20 Apr

Relational Research Responds to Green Paper on Corporate Governance Reform

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Response to Green Paper on Corporate Governance Reform published by Department for Business, Energy & Industrial Strategy on 29th November 2016.

Jonathan Rushworth and Dr Michael Schluter

Introduction.

The Government is to be commended for bringing into public debate issues of concern over the practice of certain companies which fall short of standards expected in the corporate world. Companies have the benefit of limited liability for shareholders (no liability for the debts and other obligations beyond their investment in the company) and beneficial tax and other treatment and, in return, a certain responsibility to stakeholders and society generally is expected. For companies operating in the private sector (whether listed or non-listed) the standard of behaviour should be overseen by shareholders who jointly have the ownership and controlling interest in companies.

However, encouragement is needed by legislation, regulation and code in particular to provide the framework within which companies should operate.

This generally works well where companies recognise the boundaries and their responsibility to all stakeholders who rely on the company for their livelihood and wellbeing but there are times when society at large (prompted by politicians, business leaders, academics and opinion formers) challenges the legitimacy of the corporate world where unacceptable, sometimes egregious, practices are allowed to flourish.

Many shareholders regard their investment purely as a tradable commodity and, by delegating full authority to the directors to operate the business, have little interest in the underlying business of the company, with its impact on employees, suppliers, customers and wider society, beyond their own financial return. Indeed, shareholders tend to exert little or no control over the behaviour of the directors, nor do they hold directors to account for their actions. Individual capital providers (those investing in companies through pension funds or personal investments) often have no say and their investments are in any event held through intermediaries, for instance nominee accounts or investment funds. The publication of the Green Paper is a necessary recognition that certain aspects of corporate behaviour need to be addressed.

Indeed, many of the proposals for consultation in the Green Paper reflect ideas suggested by ourselves and others that there is an urgent need for a change of emphasis in the purpose of the corporate world from the relentless focus and demand on short-term and ever increasing financial return for shareholders in listed companies, in the form of dividend payments and share price increase, often achieved through share buy backs, towards an approach which recognises and values the benefits of positive, nurtured and mature relationships with stakeholders and their interests. This reflects the value of the company’s social and relational, and not just financial, capital in which companies display commitment to their stakeholder community.

The stakeholders are, as the Green Paper suggests, employees, suppliers, customers and the local community, but we suggest that they should include others who work with or have an interest in the success of the company, for instance financial lenders to the company (banks and holders of tradable debt) and regulators (as representatives of Government and public interest).

There should also be recognition of the responsibility of the company in its relationship not only to the local community but also to society at large.

It should be noted that current legislation recognises this responsibility to a limited extent (in particular in s172 Companies Act 2006) but City Codes in the form of the UK Corporate Governance Code and the Stewardship Code do not address relationships with stakeholders other than shareholders. Third party stakeholders are of course affected by company decisions and operations with little or no direct influence or recourse.

Many companies strive to achieve ethical standards and have active CSR projects but these do not go to the heart of how they relate to employees, suppliers, customers and others who rely on the business for their jobs or livelihood.  Para 2.4 of the Green Paper recognises that many companies are aware of the economic benefits of understanding and maintaining healthy relationships with interested groups such as employees, the local community, customers and suppliers. The paragraph acknowledges that more needs to be done to develop an appropriate model to develop this approach. The paper reflects that the requirements of s172 Companies Act 2006 need to be properly understood and applied. This relates directly to the requirement for the directors to have regard to various stakeholder interests and for the strategic report to provide shareholders with information that will enable them to assess how the directors have performed their duties under s172.

Companies whose interests are aligned with those of its stakeholders and which operate as a community of interests, are likely to be more competitive, sustainable, profitable and overall more successful as well as attracting loyalty from employees, suppliers and customers.

Properly paid employees with promotion prospects who are incentivised (through cash bonuses and share schemes), who are respected and their ideas and concerns listened to, will tend to be loyal to the company, more productive and less likely to leave or be absent from work through illness. Similarly, suppliers who are paid within a short time-frame and on the contractually due date, as well as being supported by the company, are more likely to give loyal commitment and service than if they are treated at arm’s length and with late payment with its damage to cash flow and the threat, for instance, of demands for more payments to display goods and early termination if price reductions are not forthcoming. Customers who are treated with concern and whose complaints are properly, promptly and personally handled will show loyalty and support for the business.

