Chapter 4. Board composition, board committees and board member qualifications

This chapter presents the results of the review in the area of board composition, board committees and board member qualifications. It takes stock of the criteria and mechanisms that may motivate and allow flexibility and proportionality in the implementation of rules and regulations relating to the area across the 39 jurisdictions that responded the survey used for the reviews. It also includes a case study of the British corporate governance framework in the area submitted by Widad Chhibi and Ilaria Miller from the UK Department for Business, Energy and Industrial Strategy (BEIS).



Board regulations: background and context

The OECD Corporate Governance Factbook tracks board regulations and practices across the 47 jurisdictions included in its latest edition, noting the different national models of board structures found around the world. Although one-tier boards remain the most common structure (in 19 jurisdictions), a growing number of jurisdictions (12) offer the choice of either single or two-tier boards, consistent with EU regulation for European public limited-liability companies (Council Regulation (EC), 2013). Ten jurisdictions have exclusively two-tier boards that separate supervisory and management functions into different bodies.1

Thirty jurisdictions require or recommend a minimum board size of 3 or 5.2 Seven jurisdictions set forth a maximum board size ranging from 5 to 21, while the others leave it to the company's discretion. For management boards in two-tier systems, only the People’s Republic of China (China) and France establish a maximum size requirement, while 10 jurisdictions set a minimum size requirement.

The maximum term of office for board members before re-election varies from one to six years (most commonly 3 years). There are no compulsory limits on the number of re-elections of board members in any jurisdiction. Annual re-election for all board members is required or recommended in 7 jurisdictions but it is more prevalent among companies in many jurisdictions that do not require or recommend annual re-elections.3

The recommendation for boards to be composed of at least 50% independent directors is the most common voluntary standard, while two to three independent board members are more commonly subjected to legal requirements. Some jurisdictions link the board independence requirement with the ownership structure of a company.4 National approaches on the definition of independence for independent directors vary considerably, particularly with regard to maximum tenure and independence from a significant shareholder.

China and 12 European countries have requirements for employee representation on boards, fixing a minimum share of employee representation which varies from one member to half the board members, with one third being the most common. Jurisdictions that require employee board members usually have 2-tier boards or allow for one and two-tier board structures.

Nearly all jurisdictions require an independent audit committee, while the remaining jurisdictions recommend it in corporate governance codes. A full or majority (comprising the chairperson) independence requirement is common.5 Nomination and remuneration committees are not mandatory in most jurisdictions, although many recommend these committees to be established and to be comprised wholly or largely of independent directors.6 A majority of jurisdictions require audit committees to have an independent chairperson. Independent chairs are rarely required in nomination and remuneration committees.

In almost all jurisdictions, shareholders can nominate board members or propose candidates. Some jurisdictions set a minimum shareholding requirement for a shareholder to nominate, usually at the same level as the shareholders’ right to place items on the agenda of general meetings. A wide variety of voting practices can be observed, with most jurisdictions having established majority voting requirements for board elections, usually for individual candidates (i.e. not for list) and around half allowing cumulative voting. Seven jurisdictions have special voting arrangements to facilitate effective participation by minority shareholders.7

A majority of jurisdictions set out general requirements or recommendations for board member qualifications. Some jurisdictions give more emphasis to the balance of skills, experience and knowledge on the board, rather than on the qualifications of individual board members.8 About half of jurisdictions require or recommend that some of the candidates go through a formal screening process, such as approval by the nomination committee. Requirements for disclosure of information to shareholders on candidate qualifications is lacking in many jurisdictions, with significant variations regarding more specific requirements.

Issues and trends

The well-functioning of boards and their capacity to steer companies towards long term profitability has been considered an evolving challenge that not only has to manage the changing landscape at company level, but also national and global trends. New issues, technological developments and societal attitudes constantly introduce new risks and opportunities that boards need to understand and manage when serving the interest of the company and its shareholders.

The ownership landscape for companies has also significantly changed, so boards more often have to interact with controlling or block holding shareholders than dispersed owners. Institutional investors, in turn, have also concentrated and amassed large stakes in many firms that make them relevant counterparts, even if they hold those assets on behalf of thousands of retail investors or future pensioners (Çelik and Isaksson, 2013).

As the case study of the UK shows, these developments have put boards under strong scrutiny. In some jurisdictions there is a perception that they have neglected their broader legal and fiduciary responsibilities, particularly vis-à-vis stakeholders, and have somehow lost control of the link between executive pay and the performance of the company that they are to ensure.

Boards have been encouraged to engage more in dialogue with employees, customers, suppliers, and wider stakeholders to improve their decision-making and build confidence. This is part of an ongoing trend towards an increased professionalisation of the board duties linked to an ever increasing level of responsibility and accountability. Some argue that boards need to perform these functions to ensure the company is in compliance with the expectations, while others claim that it may also be distracting them from performing the long term stewardship functions discussed above.

And if this debate is taking place in the context of listed companies, subject to the scrutiny of the market and regulators, the concerns about the behaviour of large, privately-owned companies, is in some cases even larger. In the absence of transparency about their practices, which may be as consequential for stakeholders as those of a listed firm, some have proposed that large privately-held companies should also adhere to minimum corporate governance requirements.

The view of the G20/OECD Principles

The G20/OECD Principles devote an entire chapter to the responsibilities of the board, which are defined as ensuring the strategic guidance of the company and the effective monitoring of management, while remaining accountable to the company and the shareholders. The annotations refer to the diversity of board structures illustrated in the preceding paragraphs, but clarify that they are intended to apply to whatever board structure is charged with the functions of governing the enterprise and monitoring management.

The G20/OECD Principles state that the board should be able to exercise objective independent judgement on corporate affairs. This independence and objectivity usually requires that a sufficient number of board members will need to be independent of management, and that objectivity and independence in single tier boards may be strengthened by establishing a separation of roles between the chief executive and the chairperson. The designation of a lead director is an alternative good practice, which is often complemented by the appointment of a company secretary. But the objectivity of the board may also require independence from a dominant shareholder. In this case, the G20/OECD Principles recommend that they must remain faithful to their fiduciary responsibility to the company and to all shareholders, including minority shareholders.

Setting up specialised committees to support the board in performing its functions, particularly in respect to audit, and, depending upon the company’s size and risk profile, also in respect to risk management and remuneration is another relevant consideration. When committees of the board are established, the G20/OECD Principles state that their mandate, composition and working procedures should be well defined and disclosed by the board.

Employee representation on the board is another area covered by the G20/OECD Principles recommendations. Without taking a position as whether it should be mandated by law or collective agreements or not, they recommend that where present, employee representation should be supported by information and training mechanisms. Those mechanisms will facilitate that workers' representatives at the board can have a real opportunity to contribute to the enhancement of board performance, by improving independence, competence and information. Employee representatives should have the same duties and responsibilities as all other board members, and should act in the best interest of the company.

Flexibility and proportionality with respect to board composition

The ability of the corporate governance framework to facilitate the formation of boards that are fit for the individual firm they serve, but that can also handle these changing landscapes, is necessarily an exercise of flexibility and proportionality. That is one of the reasons why many jurisdictions have adopted flexibility and proportionality mechanisms in their governance frameworks to determine important rules like the size or the board, the number or independent directors in it, and the committees they should sit on. The most common of these is the use of codes of corporate governance. When set up under a comply or explain system, they provide enough room for companies to find the parameters that best solve the needs they have, while demanding a reasonable explanation if they depart from what is regarded best practice.

Even in jurisdictions with a long tradition of well-functioning boards, with good guidance as to what best practices are and high levels of compliance with Code's recommendations, such as the UK case study shows, boards are under scrutiny. There is a perception that the expectations of shareholders, regulators and society are intermittently not met by prominent corporate governance failures and that may erode trust in businesses.

Pressure mounts in such cases towards the introduction of new requirements for the board to comply with, setting additional levels of accountability, or expanding the reach of some rules, either by escalating their coverage or making them mandatory. These interventions may or may not have the capacity to achieve the results desired – as corporate governance may not be the best tool for fixing some of the problems (ICSA: The Governance Institute, 2017) – but a flexible and proportional approach may be key to ensure that reforms can be successful with the least possible unintended consequences over the corporate governance framework as a whole.

Survey results

All of the 39 jurisdictions included in the survey reported at least one criteria or optional mechanism that allow for flexibility and proportionality in the area of board composition, board committees and board member qualifications (Figure 4.1.).

Figure 4.1. Frequency of use of criteria and optional mechanisms per area of regulation

Source: OECD Survey.

Figure 4.2. Overall use of criteria across all areas of regulation

Source: OECD Survey.

