by Neil Campbell
By 1991, confidence in the integrity of the UK’s corporate financial reporting and accountability practices reached a new low. In response, the United Kingdom’s (“UK”) Financial Reporting Council (“FRC”) empanelled a committee with the remit of reviewing the aspects of UK corporate governance underlying the crisis. The completed report, “The Financial Aspects Of Corporate Governance,” became more popularly known as the Cadbury Report, after the committee’s chairman Sir Adrian Cadbury. Welcomed by a public wearied by high-profile corporate scandals, the report and its recommendations caused consternation in financial institutions.
The Cadbury Report’s recommendations have served the UK well for many years and, in concert with the findings and recommendations of subsequent reviews, have underpinned the foundation of the UK’s Corporate Governance Code (“CGC”). The Cadbury Report also influenced corporate governance frameworks around the world, including those in Europe and the United States.
The core recommendation of the Cadbury Report was that compliance with a voluntary governance code, coupled with robust corporate disclosures, should be preferred over rigid enforcement of a statute. Indeed, such voluntariness is the hallmark of the CGC. For companies listed on the London Stock Exchange, however, additionally-provided regulatory powers enabled the CGC to assign them a “comply or explain” status. “Comply or explain” is a regulatory approach where, instead of a one-size-fits-all disclosure, the adequacy of a company’s disclosures are to be evaluated by the market. If a company does not comply with one of the CGC principles and fails to adequately explain its rationale for doing so, the theory is that investors will react by selling their interest; the result is intended to have the effect of a market sanction. The CGC undergoes periodic review and revision, with the 2016 revision being the current edition.
In November 2016, the UK Government released a Green Paper soliciting opinions and recommendations on strengthening UK corporate governance. In February 2017 – during the CGC’s 25th anniversary year – the FRC announced plans for a fundamental review of UK corporate governance (to take place later in 2017) in light of this Government Green Paper and the supplementary findings of the Department for Business, Energy & Industrial Strategy (“BEIS”) select committee.
At the end of the consultation period, there were 375 respondents to the Green Paper. The respondents comprised individuals, business representative bodies, institutional and retail investors, public and private companies, lawyers, accountants, think tanks, academics, professional associations and trade unions. The UK Government contends that this broad range of respondents provides strong evidence on which to base its proposals.
In August 2017, the UK Government responded to the Green Paper consultation. Prime Minister Theresa May commented that the announced “range of legislative and business-led measures [would] improve corporate governance” and help build an economy “which truly works for everyone, not just a privileged few.” These measure are arranged into three main categories:
Highlighting the flexible nature of the UK corporate governance framework, the proposed changes are to be implemented through a combination of “changes to the UK Corporate Governance Code (which is the responsibility of the FRC), voluntary industry action, secondary legislation and action by relevant regulators to improve co-ordination and the use of existing powers.”
While frequently a target of media attention in the UK and US, previous regulations addressing executive pay have been largely ineffectual. The UK Government’s new proposals address the issue in three ways. First, the Government will invite the FRC to revise the voluntary CGC to be more specific about the steps that companies should take when they encounter significant opposition from shareholders towards executive pay and compensation policies. Next, legislation will be introduced to Parliament to require listed companies to report annually on the ratio of CEO pay to average worker pay. In addition to publishing these ratios, companies must also provide an explanation of year-to-year changes in the ratio, and of the effects of complex share-based remuneration packages on the ratio. Finally, the third measure is to invite the Investment Association to implement one of its proposals from the consultation process. This entails the creation of a public database of listed companies within which large-scale shareholder opposition to pay awards exists, and what the company’s proposals are for addressing the shareholder oppositions.
The Companies Act of 2006 already requires directors to consider wider stakeholders of a company when making boardroom decisions. Many of those responding to the consultation stated that this requirement was not strong enough and that employees, customers, and supplier recognition could be improved. A similar three-pronged approach to that applied to executive pay has been proposed, with a legislative, CGC-based, and industry-led measure. Larger companies will be legally required to report on compliance with the existing law, while the FRC will be invited to revise the CGC so that an “employee engagement mechanism” is assigned “comply or explain” status. The industry-led approach will aim to ask industry bodies to produce guidance on practical ways to increase engagement with employees and other stakeholders, and on their interpretation of director duties towards employees and stakeholders.
Large Private Businesses
Consultation respondents broadly supported the idea that large, privately-held businesses should be encouraged to employ high standards of corporate governance. Although their legal status precludes much of the regulation that public companies operate under, their size and number can have a significant impact on a wide range of stakeholders. In addition to the Stakeholder Voice measures described above, the Government proposes that industry groups collectively develop a set of corporate governance principles to be applied to large privately-held companies. The Government will also introduce legislation requiring such companies (and potentially large Limited Liability Partnerships) to disclose their corporate governance arrangements (e.g. their compliance with the CGC)in their annual reports and on their website, including whether or not they follow any formal code.
The UK has been long regarded as a world leader in corporate governance developments. The effectiveness and real-world application of the proposals remain to be seen. However, the inclusive nature of the consultation process and the UK’s track record in spearheading global corporate governance reforms suggest that those hoping for a more inclusive business environment should be optimistic.
The UK Government aims to have draft legislation introduced into Parliament by March 2018 and to have the recommended reforms in place and required for all company reporting by June 2018. With the UK Government struggling with negotiations over withdrawal from the European Union, this timeframe may well be ambitious, particularly as its successful implementation and, consequently, the UK’s attractiveness to companies, will be critical to its post-Brexit success.
 The Financial Reporting Council is the UK’s independent oversight agency tasked with promoting standards in corporate governance.
 1995’s Greenbury Report, 1998’s Hampell Report, 1999’s Turnbull Report, and 2003’s Higgs Report
 A Green Paper is a preliminary report of UK Government proposals that is published in order to provoke discussion.
 The Investment Association is a trade body that represents UK investment managers.