Further, individuals who are shareholders and consider their concerns and interests are listened to and respected as investors, who have prompt access to directors and senior managers and are able to gain an understanding of the business and its plans are more likely to feel a part of the company, show loyalty and take a longer-term view of their shareholding. They will also be in a position of knowledge and understanding to hold the directors to account if the company falls short of standards expected of a properly and responsibly run company. Incentives could be provided to encourage long-term investing (for instance, additional shares after 2 years).

Companies could consider ways to engage more closely with shareholders and other stakeholders on a regular basis. Companies could hold quarterly meetings with shareholders, possibly in different parts of the country and at convenient times of day, encourage attendance, and invite not only shareholders but employees and perhaps some suppliers and customers. There could be break-out groups for shareholders to meet individual directors to discuss different aspects of the business. Face-to-face meetings with directors would lead to greater openness, understanding and trust. Those investors in the company who are the main capital providers would be encouraged to hold shares directly in the company and to attend meetings with the company and other stakeholders.

The Government should encourage, through legislative or regulatory means supported by society as consumers and investors, a change in corporate culture to meet the expectation of employees, investors, suppliers, customers, regulators in the context of the responsibility of the corporate world to the society in which it operates and from which it benefits. Companies which already adopt this approach will be recognised and encouraged and will lead others by example. The debate prompted by the suggestions in the Green Paper provides an ideal opportunity to start to reframe and refocus UK corporate culture in a distinctive and exciting way, making the most of our enterprise, talents and resources, so that all will benefit and the litany of criticism of the corporate world will start to evaporate as faith and confidence is restored. There will be recognition of a more inclusive, responsible, constructive and successful form of capitalism.

A description of some of the problems with aspects of corporate behaviour, an analysis of the underlying causes (going back to company structures developed in Victorian times) and suggested ways to address the issues can be found in Transforming Capitalism from Within by Jonathan Rushworth and Michael Schluter at http://relationalthinking.net/relational-research/

These comments now address the particular chapters and questions in the Green Paper.

Executive pay.

The Green Paper reflects concerns over the increase in executive remuneration over the past 18 years, as mentioned by the Prime Minister. This has caused concern not only as to the amounts in absolute terms (which can have an adverse effect on the company, as less money is available for investing in the business) but more particularly on the impact on other employees in their companies. What does it say, for instance, to a low paid person on the supermarket checkout desk, who works long hours and has a stressful job dealing with customers, that the senior executives in the company are paid maybe 1000 times more than they are? Do they feel that their value and worth to the company is properly recognised? What does it tell them about how their job is regarded by the company? At the very least it does not promote a sense of corporate and shared endeavour.

The senior executives take considerable responsibility (but generally with no financial risk) in their roles and promoting the success of the business but there may be doubt as to whether such generous terms (often paid when the business is not particularly successful) are needed to attract high calibre leaders. The rewards of running a large company successfully are measured not only in financial terms but in their satisfaction and reputation as entrepreneurs and business leaders in achieving success in leading a prosperous company nationally or internationally.

We regard the question of what seems like ever-increasing pay differentials as illustrating a breakdown in the relational understanding and dialogue between those in senior management positions who operate the company on behalf of the shareholders, and the shareholders who have collective ownership rights. In addition to their rights to vote on the company’s pay policy, the shareholders appoint and reappoint directors, who have delegated authority and power to operate the company, and under the provisions of the Companies Act the shareholders have the right to pass a resolution (by simple majority) to remove directors from office. Yet remuneration committees frequently do not seem to have a satisfactory dialogue with shareholders to establish what an acceptable level of remuneration should be and this is reflected in the significant number of AGM’s each year when shareholders voice concern over the scale of remuneration packages.

Question 1: Do shareholders need stronger powers to improve their ability to hold directors to account on executive pay and performance?

We would suggest, as proposed in option (v) of part A (Shareholder voting and other rights), that the Corporate Governance Code be amended so that remuneration committees scrutinise more closely pay levels within the company (from the highest to the lowest), listen to and take into account the views of a range of shareholders, institutional and individual, as well as a range of employees and possibly other stakeholders. In some companies remuneration levels cause an annual battle with significant voting against pay packages at AGM’s. Directors should strive to avoid this as it reflects badly on the company and its image and does not show a consistent approach to the way in which the business is managed. Other ways to give shareholders a greater say in voting on remuneration levels, as suggested in the options proposed, should be considered but only in a way which is practical, given the long-term nature of some pay packages. In addition, there should be clear reporting annually on the nature, scope and details of executive remuneration, its justification and a summary of discussions between the remuneration committee and shareholders.

Question 2: Does more need to be done to encourage institutional and retail investors to make full use of their existing and any new voting powers on pay?