As described in the main chapter of this thematic review, among all the criteria that jurisdictions employ to promote flexibility and proportionality in their corporate governance frameworks, the criterion of listing/publicly trading and the criterion of size are by far the most used when considering all areas of practice (Figure 4.2.). This is also the case in the area of board composition, board committees and board member qualifications. Figure 4.3. shows the frequency and distribution among different types of criteria that jurisdictions have reported, on a jurisdiction by jurisdiction basis.

Figure 4.3. Use of criteria for board composition across jurisdictions

Source: OECD Survey.

The use of listing/publicly traded as criterion for flexibility and proportionality

Listing/publicly traded is used as criterion for flexibility and proportionality in the regulatory area of board composition, board committees and board member qualifications, by all but 11 jurisdictions and is present in the corporate governance framework in several dimensions, with the listing level being the most commonly used tool. (Figure 4.4.).

Most jurisdictions report that they use listing/publicly traded as a flexibility and proportionality criterion in the sense that non-listed companies are not subject to the same rules for board composition as listed ones. This is the case in Austria, Belgium; Chile; Denmark; France; Hungary; Lithuania; Singapore; Sweden; Switzerland; the UK, and the US, among others.

Figure 4.4. Use of the listing/publicly traded criterion for board composition

Source: OECD Survey.

Some jurisdictions differentiate between listing levels, often with more stringent requirements for the percentage of board members that are expected to be non-executives or independents; the need to establish certain committees (and comply with rules about their composition), and reporting on board practices. That is the case in Brazil; France; Germany; Italy; Malaysia; Russia, and Saudi Arabia. In Italy, firms listed on the STAR segment have additional requirements issued by the exchange that enhance independence and control.9 In Malaysia, the firms included in the LEAP segment, foreseen for SMEs, do not have requirements on independent directors and the formation of committees by the board. In Russia, the listing level demand diverse percentages of independent members for the board and the formation of only an audit committee or also the formation of remuneration and nominations committees. In Saudi Arabia, firms included in the NOMU listing segment are only encouraged to adopt voluntarily the mandatory requirements for board composition set for the Main market.

Whether the firm is traded in a regulated market or not, and the trading of its securities in alternative trading platforms (ATPs) is also a relevant consideration used to introduce flexibility and proportionality in a number of jurisdictions. That is the case in Italy, Slovenia and Sweden. In Italy and Slovenia, listing in regulated markets triggers rules on board composition that are not applicable for trading in ATP, while in Slovenia, this also triggers regulations on the composition of the audit committee that are not applicable to other firms (except if they have employee board participation). In the United States, in turn, non-listed firms that trade their securities in the over-the-counter market are not subject to the standards established by the Exchange Act for audit and compensation committees.

Other dimensions of the listing criterion used include a consideration for debt only listings, as in Mexico and Singapore where no requirements on board composition apply to firm that only list debt instruments, in the United States, where debt-only and preferred listings are exempt from some, but not all, corporate governance listing standards, and in Argentina, where no requirements on the audit committee apply to these firms. Cross listings are also considered, and Israel waives the fitness requirements applicable to independent directors for Israeli companies with no controlling shareholders listed in NYSE or NASDAQ (only the fitness requirements according to those exchanges rules apply), for example.

The use of size as criterion for flexibility and proportionality

Size is the most used criterion for introducing flexibility and proportionality regarding board composition, board committees and board member qualifications. Twenty-nine jurisdictions report using it in different dimensions. Size of workforce and size of market capitalization are the more frequently used dimensions (Figure 4.5.).

Figure 4.5. Use of the size criterion for board composition

Source: OECD Survey.

The size criterion is often used to introduce flexibility and proportionality for SMEs, using the dimensions of size of balance sheet, size of revenues, size of market capitalization and size of workforce as the most common definition of a small or medium size company. Some countries use a multiple test and require two or more positive answers to consider the firm an SME, as in Belgium, where the test involves a 2-out-of-3 analysis that waives audit committee requirements depending on size of workforce, size of turnover, and size of balance sheet.

The size of workforce is commonly associated with requirements for employee representation in the board, as in the case of the Czech Republic; Denmark; Germany; the Netherlands, and Sweden. In some jurisdictions this dimension is also associated with gender diversity requirements, particularly with quotas, but other dimensions are also used for this, including size of capital, size of balance sheet, size of revenues and size of market capitalization.

The size of market capitalization is frequently associated with the requirements for the independence of the board and for the formation and composition of the audit committee, as it is the case in Argentina; Australia; Chile; Israel; Lithuania; the Netherlands; Turkey, and the UK, among others. This dimension is often used in conjunction with whether the firm is or not part of an index (something often determined considering market capitalization, but not only). That is the case in Australia, Israel and Malaysia. In the United States, considering the dimension of size or the market capitalization (and also the size of the revenues), some small companies are granted certain accommodations with respect to standards for compensation committees and, on some exchanges, with respect to audit committee composition requirements.

The regulations that determine a minimum (and sometimes also a maximum) size for the board are in many jurisdictions related to the size of the equity, the size of the assets or the size of the balance sheet. That is the case in Germany, for example, where the maximum number of board members is 9 for companies with up to €1.5 million of equity; of 15 for companies with more than € 1.5 million but less than €10 million, and of 21 for companies with more than €10 million of equity (section 95 sentence 4 AktG).

In Japan, the size of equity is used in conjunction with the size of debt to impose requirements for committees to be composed with a majority of outside directors.

The use of ownership/control structure as criterion for flexibility and proportionality

The ownership/control structure criterion is used less often for board composition, board committees and board member qualifications than the previous criteria. Twelve jurisdictions report using it and most commonly in the dimension that looks for the presence of a controlling shareholder (Figure 4.6).

Controlled companies are in some cases allowed more flexibility to comply with board composition requirements, particularly with a ratio of independent directors either for the board or also for the audit committee. That is for example the case in France, where the presence of a controlling shareholder waives the recommendation in the code of corporate governance for half of the board to be composed on independent directors, but also in Germany, Hungary, and Mexico.

Figure 4.6. Use of the ownership/control structure criterion for board composition

Source: OECD Survey.

In the United States, controlled companies (defined as those where more than 50% of the voting power is held by an individual, group, or another company) are exempt from the requirement to have a majority of independent directors on their boards; from standards for nominations and compensation committees; and, in some cases, from certain exchange standards for audit committees.10

In Italy, on the other hand, controlled listed companies have more stringent requirements for board composition including boards with a majority of independent directors and committees composed with only independent directors.11

The use of legal form as criterion for flexibility and proportionality

The legal form of firms is also a relevant consideration to introduce flexibility and proportionality in the corporate governance framework of several jurisdictions in relation to board composition, board committees and board member qualifications. In Ireland, the legal form determines the minimum size of the board; Israel adopts special rules for partnerships; and in Mexico SAPIBs12 have lower requirements for independence of board members and of audit committees, and no limitations for the maximum number of board members, which is set at 25 for SABs.

In the United States, exclusions are granted from some or all corporate governance requirements to: asset-backed issuers; unit investment trusts; foreign governments; any issuer organized as a trust or other unincorporated association that has no board of directors and limits its activities to passively owning or holding securities, rights, collateral, or other assets on behalf of its securities holders.

The use of maturity of the firm as criterion for flexibility and proportionality

Four jurisdictions use the criterion of maturity of the firm to introduce flexibility and proportionality in this area of regulation:

  • In Brazil, Novo Mercado listing rules establish the separation of roles of CEO and Chair, but this is allowed for the first three years of listing for new firms.

  • In Israel, certain exceptions for board composition requirements are available for five years after IPO (for firms remaining under a given market cap).

  • In Italy some governance requirements enter into force three years after the IPO.

  • In the United States, certain issuers are allowed phase-in or transition periods to come into complete compliance with various corporate governance listing standards. These include issuers listing in conjunction with an initial public offering or a carve-out or spin-off transaction; issuers emerging from bankruptcy; and issuers listing on an exchange after having traded over-the-counter.

The use of opt-in and opt-out mechanisms

Opt-in and opt-out mechanisms are used for the regulation of board composition, board committees and board member qualifications by 18 jurisdictions (Figure 4.7.). A large variety of optional mechanisms are in place, particularly in terms of the number of committees.

Figure 4.7. Use of opt-in and/or opt-out mechanisms for board composition

Source: OECD Survey.

The use of sectoral criteria for flexibility and proportionality

An analysis of the results per sector of activity reveals that flexibility and proportionality criteria for board composition, board committees and board member qualifications are used by most jurisdictions (31), with a varying degree of scope (Figure 4.8.). Most jurisdictions that present flexible sectoral regulations report having special regimes for the financial sector and for their State-owned companies.

Figure 4.8. Use of flexibility and proportionality in different sectors for board composition

Source: OECD Survey.

