Earlier this year Glass Lewis published an interesting review of the impact of the 2018 UK Corporate Governance Code (the “Code”) on governance practices, in which it sets out its approach to the most common provisions of non-compliance among FTSE 350 companies (the “Review”).
Glass Lewis is one world’s largest independent providers of governance and engagement support services, helping institutional investors understand and connect with the companies in which they invest. As such, Glass Lewis’s feedback and analysis on compliance with the Code is helpful to gain an insight into market best practice and to better understand how to facilitate compliance with corporate governance from a practical point of view.
Although the Code is only applicable to listed companies, it is recommended that non-listed companies consider the Code in light of their own corporate governance to consider any improvements that may be required to ensure policies and procedures are in line with market expectations.
WHAT IS THE CODE
The Code has been around for a number of years and is a key source of corporate governance recommendations and applies to all companies with a premium listing. The Code emphasises the value of good corporate governance for long term sustainable success. The body responsible for setting the Code is the Financial Reporting Council (“FRC”), which regulates auditors, accountants and actuaries and promotes accounting standards in the UK.
Each listed company in the UK is required to include a statement in their annual financial reports stating how they apply the principals of the Code (“Disclosure Statement”). Strict compliance with the Code is not required, and instead the FRC offers flexibility through the application of principles and provisions via a ‘comply or explain’ policy, whereby if companies are not able to comply with a provision or principle, they must provide a thorough and reasoned explanation for non-compliance. It is therefore the responsibility of companies to assess their compliance carefully and thoughtfully.
The Code consists of 18 principles of good governance and 41 provisions, covering the following main areas:
- composition, succession and evaluation;
- board leadership and company purpose;
- division of responsibilities;
- audit, risk and internal control; and
The Review analysed the Disclosure Statements of FTSE-listed companies during the financial year 2020, which revealed that a significant number of FTSE 350 public companies complied with the Code in full, whereas only a minority of small public companies complied in full with the Code. As mentioned above, the Review focused on the most common provisions of non-compliance.
FTSE 350 COMPLIANCE
According to the Review the most common deviations from the Code were in respect of chair tenure, followed by independent chair requirements and pension alignment, which are outlined in further detail below.
Chair Tenure – Provision 19 of the Code
Provision 19 states that the chair of the board should not remain in post beyond nine years from the date of their first appointment to the board. Its noted that non-compliance with this provision did not result in significant shareholder opposition to the re-election of any director.
As the Code allows for some flexibility to extend this period for a limited time in order to facilitate effective succession planning and the development of a diverse board, many companies relied on this extension in respect of not complying with the time limit. Most companies cited various explanations, the most common along the lines of earlier departure causing disruption and significant deficiency in corporate knowledge.
Glass Lewis was supportive of extensions beyond the nine-year mark, where there was a clearly defined timeline in place for succession, or where companies might benefit from continuity and stability during the COVID-19 pandemic. Where disclosure regarding chair succession plans was lacking, it advised that shareholders vote against the re-election of the chair of the nominations committee on the basis of poor succession planning.
Independent Chair – Provision 9 of the Code
Provision 9 of the Code requires that the chair be “independent upon appointment”. The most common reasons for failure to comply with this provision were that the chair: (i) also serves as an executive at the company; (ii) formerly served as an employee or executive of the company; or (iii) were representatives of a major/ controlling shareholder. Notably, non-compliance with this provision did not result in any significant shareholder opposition.
Where a board does not consider its chair as ‘independent’, Glass Lewis mentioned that it will look for evidence that the company in question has mechanisms in place to ensure a proper division between management and non-executive oversight, commenting that it expects a senior independent director to be appointed in addition, in order to serve as an intermediary for the other directors and shareholders. As such, where a company has explained that it has these types of mechanisms in place, Glass Lewis will generally not oppose the re-election of any directors.
Pension Alignment – Provision 38 of the Code
In line with the Investment Association’s (the “IA”) lobbying and various annual publications of its “Principles of Remuneration”, in recent years pension contributions and executive pension entitlement has been high on the agenda for public companies and investors alike. The expectations as set out in the IA’s Principles of Remuneration are that, where the pension contributions for incumbent directors are above the majority of the workforce rate, it is expected that companies’ remuneration committees set out a credible action plan to align the pension contributions of incumbent directors to the majority of the workforce rate by the end of 2022.
Prior to their 2020 annual general meetings, approximately 27 FTSE companies did not comply with provision 38. However, the Review highlighted that most companies did in fact update their remuneration plans in order to ensure compliance by the meeting or outlined a plan of action.
In particular, it was noted in the Review that there is a renewed focus on the alignment of executive pension contributions with those of the wider workforce with a number of companies reducing the pension contribution limit available to newly appointed executives with the above expectations.
Glass Lewis expects pension provisions for executive directors to be in line with those available to the majority of the wider workforce. Although new executive directors must be appointed on this level of pension contribution, it recognises that pension rates for incumbents may need to be reduced over time. Glass Lewis concludes that it expects the remuneration committee of each board to provide additional disclosure regarding their commitment to reduce the pension contributions for incumbent executives by the end of 2022.
Although non-listed entities, such as private companies and partnerships, are not required to comply with the Code, the Review provides useful analysis and explanations of trends in the market. The Code can be used by non-listed companies as a useful tool in guiding the structure of their boards as well as any applicable committees. Additionally, planning for business decisions to be in line with the spirit of the Code, aides in ensuring companies’ culture and governance are up to date and in line with the latest market expectations.
For a copy of the Code, please click here.
To access the Review, please click here.
For more information, and any guidance or advice on corporate governance Cleveland & Co External in-house counsel™, your specialist outsourced legal team, are here to help.