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FRC corporate governance research tackles priority areas

Author: ICAEW Insights

Published: 25 Aug 2021

The Financial Reporting Council’s revisions to its Corporate Governance Code are starting to make a difference, according to academic research.

Although the current version of the Corporate Governance Code isn’t brand new, it is still in its infancy. The FRC has commissioned and published academic research in the priority areas of remuneration, workforce engagement, and board diversity & effectiveness. These three areas attracted particular attention when the code was being revised. The research shows that the FRC is making progress on its original policy objectives.

Code provisions on remuneration

Remuneration reporting is improving year-on-year, but naturally there is always room for improvement and the FTSE 100 are doing better than the FTSE 250. A sectoral analysis shows that real estate is doing particularly badly. 

Incentive schemes are increasingly being aligned with company purpose, values and strategy. However, companies tend to prefer to report this type of good news. For example, it isn’t always clear how companies avoid rewarding executives’ poor performance. There’s also a lack of information about how companies engage with their workforce about how executive remuneration aligns with general pay policies. On the other hand, the research shows a rise in the use of non-financial KPIs, and CEOs’ KPIs tend to focus on environmental, social and governance issues. 

The research lists the very high thresholds which companies typically use for malus and clawback, for example, deliberately misleading the market and/or shareholders and material failures of risk management. The BEIS White Paper on restoring trust in audit and corporate governance reflects the Government’s continuing frustration with this area. 

There are deficiencies in how some companies report negative shareholder votes, and the research refers to examples of companies being overly positive or justifying themselves. However, the portion of the analysis which pertains to remuneration policies may be misleading. Many companies drafted their remuneration policies prior to the COVID-19 lockdown, so it’s almost inevitable that these policies would be rejected by shareholders because they didn’t reflect the enormous change in circumstances. Nevertheless, it is interesting that negative voting on remuneration policies is usually accompanied by other negative votes on other issues, for example, re-election of directors or increased shareholdings by directors. 

Workforce engagement

A key finding from this research is that companies need to decide what they want out of the engagement, ie, a sounding board for decisions either already taken by the board or still being considered by them, or a channel for workers to raise their concerns, or both?

The code allows four options for workforce engagement; a designated NED; worker director; advisory panel; or alternative arrangements. Companies who have taken the ‘alternative’ route have tended to rely on their existing arrangements, for example, site visits and town halls.

The most popular option is designated NED. Most companies have designated an existing NED, but they may conduct full recruitment exercises when these NEDs retire. Some NEDs perform the same role at more than one company, and some companies have designated more than one NED to cover different geographic regions. A designated NED is often combined with an advisory panel. This is helpful because it gives the NED a specific role, ie, the NED acts as a conduit between the panel and board. 

However, the research highlighted a problem around the term ‘advisory panel’. Some companies are confused as to whether their existing groups are in a scope, ie, people forums or colleague contribution panels.

Panel members are usually chosen by management, ie, by the Head of Engagement or Chief People Officer, although election by fellow workers isn’t unheard of. Some companies take a two- stage approach whereby workers compile a long list and management makes the final choice of panel members from that list. The agendas for panel meetings are often set in consultation with management in order to ensure that matters of concern to both sides are discussed. Panels may start to produce their own annual reports. 

Worker directors are rare despite their advantages, ie, their ability to disrupt group think and monoculture. The research refers to evidence that employee participation during restructuring can operate as a ‘beneficial constraint’ on senior managers. One of the barriers to worker directors may be ambiguity as to whether their role is to channel the views of the whole workforce or just their own personal views 

Staff surveys are very common. Surveys typically cover matters such as flexible working, mental health and well-being, and sustainability. If the company has a designated NED then they may take responsibility for commissioning the survey and considering the feedback

However, when worker engagement is performed, it's essential that there is a feedback loop to reduce the say-do ratio, ie, the gap between what a company says about its values and what it does about them.

Board diversity and effectiveness 

Fortunately we’ve moved on from asking why we need diverse boards. The focus has moved on to how we make it happen, so hopefully the familiar swing between the overly subjective morality argument and the overly objective business argument is firmly behind us.

Achieving true diversity and inclusion is a multi-stranded journey where progress in one area is not a guarantee of progress in another. Successfully navigating this journey requires a committed Chair as they play a key role when it comes to inclusion. The researchers remind us that the Higgs Report referred to boards as teams.

The research shows that gender diversity prompts a reduction in shareholder dissent. An analysis of ethnic diversity shows the same trend but to a lesser extent

The research also shows a correlation between board diversity and board effectiveness, but this fell short of a causal link. Having said this, the research is clear that more female directors leads to more collaboration and consensus, and to a reduction in boards’ overconfidence in their problem solving skills. Being diverse allows directors and companies to learn things which they never knew they needed to know. 

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