Case study: United Kingdom

This section sets out the UK’s approach to the creation and governance of companies, the role and appointment of directors, their duties and responsibilities and the composition of the board as a whole, including board diversity.13 It concludes with a look ahead to future developments including changes to the UK Corporate Governance Code, industry-led action and planned legislation.

Overview of Company Law

The UK approach to corporate governance is based on a mixture of legal statute, codes of practice and precedent set by the courts. The statutory framework is deliberately open (for example, there is no definition in law of a non-executive director). This has the great advantage of flexibility: best practice can evolve through case law and industry-led action without the need to wait for legislative change. Any necessary enforcement action can be taken by regulatory bodies in a proportionate way without the expense of court proceedings. An arguable shortcoming is that there is no single source setting out the duties of directors and of the board as a whole.

Company Law in the UK is codified in the Companies Act 2006 (CA 2006). This iteration of the Act was the culmination of a nine-year project which amounted to the biggest review of UK company law for over 40 years. The project comprised a three-year in-depth investigation by a Government-appointed expert group—the Company Law Review Steering Group (CLR)—alongside detailed research on specific issues by the Law Commissions of England and Wales and Scotland, and extensive public consultations on a wide range of technical matters by the Government itself. The new Act which emerged from this exercise consolidates the great bulk of the pre-existing companies’ legislation and makes it more relevant to the business conditions of the 21st century.

One area of discussion was whether any new legislation should be more specific about what the responsibilities of company directors should be. The outcome was that not only have the legal responsibilities of directors been for the first time ‘codified’ – in other words set out in statute, rather than left to be addressed by common law principles – but they have been in some respects expanded with the aim of ensuring that, in running their companies, directors take into account a range of wider factors, economic, social and environmental, that are considered part of responsible corporate behaviour in the 21st century. The Act also recognised the trend of the courts in recent years of expecting higher standards of skill and care from company directors. The changes made in these two areas now form the basis for how directors are expected to operate and account for their actions to their companies and the outside world.

Why reform took place

The Company Law Review’s 1999 Strategic Framework paper promoted the approach of ‘think small Company first’, in an attempt to reform the law in a manner which had regard to problems faced by small companies, who make up the majority of business models in the UK. The paper noted that ‘Company law...makes little attempt to respond to the peculiar needs of small firms, either in accessibility and simplicity of operation or in substantive provision. The start-up and development of such businesses is a particularly important process for which the law should provide an optimal climate’.14

One of the main objectives was to simplify the procedures for small companies and remove high costs associated with compliance with prior regulation, which was considered archaic and burdensome. This approach ensures that anybody is able to start and run a company and benefit from limited liability, and where a company is small enough, be exempted from some more complex requirements (such as company secretaries, audit regimes or annual meetings).

It was felt that the UK should update its Company law principles and align them with changes in business practice, especially in relation to director duties. These duties (along with other company law principles) had been developed by case law pre-dating the 19th century, and the Government was concerned that both the members of the company (shareholders) and directors themselves needed to better understand the duties of directors. In this area, both the Company Law Review and the Law Commission were in agreement that the law needed to include codified duties which were clear, accessible, certain and comprehensible.15 The 2006 Act created an integrated system of legislative regulation that combines industry self-regulation with external regulatory monitoring and control.

Company registration

When a company is registered with the registrar, Companies House,16 the process is referred to as ‘incorporation’. This term is referenced in the governing legislation17 and derives from the Latin verb ‘corporare’, meaning to ‘furnish with a body’.18 In legal terms, the process of registration brings into existence a distinct entity with its own legal personality, the ability to enforce and exercise legal rights, own property and be subject to enforceable legal liabilities. Ultimately, the company is recognised as an entirely separate body from its shareholders and the directors who control it, with the ability to sit as a corporate director on a board in its own capacity.19

The CA 2006 facilitates a number of forms of registered companies, including limited liability (by shares or a guarantee), unlimited liability, public20 and private companies.21 The legislation is exceedingly flexible in the sense that it provides companies with the freedom to organise their boards in the manner they deem appropriate to their business model, rather than provide a substantive list of ‘rules’ regarding the qualification and composition of director boards.

The law differentiates between private and public companies by requiring private companies to appoint a minimum of one director, and public companies a minimum of two directors.22 Further, the legislation stipulates that both private and public companies must have at least one director who is a natural person23 to ensure that an individual can be held accountable for the actions of that company, as well as requiring the director to be of the minimum age of 16 years old.24 The first directors of the company are named in the application for registration of the company, with any subsequent changes in directors requiring notification to the registrar. The last qualification requirement necessitates the director appointed to have no previous disqualifications under the Company Directors Disqualification Act 1986.

The concept of executive and non-executive directors does not derive from statute. It is introduced by supplementary codes of practice, a range of which exist to cover different circumstances. The UK Corporate Governance Code is the main source of guidance for public companies on how they should appoint, compose, conduct and separate the functions of the board and their committees. The Code is overseen by the Financial Reporting Council (FRC).25

Appointment and removal of a company director

The procedure for the appointment of new directors is usually set out in the company’s articles of association.

A ‘de jure’ director is an individual who is validly appointed to the board. This entails an application for registration of the company with information provided on the proposed directors (and company secretary if the company is a public company). The individuals must give their consent to act as directors.26 Once the certificate of incorporation is issued by the registrar, those persons named as directors are deemed to have officially been appointed to office, by virtue of section 16 (6) CA 2006.  Thereafter, subsequent appointment procedures will be determined by the company’s articles of association, usually requiring ordinary resolution (more than 50% of vote) or a decision made by the board to elect a new director.

Under the UK Corporate Governance Code all directors of FTSE 350 companies should be subject to annual election. Non-executive directors should be subject to annual re-election if they have served on the board for longer than 9 years.

The company’s shareholders can remove a director by the act of an ordinary resolution at a general meeting,27 notwithstanding any agreements between the individual and the company (since removal may leave the company liable for damages).28 Further, it is common for the articles of association to permit directors to remove an individual director before the expiration of his period in office. The delivery of notice to the individual is a necessity in both instances.

Both appointment and removal of directors must be notified to the registrar by the company within 14 days.29 Such information will then be available for public inspection.

Definition of a director

The term ‘director’ is not defined in the Act. The nearest that the Act comes to a definition of the term is found in section 250 CA 2006, which says that the term ‘director’ includes any person occupying the position of director by whatever name called. This is a long-standing feature of UK company law and has remained intact following the law reform process. It means that, in determining whether any person is or has been a director of a company, account must be taken not only of whether a person has been duly appointed and registered as a director in accordance with the prescribed procedures (legally recognised as a ‘de jure’ director), but also of whether that person is or has been exercising the functions of a director, such as making the sort of decisions that directors routinely make.

The CA 2006 includes provisions to identify individuals who are not formally appointed as directors but play an influential part in the managing of the company. The decision to avoid formal appointment can be taken for numerous reasons, including the desire to escape liabilities of a director, or the desire to act as a director despite prior disqualification. Section 251 (1) defines an individual as a ‘shadow director’ if they are a person in accordance with whose directions or instructions the (majority) directors of a company are accustomed to act. The Act excludes from this definition a person functioning to provide directors with advice in a professional capacity or a parent company holding subsidiaries. The courts have developed legal tests to determine when an individual is acting as a shadow director. If a person is found to be a shadow director, they will owe fiduciary, common and statutory duties to the company.

A third category of ‘de facto’ director is not referred to in legislation and has been developed in common law. A de facto director is someone who has not been formally appointed and notified to Companies House as a director, but nevertheless considers, acts and represents themselves as a director of the company to third parties. Typical actions would be signing documents on behalf of the company, being present in board meetings and exercising powers usually reserved for the board. It is possible for one individual to be acting as both de facto and shadow director.

In summary, the broad definition of the term ‘director’ ensures that persons who are commonly referred to in such terms will be directors for company law purposes and will be treated as directors by the law. Further, the deliberately wide definition also allows the law on directors’ duties to be applied to persons who, for one reason or another, do not formally register themselves as directors.

Directors, shareholders and directors’ fees

The nature of directorship is central to company law, with directors having fiduciary duties to the company.30 Directors may have various other capacities. In private companies, the directors are usually also the shareholders owning most if not all the shares in the company. They may be paid through dividends, fees or a mixture of the two. In such instances there is less need for mechanisms to ensure accountability of directors to shareholders, since they are one and the same. In public companies, the directors will normally own some shares but their main sources of remuneration will typically derive from their fees and other reward packages. Agreeing the remuneration of executive directors is a significant responsibility, which for quoted companies is typically entrusted to a remuneration committee composed of non-executive board members.

