’.

The FRC has continually emphasised that the Code is not a rigid set of rules and that code companies should always feel they have the freedom to deviate from Code provisions, provided they give clear and cogent reasons why that is necessary in the best interests of the business and its stakeholders. However, the Capital Markets Industry Taskforce (CMIT) has commented, and some of our clients would agree, that the regulators’ focus on reporting instead of value creation has caused companies to believe ‘comply or explain’ is, in reality, ‘comply or else’.

Investors need to play their part by being clear about their position on governance, in terms of investment strategy and expectations and in relation to detailed and important aspects of governance, including remuneration.

The imminent review of the Stewardship Code is important to maintaining confidence in UK corporate governance in general and the principle of ‘comply or explain’ in particular. The UK Corporate Governance Code sets comply or explain in the context of issuers and their governance obligations. The Stewardship Code, aimed at asset owners and managers, is the other, important, side of the coin.

In our experience, a frequent complaint from boards relates to their frustration about differences of opinion between compliance and investment managers. What might we expect from this important review? In our view focusing on the following should facilitate clearer messaging and understanding between issuers and asset owners/managers, help competitiveness and maintain the flexibility (and even-handedness) of ‘comply or explain’:

  1. A frequent complaint from boards relates to their frustration about differences of opinion between compliance and investment managers. Governance and fund management functions should be fully integrated across to all asset classes. We agree with the CMIT on this.
  2. The reports Stewardship Code signatories are required to submit should fully explain how integration has been achieved and is working.
  3. Final voting decisions should lie with asset owners/managers, not their proxy agents, and should be explained in the context of their investment strategy.
  4. There should be a consistent approach to both UK and overseas companies and, throughout the investment chain, to incentives.

Finally, regarding the IA’s review of its Principles of Remuneration, a vote by the holders of 50% plus one share is sufficient to pass an ordinary resolution. Naming and shaming companies that fail to receive more than 80% votes in favour of remuneration committee proposals and requiring companies to explain action taken to ‘remedy’ the situation, serve only to reinforce the perception of ‘comply or else’. Secondly, a dilution limit of 10% in 10 years for share schemes adopted by listed companies may inhibit fast-growing innovative companies. We would join with other commentators to urge the IA to consider relaxing both requirements to help improve competitiveness and growth.

Dilution that does not materially alter the balance of control becomes a problem only if the value of a diluted shareholding is lower than its undiluted value. That places the focus firmly on incentive plan design to ensure there is a direct and visible link between vesting and performance.

MM&K is an independent, full-service adviser on executive remuneration, performance and governance. For more information about points raised in this article or about MM&K’s services, please contact Paul Norris.

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