Corporate governance remains firmly in the spotlight with several consultations about to close or, having recently closed, the Government’s response expected shortly. The year 2012 may therefore see significant changes in, among others, the way quoted companies prepare their directors’ report and business review, how executive remuneration is structured and disclosed and how shareholders participate in setting executive pay, and possibly a shift in the focus of boards’ decision making.

 The future of narrative reporting

The responses which the Department for Business Innovation & Skills (BIS) received in relation to its 2010 consultations on ‘The future of narrative reporting’ and ‘A long-term focus for corporate Britain’ indicated that changes to the existing narrative reporting framework and the framework for executive remuneration were desirable and needed. Therefore, in September 2011, BIS launched a further consultation on the future of narrative reporting.[1] The purpose of the consultation is to improve the quality of companies’ narrative reporting and reduce the administrative burden for companies.

BIS’ main proposals are, among others:

– replacing the directors’ report and the business review with:
* a strategic report providing an overview of the company’s key strategic information (its strategy, business model, performance, corporate governance and remuneration) including key risks and forward looking analysis, and
* an annual directors’ statement providing more detailed disclosures in a more closely prescribed format including the directors’ remuneration report, corporate governance statement and audit committee report;

Although the proposed changes will affect all companies, they focus on quoted companies. BIS states that the changes affecting non-quoted companies should be minimal and, at least in relation to small companies, just a matter of renaming their directors’ report to annual directors’ statement while the statutory disclosure requirements remain the same and they would not be required to produce a strategic report.  In contrast, the disclosure requirements applying to medium to large unquoted companies will change slightly, and they will have to rename their business review to strategic report and move some of the content of the directors’ report to the annual directors’ statement.

 – making the annual directors’ statement available online with hard copies only on request;

– disclosing the total remuneration of each director in a single cumulative figure – although it seems unclear what would need to be included in the total remuneration figure and how certain elements of the directors’ remuneration (in particular pensions) should be valued; and

– disclosing the pay of the highest earning executive officers below board level and other remuneration related factors such as how remuneration relates to the company’s performance and strategic objectives.

The consultation closed in November 2011 and the Government is planning to publish draft regulatory and non-regulatory solutions with the aim for them to become effective from 1 October 2012. In light of the fact that the requirement for quoted companies to prepare an enhanced business review has only been in place in relation to financial years beginning on or after 1 October 2007, with the first reports including the new requirement coming out in 2009, this fairly tight timeframe raises the question whether there has been enough time to fully assess the impact of this recent legal change to the narrative reporting requirements.

Executive remuneration

At the same time, and sitting alongside the proposals in relation to executive remuneration in the consultation on the future of narrative reporting, BIS launched a separate consultation on executive remuneration in quoted companies.

While the aim of the narrative reporting consultation in relation to remuneration is to increase disclosure and transparency, the focus of the executive remuneration consultation is on the role of shareholders and the remuneration committee in the process of setting pay and its aim is to promote a clearer and stronger link between executive remuneration and company performance.

The Government is proposing a package of measures to address the issue of ‘payments for failure’ in four areas:

– Greater transparency. BIS is expected to publish secondary legislation later this year to require remuneration reports to be split into two sections: one setting out the proposed future policy for executive remuneration, the other how explaining how pay policy has been implemented in the preceding year including providing a single figure for the total remuneration paid for each director.

– More shareholder power. BIS will shortly launch another consultation to reform the current shareholder voting arrangements and give shareholders a binding vote on remuneration, either (i) on future pay policy or (ii) on any director’s notice period which is longer than one year and on exit payments over one year’s salary. The consultation will also contain proposals to raise the threshold for passing the shareholder vote on the future pay policy to 75% of the votes cast.

The UK Corporate Governance Code (the Code) will be amended to require all large public companies to adopt claw-back mechanisms which allow companies to withhold or demand payback of all or part of a director’s pay awards when the company’s performance has not lived up to expectations. The Code currently only requires companies to give consideration to proposals to adopt such claw-back policies.

– More diverse boards and remuneration committees. The Code will be amended to prohibit serving executive directors from being a member of the remuneration committee of other large companies.

– Best practice led by the business and investor community.

However, BIS is not going to require companies to include employee representatives on remuneration committees or offer employees an endorsement vote on the remuneration report.

The Kay Review

The ‘Kay Review of UK Equity Markets and Long-Term Decision Making’ (the Kay Review)[2] was launched in September 2011 and seeks to establish and understand the incentives, motivations and timescales of all participants in the equity markets. It raises ten broad questions in relation to the “mechanisms of corporate control and accountability provided by UK equity markets and their impact on the long term competitive performance of UK businesses” including, among others:

– whether the timescales considered by the relevant decision makers (boards, senior management, institutional shareholders, asset managers) in evaluating risks and opportunities match the time horizons of the underlying beneficiaries;

– how a company’s underlying competitive strength is assessed and considered when making an investment decision;

– whether equity markets and relevant Government policies sufficiently encourage boards to focus on the long term effects of their decisions;

– whether relevant Government policies encourage institutional investors and asset managers to adopt and apply a long term time horizon; and

– the long term impact of the internationalisation of share ownership on UK equity markets and business.

The call for evidence focuses on establishing the factual background to these questions. An interim report with preliminary findings and possible recommendations is expected for February 2012 with the aim to publish the final report in July 2012.

Marlies Braun