The remuneration paid to directors has recently become controversial, partly because of the value of the packages earned and partly because of a perceived lack of connection between the directors’ pay packet and the performance of the company. In response, shareholders in quoted companies now have the opportunity to vote on proposed remuneration. Planned legislation will require large quoted companies to publish the ratio between directors’ remuneration and average UK employee earnings in the company. Several companies already publish this information on a voluntary basis.

The evolution of board powers

Until the end of the 19th century, it was generally assumed that the general meeting of shareholders was the supreme organ of the company, with directors acting as agents of the company subject to the control of the shareholders in general meetings.31 However, in a Court of Appeal decision in Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame [1906] 2 Ch 34, judges established that the division of powers between the board and shareholders depends on the construction of the articles of association, and where the managerial powers were vested in the board, the general meeting could not usurp or interfere with their lawful exercise. The articles were held to constitute a contract by which the members had agreed that "the directors and the directors alone shall manage”.32 This approach was confirmed by the House of Lords in Quin & Axtens v Salmon [1909] AC 442 and has since received general acceptance.

Legislation has sought to codify these principles. Section 33 of CA 2006 provides that the articles of association formulate a statutory contract between the members (shareholders) of the company and the company itself. Unless the directors are acting contrary to the law or the provisions of the articles of association, the powers of everyday management of the company are vested in them.

In summary, for private companies the division of powers as between board and shareholders is a matter for private ordering by the members of the company rather than something specified in law. The directors’ authority is derived from shareholders through a process of delegation via the articles of association and not from a separate piece of legislation from the State. For public companies, this principle is modified through the UK Corporate Governance Code and secondary legislation, reflecting the legitimate public interest in the management of these companies.

Board structure

The United Kingdom has a unitary board model with a single tier of management, comprised of executive and non-executive directors (if the company has appointed them) serving collectively and equally liable under the eyes of the law. This differs from many countries in continental Europe where a two-tier structure is implemented, differentiating between directors with an operational role and supervisory directors responsible for the oversight of the managerial board.33

The duties of directors

The CA 2006 sets out in sections 170-77 the duties owed by directors to the company. The duty to exercise reasonable care, skill and diligence is one of these and illustrates the importance of a high standard of business conduct and consideration of the long-term consequences of decisions. This duty also provides an example of the proportionality present in the law as it provides the courts with flexibility to determine the threshold against which the directors should be performing.

The question for the court is to conclude whether directors have carried out their duty according to the ‘general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions in relation to the company’.34 The level of skill, care and diligence required for the running of a small private family-run business with two shareholders and one employee is clearly going to be fundamentally different from that of a public entity with 1000+ shareholders, 250+ employees and a significantly high turnover. The law accommodates for the different types and sizes of companies present in the UK and holds the directors accountable in a proportionate manner.

This section of CA 2006 provides further flexibility and proportionality by requiring the judiciary to consider, when deciding whether or not a breach of duty has occurred,35 both the knowledge and skills that would objectively be expected of anyone acting as a director and also the subjective knowledge held by the individual director in question. This objective requirement acts as a protective measure to ensure that directors are not able to rely on the defence that they are ill-informed or unexperienced.

“Enlightened shareholder value”: Section 172 of CA 2006

The central duty for directors is found in section 172 of the CA 2006, which states that a director must “act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to:

a) the likely consequences of any decision in the long term,

b) the interests of the company's employees,

c) the need to foster the company's business relationships with suppliers, customers and others,

d) the impact of the company's operations on the community and the environment,

e) the desirability of the company maintaining a reputation for high standards of business conduct, and

f) the need to act fairly as between members of the company”.

The Company Law Review Steering Group was presented with the task of evaluating the most suitable approach for duties owed by company directors.

The Company Law Review came to the conclusion that the enlightened shareholder value approach, combining a focus on long-term shareholder value, whilst capturing the inclusivity of the pluralist approach was best. Section 172 requires directors to pursue shareholder wealth with a long-term focus that seeks sustainable growth and profits based on responsible attention to the full range of relevant stakeholder interests, including those of creditors.

The UK Corporate Governance Code

The main guidance on principles relating to the board of directors and board committees can be found in the UK Corporate Governance Code 2016. The underlying principle of the Code is to ‘facilitate effective, entrepreneurial and prudent management that can deliver the long-term success of the company’36. It states that the fundamental principles of good corporate governance are accountability, transparency, probity and focus on sustainable success of the company in the long term. The Code applies to all public companies with a Premium listing of equity shares (rather than debt instruments) on the London Stock Exchange. The Code applies irrespective of company size or country of incorporation.37

The flexibility and proportionality of the Code

The UK Corporate Governance Code is widely recognised as an international benchmark for good governance practice. It is considered proportionate and flexible because of the comply or explain principle, meaning that companies should comply with the rules or explain why they do not. The explanation should also indicate whether the deviation from the Code's guidelines was limited and when the company intends to return to conforming with the provisions. The Code provides a coherent and focused method of company disclosure, with the aim of initiating sanction through investor behaviour.

Statements of compliance or non-compliance can be found in the Corporate Governance statement, which is contained in the Annual Report. As the Annual Report is a public document and available to shareholders and other stakeholders, this approach enables interested parties to challenge companies on their compliance with the Code. Companies and their major investors engage on a regular basis on key matters, such as remuneration policy and director appointments.

The role of the board

The Code requires the board of directors to take equal, collective responsibility for the long-term success of the company, taking account of a range of stakeholders as set out in Sections 172 of CA 2006. It provides high-level guidance which advocates the organisation of protective mechanisms to provide prudent and effective controls by the company in order to assess and manage risk, without hindering or discouraging entrepreneurship.

Information on how the board operates and who is responsible for which decisions should be published annually in the company report. Information on delegation of powers should be clear and accessible to the company investors, so the right people are held to account and shareholder activism is stimulated. Additionally, the annual report should include information on the chairman, deputy chairman (if one exists), chief executive, senior independent director, and committee composition (members and chairman). This is the ideal breakdown of the board composition for listed companies in the UK.

Division of responsibilities

One of the main provisions of the Code is that no individual should have unfettered powers of decision. The Code prohibits the same individual acting in the capacity of a chairman and chief executive (unless consent of major shareholders is obtained). It also requires the responsibilities of these respective roles to be clearly set out and made public. The Code also provides criteria against which the Chairman can be tested to ensure there are no conflicts of interests.

The Chairman has responsibility to facilitate constructive relationships between executive and non-executive directors. This is to be achieved by providing an open culture for debate and contributions, ensuring enough time is dedicated to all agenda items and special attention granted to strategic issues. The Chairman should also be the intermediary between the board and shareholders, providing them with accurate information on key board decisions.

Non-executive directors

The Code sets out the role of Non-Executive Director (NEDs). They provide scrutiny of the executive branch of the board of directors, constructively challenging and aiding with strategy of the company as a whole. They are not responsible for the day-to-day functioning of the company’s management, but nonetheless are a part of the unitary board and are equally liable with the executive directors. The Code prescribes that apart from smaller companies, at least half of the board should consist of independent NEDs. Small companies are expected to appoint a minimum of two NEDs.

The NEDs are advised to assign amongst themselves a senior independent director who can provide a sounding board for the chairman and a point of contact for shareholders when the normal channels (through the chairman or executive directors) are inappropriate or unavailable.

Board committees

The Code sets out the role of the board sub-committees and enables the board to delegate important tasks and ensure independence. This has two main advantages: important topics such as the relationship with the company’s auditors can receive adequate attention without the need to engage the whole board and second, the board committee can take an independent view on matters that may affect the executive directors (such as remuneration) without presenting a conflict of interests.

Companies will typically have remuneration, nomination and audit committees comprised mostly of NEDs and chaired by the executive chairman. The attendance of these committees should be restricted to members only, unless an invitation is provided to other board members.

Qualification of directors

The Code stipulates that responsibility for ensuring that directors possess the suitable level of skills, experience, knowledge and familiarity with the company is left to the board itself. However, the Chairman is entrusted to encourage the board to refresh their skills and knowledge and provide the resources for them to do so. The Chairman is also advised to provide tailored, formal inductions to new directors and review and agree development plans with existing members of the board. It is good practice for boards to conduct ‘board effectiveness reviews’ with an independent consultant, which allows the directors to voice any concerns about how business is conducted or the relationship between other board members.

Diversity of company boards

The boards of public companies have not generally been very representative of the composition of the company’s workforce or its customers. The Government and professional bodies are united in wishing to capitalise fully on the skills and talents of all those involved in business. There is also evidence that diverse boards are more independent and take better decisions. Diverse boards with a plurality of views and experience, would be in a better position to compete globally. For these reasons of fairness, competitiveness and resilience, the UK has sought to ensure that the boards of listed companies in particular should better reflect their workforces, customers and the wider society.

