This is the third reporting season that companies will be disclosing the Section 172 statement, but there remains room to improve. Section 172 disclosures were introduced in response to the high-profile corporate failures that drove the UK government to push for better disclosure on how directors take into account their stakeholders in their decision making.
“It was a time when governance became politicised,” says Mala Shah-Coulon, EY UK Associate Partner and Head of the Corporate Governance team at EY.
Around the time of the 2016 General Election, there was significant political interest in the quality of corporate governance within larger UK companies – this was in the wake of a number of high-profile corporate scandals, and in some cases failures. This led to a Government Green Paper in late 2016, and a parallel and influential report by the Department for Business, Enterprise and Industrial Strategy Select Committee in early 2017.
Company directors were already subject to s172, but they weren’t explaining how they had considered the stakeholder voice and other important factors such as the company’s regard for the environment in making decisions for the long term. By mandating disclosures, it was hoped that boards would be encouraged to make appropriate long-term decisions, which holistically considered the stakeholder voice and this, in turn, would help restore public trust.
“Section 172, in and of itself, is a directors’ duty that has been around for more than 12 years,” says Shah-Coulon. “It's the requirement to disclose against it that was new.”
Mandating those disclosures was important to create more transparency, Shah-Coulon explains. That in turn creates accountability. “That transparency creates a hook by which your stakeholders can ask questions and engage with you.”
In the context of COVID-19, this has seemed more essential than ever. It became very apparent that a business’s success and resilience relies heavily on its relationships with stakeholders, suppliers and employees.
“With the current supply chain crisis, if a company doesn't listen to its suppliers that company will be more impacted than a company that understands the risks within the supply chain because it has listened to suppliers and tried to manage and mitigate those risks as much as they can.”
The Section 172 statement was introduced as part of a suite of regulations – Miscellaneous Reporting Regulations, which looked at directors’ engagement with employees, and management’s engagement with suppliers and other stakeholders with whom the company has a relationship and secondly, but most importantly, the effect this has on decision making.
From an engagement point of view, it’s not a one-way street, says Shah-Coulon.
“It’s not: ‘we tell our suppliers about our modern slavery policy’ or ‘we tell our employees about our flexible working policy’. It's also the other way around. What are your employees telling you about their needs and wants? What are your suppliers telling you about? What are the issues and risks they're facing?”
Businesses then need to demonstrate how that factors into the decisions they’ve made – this is critical, says Shah-Coulon. “It's not every decision, but principal decisions. How were they made, and how were the voices of stakeholders considered?”
Investors also want to see a link to the strategic narrative. Companies must consider how their material stakeholders impact the company's business model and strategy, and the risks and opportunities they give rise to. This is especially important for organisations that have strategic partnerships with other entities.
There are a lot of links between the section 172 statement and wider non-financial or narrative reporting. For example, if your business model relies on outsourcing manufacturing processes to a third-party organisation in another country, that organisation and potentially even policy-makers within that country, become key stakeholders which management and/or directors need to engage with.
The statement should be relevant to the reporting period in question and not generalities about engagement processes. The narrative needs to be thoroughly integrated into the report, not bolted on. “Some companies prefer to put it in the governance statement over directors telling their story of what they did to govern the company. Either way, it needs to be integrated.”
This needs to fit holistically with other non-financial disclosures in the annual report. It goes beyond stakeholder engagement to touch on ethics and environmental impacts (both the company’s impact and the impact of climate change on it), among other things.
It's also linked to your narrative on risk management, says Shah-Coulon. “If you know you are solely reliant on that outsourced service provider, that itself could present a principal risk that you need to report on and understand.”
The narrative should also be linked to company culture. Most listed companies have to outline their culture, and how the board monitors it, within their annual reports.
“It goes back to what kind of culture are you trying to create for the long term success of your organisation,” says Shah-Coulon. “Therefore, what are the issues you need to address within your engagement with stakeholders?”
Companies are required to report on their principal decision making, but there is no definition of what classifies as a principal decision. As a rule of thumb, Shah-Coulon says, “if it affects the strategy, business model or the long-term viability of the organisation, it’s a principal decision.”
“If the chair of the board or the CEO says: this year, we made a substantial investment in this joint venture because it complements our business model and helps advance our strategy, you expect to see a link back to that in the Section 172 statement.”
It’s critical that organisations don’t leave it until year-end to consider the Section 172 statement, says Shah-Coulon. It should be considered throughout the year and underlying processes, for example, engagement activities with stakeholders, planned appropriately. so that it’s a matter of tying together various pieces of information when it’s time to write the annual report. “After all reporting is an outcome – companies can only report what they have done in the year.”
“You might also need to think about how board meeting papers are presented to enable the board to actively consider section 172 as it's making decisions. Then at the end of the year, the person writing that section of the annual report just has to extract elements from the board meeting minutes to demonstrate how stakeholder voice and the environment were considered throughout the year in the decisions the board makes.”
One of the biggest mistakes companies make when completing the Section 172 statement is not reporting outcomes, says Shah-Coulon. It’s not enough to say you’re engaging with employees; you need to articulate what you heard and how you acted upon that information.
“If there is no outcome to engagement, you may just be engaging for the sake of it and/or not addressing material issues.”
“Section 172 is also not just stakeholder engagement. Generally, it’s about the thought the directors have given to the impact of their decisions on the company’s long-term success including its reputation or brand. This is where you circle back to the objectives of introducing this requirement – rebuilding trust.”
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