The Davies Review

In 2010, the Government appointed Lord Davies of Abersoch, to chair a review to examine the underrepresentation of women on boards. In 2011 Lord Davies published a ‘Women on Boards’ report which aimed to push the issue of gender equality forward and promote the cause amongst UK listed companies. 38 

While encouraging companies to go beyond compliance, successive Governments have chosen not to introduce overly prescriptive regulations in this area. Following the Davies review, a gender disclosure requirement was introduced in the narrative reporting regulations that came into force in 2013. These regulations require all quoted companies to disclose, in their annual report, the number employees of each gender, on their board, in senior management positions and in the company as a whole. The rationale was to allow the board and shareholders to have a clear picture of how gender diversity was represented across the workforce. The increased level of transparency would also allow wider public accountability, encouraging companies to take diversity on boards more seriously.

In addition to the legislative measure, the UK has adopted a voluntary, business-led approach to improve the number of women on the board of the top 350 listed companies. Lord Davies published his final report in October 2015; it showed that FTSE 10039 companies exceeded the 25% target that he set in 2011. At that time, only 12.5% of those posts were occupied by female directors, so the proportion had doubled in just six years to over 27%. There were 152 all-male boards across the FTSE 350, now there are 8. In his final report Lord Davies extended the voluntary target to 33% for the FTSE 350 by 2020, he also recommended the appointment of a new Chair to focus on women in the executive layer of FTSE 350 companies.

The Hampton – Alexander Review

In February 2016, the Government appointed Sir Philip Hampton, Chair of GlaxoSmithKline and the late Dame Helen Alexander to chair an independent review that would continue the work of Lord Davies in pushing for increased female representation on FTSE boards, whilst also extending its focus to women in senior executive positions. The Review published its first report in November 2016 and a progress report in November 2017 recommending that: (i) 33% of FTSE 350 Board members should be women by the end of 2020, and (ii) 33% of FTSE 350 leadership teams (Executive Committees and their Direct Reports) should be women by the end of 2020.40

Future board scheme

The Department for Business, Energy and Industrial Strategy (BEIS) and UK Government Investments is actively supporting the Future Boards Scheme, which is a business-led initiative to help talented, senior women get board-level development opportunities and gain the experience they need to successfully apply for board positions. A good match will benefit both the board and the participant, so boards will be asked what skills/experience they are looking for and matched with carefully-selected candidates. Individuals will not be matched with boards where there is a conflict of interest or a chance of them gaining a competitive advantage.

The model has been designed so that in the medium term it could be expanded beyond women candidates, to improve broader diversity on boards.

The Parker Review—Beyond One by ‘21

Sir John Parker led an independent review into the ethnic diversity of UK boards between 2014 and 2016. He published a report and draft recommendations for consultation in November 2016, and a final report and recommendations in October 2017.41

The Review concluded that boardrooms did not reflect the ethnic diversity of the UK. 8% of FTSE 100 board directors are people of colour compared to 14% of the population. Only 2% of board directors are UK citizens of colour. 51 companies do not have any directors of colour.

The Review has recommended that each FTSE 100 board should have at least one director of colour by 2021, and each FTSE 250 board should have at least one director of colour by 2024.

While Government did not commission the review, it welcomed the recommendations and will be helping to monitor progress.

Diversity reporting

The EU non-financial reporting directive42 introduced a requirement for the large public interest entities to disclose the diversity policies applied to their boards. The UK Corporate Governance Code and other guidance already supports best practice by instructing that on new appointment of directors, companies should have regard to the benefits brought from diversity on the board, including gender.

As part of its response following the recent Corporate Governance Reform consultation, the Government asked the FRC to consider how best to encourage greater transparency for all quoted companies regarding company diversity policies, targets, and progress towards those targets. The FRC consultation43 on these and other matters closed at the end of February 2018.

Planned corporate governance reforms

As highlighted in the previous sections, the current UK regulatory framework setting out the roles and duties of company directors (section 172) and also providing for current shareholder voting rights as well as reporting requirements of companies, such as the requirement to produce a triannual pay policy and an annual remuneration report, is largely embedded in the Companies Act 2006. The legislative requirements apply proportionately to different subpopulations of companies. For example, while the directors’ duty set out in section 172 applies to all company directors, smaller companies are exempt from the requirement to produce an annual Strategic Report,44 and only ‘quoted companies’45 are required to comply with the existing shareholder voting regime46 (The number of ‘quoted’ companies has fallen through the years, and there are currently “only” around 900 such companies, which have to comply with the current reporting requirements around executive pay and apply the shareholder voting arrangements for executive pay matters).

As already explained, in the UK model of corporate governance, this regulatory framework is then complemented by voluntary measures, by the Financial Conduct Authority’s (FCA) Disclosure and Transparency Rules (DTR) and Listing Rules47, and by the UK Corporate Governance Code.48

One of Britain’s biggest assets in the global economy is its reputation for being a dependable place in which to do business. The UK’s legal system, framework of company law and standards of corporate governance are admired internationally and are important factors in making the UK an attractive place in which to invest.

During the last few years there has been a number of proposals, sometimes developed by business itself, to update the corporate governance framework. In some cases, these have been made in response to concerns raised by actions of few businesses risk undermining the reputation of British business generally.

The 2017 Green Paper on corporate governance reform49 focused on three specific aspects of corporate governance where the Government thought there could be particular scope to build on, and enhance, the current framework: i) Executive pay and shareholder voting; ii) Strengthening the employee, customer and wider stakeholder voice, and iii) Corporate governance in large privately-held businesses.

Executive pay

Overall, executive compensation levels in the largest companies have increased significantly since 1998, particularly in the period to 2011. The large increase in pay levels from c. £1m in 1998 to £4.3m in 2015 is not reflected by increases to pay levels in the wider economy. The result of this is that the gap between executive remuneration and the pay for the wider workforce in a company has widened very significantly in many companies.

Disquiet about executive pay has become more acute in recent years in the context of the economic downturn and relatively weak overall pay growth during the recovery. Issues around general income and wealth inequality have come to the forefront of public discussion, and executive pay is seen as emblematic of an unfair division of reward in society. There is strong concern that executive pay is often excessive, and that success is not shared fairly.50 There is also evidence that current pay structures can provide problematic incentives,51 and that pay can be asymmetric (i.e. strong performance is rewarded, but poor performance is not punished).52

Despite signs that reforms introduced in recent years have resulted in behavioural change of some companies, and that the growth of executive pay has been more modest in recent years, there is still significant concern about the level of pay and about its structure. There has also been concern from shareholders that, while most companies demonstrate good practice, there remain too many examples of companies that do not act in accordance with the intended spirit of the rules, for example by not reacting to significant dissent, or even the loss of advisory shareholder votes on remuneration, or by providing little evidence that they have taken employee and wider stakeholder considerations into account.

While it remains vital to allow companies the flexibility on pay they need to recruit and retain talent, there is thus still scope for possible improvement.

Strengthening the stakeholder voice

Shareholders are the owners of the company, and a shareholder focus thus appears natural. The UK equity market is one of the largest in the world, attracts a lot of investment and has a very international shareholder base. According to ONS analysis, shares in UK quoted companies were worth a total of £2.04 trillion at the end of 2016, with 53.9% of this value of shares being held by the rest of the world rather than UK shareholders.53 Good investor protection is a vital driving force in attracting investment, and being able to have a strong say about how your money is utilised is a dominant component of this.

Section 172 in the Companies Act is a careful balance, maintaining shareholder primacy whilst also putting a duty on directors to “in doing so” (i.e. while acting in the interests of the owners of the company) have regard to a variety of other stakeholder and wider considerations. These wider considerations range from impacts on the local community, to environmental impacts, to listening to employee voices and considering relationships with suppliers and customers.

Investors and asset managers are increasingly emphasising the importance of wider societal factors for long term sustainable growth and calling for more transparency around how companies manage the considerations above in order to demonstrate that they are creating long term value.54

Furthermore, given that many companies will benefit from public investment and use public services, that they rely on their employees and that they have the capacity to cause large externalities on the environment and on supplier businesses, it appears right that section 172 places this duty on directors.

There are recent developments such as B Corps, which meet high social sustainability and environmental standards, and the Big Innovation Centre with its Purposeful Company agenda.55 They make the point that long-term value creation depends on companies having a clear strategic vision around their purpose – “their role in the world from which profits result”. Having a clear understanding of all the relevant stakeholder voices appears of vital importance for this.

While we acknowledge such developments coming out of the business community, it is clear from recent corporate failings, and from the responses we received during the consultation period, that more could be done in this area to drive further change. The consultation responses raised concerns that many businesses and directors treat the wider considerations in section 172 as too much of a tick-box exercise, without really giving sufficient thought to them.

Corporate governance in large privately-held and public unlisted companies

While the agency problem and the issues arising from it are less acute in the case of private companies because ownership and control of the business are usually closely intertwined, all the wider problems identified above arise independent of the legal form of the business. This is especially true where companies should have due regard for wider stakeholder views.

Employees are as important a stakeholder in private companies as they are in public companies. The impact bad employment practices can have on the business itself in the long-term, but also on wider society, applies irrespective of the legal form of a company. The same holds for the effects caused by companies not taking into account their environmental impacts, effect on the community, or poor treatment of suppliers; they exist whether a company is public or private. Bad practices among private companies contribute to the erosion of trust in business, and where bad business practice leads to the collapse of companies and potentially large pension schemes, this can have devastating effects on local areas and create wider economic costs.

We acknowledge that private companies are different, and that many successful private companies are driven by the entrepreneurial spirit of their owners. Our approach is thus not to treat public and private companies identically. There are, however, areas in which the legal form of a company is largely irrelevant. In areas where this is the case, we think it is fair and beneficial to ask private companies to think about their governance standards with the aim to spread good practice and increase standards among those companies that are currently not thinking about good governance enough.

Rationale for intervention

The proposed reforms are unlikely to affect substantially the large majority of UK companies that already follow good governance practice. Instead, the proposals build on the existing strengths of the system, with targeted further interventions. They aim to incentivise more companies to think long-term and take stakeholder voices into consideration, and to ensure that systems are in place to address instances of bad governance and corporate excesses. Such bad practices in a small number of companies can and have had, large negative impacts on perceptions of business overall. They reduce trust in business as a force for good. Ensuring that good practices are more wide-spread and that bad practices are addressed should thus, by improving the public perception of business, be beneficial especially to those companies that already do the right thing.56

The rationales for intervention can broadly be classified in three areas. Firstly, the proposed policy package aims to address equality and fairness concerns; it aims to address the notion that current systems do only benefit a small minority and to halt the observed erosion in trust in business. This rationale is primarily not about economic efficiency but aims to address distributive concerns. It is overarching and is thus a rationale for intervention across all three main areas for reform.

The second rationale evolves around asymmetric information and a principal-agent problem. As explained above, corporate governance systems and especially executive pay has evolved in order to address the principal-agent problem in public companies. However, it seems clear that some problems still remain, and that implemented solutions might at times cause unintended consequences. Short-termism might be a particular problem as, according to a recent study by PwC, median CEO tenure has fallen significantly to 4.8 years.57 Therefore, CEOs often do not face potentially negative consequences associated with short-termism. The interests of stakeholders, whose relationship with the company is often much more long-term than that of short-term shareholders or CEOs, can often be better aligned with those of long-term shareholders. Giving more emphasis to the stakeholder voice could thus provide valuable insights to companies themselves.

Finally, not only are there externalities of good and bad governance as described above (i.e. bad governance causing an erosion in trust in business which ultimately can affect all businesses), but companies, independent of legal form, can cause more direct externalities. Bad employment practices can be to the detriment of employees, not having due regard to environmental impacts can cause unnecessary environmental damage, and companies not maintaining good relations with suppliers and not factoring in impacts on the local community can have devastating localised effects. Incentivising all companies to have proper regard to such issues should thus mean that companies might internalise more of these externalities into their decision-making, leading to better outcomes for society as a whole.

The reforms are targeted and specific. They are designed with the aim of introducing negligible or limited burden on the majority of businesses that are already following good practice. Instead, the proposals are largely targeting those businesses that currently fail to follow good standards and are causing negative impacts on business as a whole. Where the Government introduces new requirements to all businesses, it aims to be proportionate by exempting smaller businesses, and cause minimal administrative burden by building on existing requirements and processes.

As explained in detail in the following section, the reform package includes four areas of legislative change, which are going to be introduced via a single statutory instrument. The legislative changes are combined with a number of non-legislative initiatives, for example industry-led and shareholder initiatives and inviting the FRC to consider changes to the Corporate Governance Code. These elements are mutually reinforcing and will help deliver the desired outcomes.

Reforms in detail

Executive pay

(Secondary Legislation). Require quoted companies58 with over 250 UK employees subject to current executive pay reporting requirements to:

  • report annually, in their remuneration reports, the ratio of the CEO’s total annual remuneration to the average of the company’s UK employees. The ratio will be based on the CEO’s Single Figure of Total Remuneration and compare that to the figure for the UK employee median full-time equivalent remuneration, and also to each quartile of UK employee remuneration. Employee remuneration must include wages and salary, employer pension contributions and variable pay, and it can include other pay and benefits the company may wish to include provided that this is stated clearly; and

  • provide a short narrative explanation each year showing how the ratio relates to the company’s wider strategy and workforce pay and policies, including a comment on the change to the ratio compared to the previous year and on long-term trends.

(Secondary legislation). Require companies to provide more clarity and explanation on the impact share price changes have (had) on executive compensation. Quoted companies will have to:

  • set out, in the annual remuneration report, the amount of the executive compensation package (SFTR figures) for executive directors that is a result of share price changes, and whether the remuneration committee has used discretion when awarding the pay package, especially as a result of share price changes.

  • show, in the forward-looking pay policy, the impact share price changes could have on compensation of executive directors, specifically on variable remuneration under Long-Term Incentive Plans (LTIPs). The illustrative share price increase will be 50%.

(Non-legislative). Invite the FRC to revise the UK Corporate Governance Code to:

  • be more specific about the steps that premium listed companies should take when they encounter significant shareholder opposition to executive pay policies and awards (and other matters);

  • give remuneration committees a broader responsibility for overseeing pay and incentives across their company and require them to engage with the wider workforce to explain how executive remuneration aligns with wider company pay policy (using pay ratios to help explain the approach where appropriate); and

  • extend the recommended minimum vesting and post-vesting holding period for executive share awards from three to five years to encourage companies to focus on longer-term outcomes in setting pay.

(Non-legislative). Invite the Investment Association to implement a proposal it made in its response to the green paper to maintain a public register of listed companies encountering shareholder opposition to pay awards of 20% or more, along with a record of what these companies say they are doing to address shareholder concerns. The Investment Association launched this register in December 2017.

Stakeholder voice in the boardroom

(Secondary legislation). Introduce new reporting requirements on all large companies to explain how their directors comply with the requirements of section 172 of the Companies Act to have regard to employee interests and other factors.

  • ‘Large’ companies that are already required to produce a strategic report will be required to add a statement in the Strategic Report describing how directors have had regard to the wider stakeholder matters and interests set out in section 172(1)(a)-(f) of the Companies Act.59 In order to achieve more visibility for reporting on this aspect of the duty of directors, companies not already required to make their annual accounts and reports available on a website will be required to make this new statement available on a suitable company website.

  • Build on the existing content of the Directors’ Report to require companies to provide a summary of how the directors have engaged with employees, how the directors have had regard to employee interests, and the effect of that regard on the principal decisions taken by the company during the financial year. This requirement thus extends the existing ‘Employee Involvement statement’ and will apply to all companies covered by the current reporting requirement, in other words all companies with more than 250 UK employees.

  • Require ‘large’ companies60 to report, as part of the Directors’ Report, on their engagement with suppliers, customers and others in a business relationship with the company. This will comprise a statement summarising how the directors have had regard to the need to foster the company’s business relationships with suppliers, customers and others, and the effect of that regard on the principal decisions taken by the company during the financial year.

Companies can set out all the new information required in their Strategic Report with a cross-reference in the directors’ report.

(Non-legislative). Invite the FRC to augment this by consulting on the development of a new Code principle establishing the importance of strengthening the voice of employees and other non-shareholder interests at board level as an important component of running a successful, sustainable business. As a part of developing this new principle, the

Table 4.1. Summary of reform elements and their estimated impacts

Executive Pay

Proposed measure



Pay ratio reporting

Secondary legislation

Benefits (non-monetised)

Incentivises company boards and senior management to think more about pay dispersion within their companies and how pay is shared across the wider workforce.

Provides a tool that enables shareholders and stakeholders to observe basic trends on pay distributions within companies over time, and to question boards more effectively about levels of pay and reward within the company.

Costs (monetised), best estimates

Additional regulatory burden of (in total):

£4.05m in year one; and

£2.56m annually thereafter.

Illustrate impact of share price changes on executive remuneration

Secondary legislation

Benefits (non-monetised)

Greater transparency to shareholders and others on how future share price changes may affect executive remuneration.

Encourage a more informed approach to the scrutiny and approval of share-based remuneration that discourages mechanistic outcomes.

Costs (monetised), best estimates

Annualised additional regulatory burden to business, estimated to be £1.18m in total.

Invite FRC to revise the UK Corporate Governance Code with respect to the three elements set out under 3) on page 16.

Non-legislative / code-based

Changes to the Code apply on a ‘comply or explain’ basis. While Code provisions are thus not legislative requirements, they are likely to have some cost impact on businesses. The Code is owned by the FRC. Should the FRC decide to adopt the Government’s proposal, it will assess the regulatory impacts of changes.

However, we expect any possible Code-changes to have a minimal impact on business overall. This is because: a) the impact on individual business would be limited - many companies already follow good practice in this area and could implement changes to their practice at minimal cost; b) the Code applies ‘only’ to premium-listed companies. As of January 2018, the FCA Official List identifies c. 1 200 premium equity-listings, with 750 being by UK companies. A large proportion (over half) of these 1 200 listings are also by closed-ended investment funds and open-ended investment companies.

Invite the Investment Association to implement a register of listed companies encountering shareholder opposition of 20% or more, along with a record of what these companies say they are doing to address shareholder concerns.

Non-legislative / industry-led

The register will help to hold those companies that encountered significant shareholder opposition to account, but also gives such companies a visible platform to explain their decisions, and to demonstrate what they are doing to address concerns raised by shareholders.

The register does not introduce any direct regulatory burden on business. It is now live and is available under:

Strengthening the stakeholder voice

Proposed measure



Section 172 reporting

Secondary legislation

Benefits (non-monetised)

Driving up overall standards to levels already attained by many companies.

Incentivise stronger stakeholder engagement, sustainability and long-termism.

Help reduce the risk of future governance failures, improve transparency and restore trust in business.

Costs (monetised), best estimates

Additional regulatory burden, estimated to be (in total):

£11.41m in year one; and

£5.46m per annum thereafter.

Invite FRC to develop new Code principles on importance of stakeholder voices at board level.

Non-legislative / code-based

See explanation provided for “Invite FRC to revise the UK Corporate Governance Code with respect to the three elements set out under 3) on page 16” above.

Asking ICSA and the Investment Association to complete guidance on engagement with stakeholders. Invite the GC100 group to complete and publish new advice and guidance on the practical interpretation of the directors’ duties in section 172.

Non-legislative / industry-led

This work will complement legislative changes by providing helpful guidance to companies.

By providing guidance on the interpretation of s172 duties it should make it easier for companies to comply with the newly introduced reporting requirement in a meaningful way.

Corporate governance in large privately-held and public unlisted companies

Proposed measure



Require companies of a significant size to disclose their corporate governance arrangements in their Directors’ Report and on their website

Secondary legislation

Benefits (non-monetised)

Driving up overall governance standards to levels already attained by many companies.

Help reduce the risk of future governance failures, improve transparency and restore trust in business.

Build lender and supplier confidence that a company is well run.

Costs (monetised), best estimates

Additional regulatory burden, estimated to be (in total):

£1.23m in year one; and

£0.59m per annum thereafter.

Invite the FRC to work with a Coalition Group consisting of the Institute of Directors, the CBI, the TUC, the Institute for Family Business, the British Venture Capital Association and others to develop voluntary corporate governance principles for large private companies.

Non-legislative / industry-led

This work will complement legislative changes by providing a helpful framework for companies.

The development of governance principles for private companies that has wide support from stakeholders should:

a) help raise standards by identifying what is best-practice and what is expected; and

b) provide a widely used – but voluntary - reference point which large private companies can use in reporting on their corporate governance arrangements.

The work of the Coalition Group, for which the FRC provides the secretariat, is now underway under the leadership of James Wates (of Wates Construction).


Proposed measure



Invite the FRC, FCA and Insolvency Service to update existing MoUs and letters of understanding between them (or conclude new ones).


This work will ensure that existing enforcement powers are used effectively and reduce duplication, overlap and regulatory inefficiency.

It will help build confidence in the robustness of the existing enforcement regime.

Source: UK BEIS.

Government has invited the FRC to consider and consult on a specific Code provision requiring premium listed companies to adopt, on a “comply or explain” basis, one of three employee engagement mechanisms: a designated non-executive director; a formal employee advisory council; or a director from the workforce.

(Non-legislative). Encourage industry-led solutions by asking ICSA (the Institute of Chartered Secretaries and Administrators: The Governance Institute) and the Investment Association to complete and publish joint guidance on practical ways in which companies can engage with their employees and other stakeholders. The Government has also invited the GC100 group of the largest listed companies (FTSE100 General Counsels) to complete and publish new advice and guidance on the practical interpretation of the directors’ duties in section 172 of the Companies Act 2006.

Corporate governance in large private companies

(Secondary legislation). Require companies of a significant size to disclose their corporate governance arrangements in their Directors’ Report and on their website, including whether they follow any formal code, or recognised set of corporate governance principles. Following discussions with stakeholders, the Government has decided that the threshold for “significant size” will be set such that companies will be covered by this requirement if they: a) have more than 2 000 employees globally; or b) have a global turnover figures over £200m and a balance sheet over £2 billion. This is unless they are subject to an existing corporate governance reporting requirement (such as listed companies, charitable companies and others).

(Non legislative). Inviting the Financial Reporting Council to work with the Institute of Directors, the CBI, the TUC, the Institute for Family Business, the British Venture Capital Association and others to develop corporate governance principles for large private companies. These will be voluntary principles, and companies will be under no compulsion to adopt them. The objective is to develop principles that command widespread support and endorsement from business and that, in due course, they become the framework which most large privately-owned companies will choose to reference.


(Non-legislative). Government has asked the FRC, the FCA and the Insolvency Service to conclude new or, in some cases, revised letters of understanding with each other to ensure the most effective use of their existing powers to sanction directors and ensure the integrity of corporate governance reporting. The Government will consider, in light of this work, whether further action is required.


The survey results show that flexibility and proportionality are used by all jurisdictions included in the review for the implementation of board composition, board committees and board member qualifications. This was to some extent expected, as the OECD Corporate Governance Factbook had already documented a great diversity of board arrangements across jurisdictions, with corporate governance systems often using soft law to offer guidance as how to foster well-functioning boards within a flexible and proportionate framework.

The case study from the UK illustrates the process of setting the framework for board composition, board committees and board member qualifications that has taken place in one of the most advanced equity markets in the world. It highlights the combined approach of setting key requirements in the law and using the UK Corporate Governance Code61, which is a legislative requirement for companies with Premium listing of equity shares, and its flexible approach to foster best board practices. Companies with a Standard listing on the London Stock Exchange benefit from wider flexibility. The requirement is limited to producing a Corporate Governance Statement in the Annual Report and disclose whether and to which extent they comply with a specific code. Companies listed on the Alternative Investment Market (AIM) are also required to apply a recognised corporate governance code but are allowed the flexibility to choose between the UK Corporate Governance Code or the Quoted Companies Alliance (QCA) Corporate Governance Code.62

The ambitious reform agenda and the rationales for change also show the UK authorities' openness to revisiting and, where necessary revising, policies and adopting reforms as it may be necessary to ensure frameworks are able to adapt to changes in markets. Among the reforms envisaged ahead, it is interesting to note the ambition to use proportionality to introduce corporate governance disclosure requirements beyond listed companies, in order to strengthen large private companies’ governance arrangements.


European Commission (2013), “Directive 2013/50/EU Of The European Parliament And Of The Council of 22 October 2013”,

ICSA: The Governance Institute (2017), The future of governance: Untangling corporate governance,

Isaksson, M. and S. Çelik (2013), “Who Cares? Corporate Governance in Today's Equity Markets”, OECD Corporate Governance Working Papers, No. 8, OECD Publishing, Paris,

OECD (2015), G20/OECD Principles of Corporate Governance, OECD Publishing, Paris,

OECD (2017), “OECD Corporate Governance Factbook 2017”,


← 1. Three countries have hybrid systems that allow for three options and provide for an additional statutory body mainly for audit purposes. Italy and Portugal have established models similar to one-tier or two-tier systems in addition to the traditional model with a board of statutory auditors. Japan amended the Company Act in 2014 to introduce a new type of board structure – a company with an audit and supervisory committee - besides models providing for a board with statutory auditor and a company with three committees.

← 2. In the UK it is two, it is seven for large companies in Chile, and 12 for the companies with two-tier boards in Norway.

← 3. In the United States, for example, while Delaware law and exchange rules permit a company to have a classified board which typically has three classes of directors serving staggered three-year board terms, many companies have adopted annual re-election, and the classified board system has become less prevalent. In France, it is recommended that the terms of office of the board members should be staggered. In Hong Kong, China, one-third of the directors are required to retire from office by rotation at each annual shareholder meeting.

← 4. In the cases of Chile, France, Israel and the US, companies with more concentrated ownership are subject to less stringent requirements or recommendations. In Italy, a stricter requirement for a majority of independent directors is imposed in cases involving integrated company groups with pyramid structures that may contribute to more concentrated control. Portugal requires an "adequate" number of independent directors that takes into account shareholder structure and free float. In Israel, according to a list of recommended (not binding) corporate governance rules set forth in the First Addendum to the Companies Law, board independence requirements is correlated to the ownership structure of the company (companies with dispersed shareholding are required to have a majority of the independent directors, while companies with controlling shareholders are required to have at least one-third of the independent directors).

← 5. Full or majority independent membership is required or recommended for all three committees in most of the jurisdictions, while provisions on chair independence in audit committees are more common compared to the nomination committee or remuneration committee. The Swedish code recommends that the largest shareholders (or their representatives) make up the majority of a nomination committee.

← 6. Some jurisdictions (e.g. Australia) allow some flexibility for listed companies to adopt and disclose more efficient and effective alternative governance practices instead of having a separate board-level committee.

← 7. In Italy, at least one board member must be elected from the slate of candidates presented by shareholders owning a minimum threshold of the company’s share capital. In Israel, it is recommended for initial appointment and required for re-election, that all outside directors be appointed by the majority of the minority shareholders.

← 8. For example, Singapore’s code states that the board should comprise directors who as a group provide core competencies such as accounting or finance, business or management experience, industry knowledge, strategic planning experience and customer-based experience or knowledge. Some other jurisdictions set out a requirement or recommendation only for certain board members, such as independent directors, members of audit committees, or Chair of the board.

← 9. The listing rules issued by Borsa Italiana for firms that belong to the STAR market segment, which includes medium-sized companies which comply with enhanced disclosure and governance requirements, require them to: (i) appoint a remuneration committee and a control and risk committee; (ii) have a minimum quorum of independent directors present within board meetings (at least 2 for boards with up to 8 members, 3 for boards with between 9 and 14 members, and 4 for boards with more than 14 members).

← 10. They are not exempt, however, from standards for audit committees mandated under the Exchange Act as set forth in Rule 10A-3.).

← 11. The Italian framework provides for some governance requirements as a condition to allow the listing of companies subject to management and coordination (“direzione e coordinamento”) by another company. The law and the implementing regulation adopted by the Italian Securities Regulator (Consob) provide some reinforced board and committees composition requirements to be fulfilled in order for the company to be listed. Such requirements are additionally strengthened if the parent company is also listed (and consequently the subsidiary is not only part of an integrated group but also a pyramid).

← 12. Listed firms in the equity market of Mexico can have the legal status of Sociedades Anónimas Bursátiles (SAB), or Sociedades Anónimas Promotoras de Inversión Bursátil (SAPIB), and these types of firms have different requirements for listing, board composition, and information disclosure.

← 13. Officials at the UK’s Department for Business, Energy & Industrial Strategy were asked by the OECD Corporate Governance Committee to produce this officials-level working document for internal discussions by the OECD Committee. As such, it is factual and does not develop or recommend new policy options.

← 14. Company law Review Steering Group, Department of Trade and Industry, Modern Company Law for a Competitive Economy, The Strategic Framework (1999).

← 15. Company Law Modernisation and Corporate Governance in the UK – Some Recent Issues and Debates, by Professor Roman Tomasic, pp.46.

← 16. An executive agency of the Department of Business, Energy and Industrial Strategy, by which the registrar of companies performs various functions including the incorporation and dissolution of registered companies, the examination and storage of information legally required by companies by virtue of the Companies Act 2006, and where required, the publication of all of this information.

← 17. Section 15(1) of the Companies Act 2006 - On the registration of a company, the registrar of companies shall give a certificate that the company is incorporated.

← 18. Susan McLaughlin (2009), Unlocking Company Law.

← 19. The existence of corporate directors is subject to reform by the Small Business, Enterprise and Employment Act 2015, in a bid to increase transparency of company ownership in the UK. Corporate directors will soon be prohibited, bar some limited exceptional circumstances.

← 20. A company whose shares may be purchased by the general public and traded freely on a stock exchange.

← 21. A company whose shares may not be offered to the public for sale and which operates under legal requirements which are less strict than those for a public company.

← 22. Section 154 (1) & (2) Companies Act 2006.

← 23. Section 158 (1) Companies Act 2006.

← 24. Section 157 (1) Companies Act 2006.

← 25. The Financial Reporting Council (FRC) is the UK’s independent regulator responsible for promoting high quality corporate governance and reporting to foster investment. The FRC sets the UK Corporate Governance and Stewardship Codes and UK standards for accounting and actuarial work; monitors and takes action to promote the quality of corporate reporting; and operates independent enforcement arrangements for accountants and actuaries. As the Competent Authority for audit in the UK the FRC sets auditing and ethical standards and monitors and enforces audit quality. It’s funded by membership fees.

← 26. Section 12 (3) Companies Act 2006.

← 27. Section 168 (1) of the Companies Act 2006.

← 28. Section 168 (1) of the Companies Act 2006.

← 29. Section 167 of the Companies Act 2006.

← 30. The fiduciary duties as a director encompass a relationship of trust and loyalty between the director, the company, its members, and stakeholders. The expectation is that directors will act in good faith, and in the best interests of the company. These common law duties overlap and inter-connect with the statutory duties as laid down in the Companies Act 2006.

← 31. Gower, Principles of Company Law (6th ed.), citing Isle of Wight Rly Co v Tahourdin (1884) LR 25 Ch D 320.

← 32. Per Cozens-Hardy LJ, p 44.

← 33. See:, pp.5.

← 34. Section 174 (2)(a) of Companies Act 2006.

← 35. Understanding Company Law, Alastair Hudson 2012.

← 36. See:

← 37. A Premium Listing is only available to equity shares issued by trading companies and closed and open-ended investment entities. Issuers with a Premium Listing are required to meet the UK’s super-equivalent rules which are higher than the EU minimum requirements.  A Premium Listing means the company is expected to meet the UK’s highest standards of regulation and corporate governance – and as a consequence may enjoy a lower cost of capital through greater transparency and through building investor confidence; see:

← 38. See:

← 39. The FTSE 350 Index is a capitalisation-weighted index consisting of the 101st to the 350th largest companies listed on the London Stock Exchange. Promotions and demotions to and from the index occur quarterly in March, June, September, and December. The Index is calculated in real-time and published every minute. Related indices are the FTSE 100 Index (which lists the largest 100 companies), the FTSE 350 Index (which combines the FTSE 100 and 250), the FTSE SmallCap Index and the FTSE All-Share Index (an aggregation of the FTSE 100 Index, the FTSE 250 Index and the FTSE SmallCap Index).

← 40. See:

← 41. See:

← 42. Directive 2014/95/EU:

← 43.

← 44. See:

← 45. As defined in section 365 of the Act, these are UK registered companies that are quoted on the main London Stock Exchange or on a stock exchange in the European Economic Area, the New York Stock Exchange or NASDAQ.

← 46. See:

← 47. See:

← 48. See:

← 49. See:

← 50. Kiatpongsan and Norton (2014) show, using international survey responses, including for the UK, that people underestimate the pay ratios between CEOs and average workers, and that their ideal ratios are much lower than actual observed ratios.

← 51. Edmans et al (2016) show that vesting equity induces CEOs to reduce investment in long-term projects and increase short-term earnings. Continuous and frequent vesting of share plans can thus result in CEOs aiming to deliver to short-term targets. Edmans et al (2014) provides evidence highlighting that CEOs strategically time corporate news around months in which their equity vests.

← 52. Bell and Van Reenen (2016) find supporting evidence for this in UK companies with weak corporate governance.

← 53. ONS: Ownership of quoted shares 2016. Available at:

← 54. See: and

← 55. See:

← 56. Acharya and Volpin (2010) explain how weak corporate governance can lead to excessive compensation even in firms with good governance because of competition on pay. Due to such externalities, the overall level of governance in the economy can be inefficiently low.

← 57. PwC: CEO Success Study. For summary findings, see:

← 58. That is, UK-registered companies with a listing on the UK Official List, NASDAQ, the New York Stock Exchange or a regulated exchange in the EEA.

← 59. Section 414A of the Companies Act 2006 requires all companies that are not small to prepare a strategic report. This new requirement will though only apply to large companies as defined in the Companies Act – i.e. companies meeting at least two out of the following three criteria: i) turnover of more than £36m; ii) balance sheet total of more than £18m; and iii) more than 250 employees.

← 60. Applying the Companies Act definition of ‘large’: companies meeting at least two out of the following three criteria: i) turnover of more than £36m; ii) balance sheet total of more than £18m; and iii) more than 250 employees.

← 61. The UK Code has just been updated and the new version will apply from 1 January 2019:

← 62.

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