Consistent with the relational approach outlined above, we believe that all shareholders should be encouraged to engage with the company in discussions not only on executive pay but on other aspects of the company’s operation and its relationships and engagement with stakeholders. Clearly the directors are appointed to make decisions on the operation of the company but there should be closer engagement with other stakeholders. Greater disclosure on fund managers’ voting practice is to be encouraged. A shareholder committee could be appointed to discuss remuneration levels and amounts with the board remuneration committee. Individual shareholders should be encouraged as long-term investors (perhaps by tax relief) and their voting encouraged either directly or through their nominee holding arrangements. A greater acknowledgment by companies of individuals who are significant shareholders and access to the directors, perhaps through a liaison committee with the company, would encourage greater interest, loyalty and responsibility by those shareholders. They could, for instance, be named in the annual report and accounts and invited to regular lunches with directors (with employees and other stakeholders).

Question 3: Do steps need to be taken to improve the effectiveness of remuneration committees, and their advisers, in particular to encourage them to engage more effectively with shareholder and employee views before developing pay policies? Do you support any of the options set out in the Green Paper? Are there other options you want to suggest?

As suggested above, there should close liaison between remuneration committees and shareholders, institutional and individual, as well as with employees and possibly other stakeholders. This could be reflected as a requirement of the Corporate Governance Code. The Code could reflect a requirement that the remuneration committee should have a measure of independence from the board of directors of the company. They could report each year how they have approached their role and summarise the consultation they have undertaken and why they consider their recommendation to the board as to the level of remuneration for executives is reasonable and proper and in the interests of the company, not just in terms of a comparison with other companies of similar size in the sector but also in the context of all remuneration levels within the company.

Question 4: Should a new pay ratio reporting requirement be introduced? If so, what form of reporting would be most useful? How can misleading interpretations and inappropriate comparisons (for example, between companies in different sectors) be avoided? Would other measures be more effective?

The issue of pay differentials and the impact they can have on a company workforce and in the mind of the public is considered earlier in these comments. Remuneration levels make headline news and cause shareholders to vote against resolutions at AGM’s, although rarely with sufficient numbers to prevent a resolution being passed (by simple resolution). To encourage directors and remuneration committees to come to reasonable views on pay levels throughout a company (or group of companies) it would be helpful for different levels of pay to be disclosed, alongside the report of the remuneration committee as suggested above. This would follow the practice of a number of companies, so that the number of employees within different payment bands would be disclosed, from the lowest to the highest paid. The report would explain the appropriateness of the differential for the business of the company and the sector in which it operates. The company would explain its policy and approach to remuneration at all levels and why, for instance, limited or no increases are given at some levels but increases are proposed at other levels. If the company outsources a significant amount of its business or has self-employed workers, consideration should be given to equivalent disclosures for the third-party contractor and self-employed workers, to encourage transparency.

These disclosures would ensure that companies have considered remuneration levels carefully throughout the business and require them to justify their approach. It would also enable comparison to be made between businesses in the same and similar sectors. The requirement for disclosure should be such that a consistent approach is encouraged by all companies which comply.

Question 5: Should the existing requirements to disclose targets that trigger annual bonus payment be strengthened?

A relational approach reflecting openness and dialogue between stakeholders suggests full disclosure but we believe that grounds of genuine sensitivity or confidentiality should be respected.

Question 6: How could long-term incentive plans be better aligned with the long-term interests of quoted companies and shareholders?

We consider that the interests of the company and its shareholders would be best served by incentive share (or cash bonus) schemes being established for all levels of the company’s employees. Simple long-term non-contributory schemes could be devised for all employees in the form of exercisable options or the issue of shares assuming various targets are met. Such targets would include investment in and expansion of the business by organic growth. Tax relief would be given if options are exercised or shares awarded if they are held for a set period of time.

Strengthening the employee, customer and wider stakeholder voice.

Question 7: How can the way in which the interests of employees, customers and wider stakeholders are taken into account at board level in large UK companies be strengthened?

The Green Paper acknowledges that many companies recognise the benefits of engagement with stakeholder interests in their business activities and that economic benefits are derived from bringing external perspectives to bear and in properly understanding and maintaining healthy relationships with interested groups. As explained above, we suggest that engagement with stakeholders, having a continuing dialogue with them to understand their interests and values, listening to their views, treating them with respect, seeking a common goal and recognising issues over the running for their business and their contribution to the success of the company (whether they are employees, suppliers, customers, the local community, lenders or regulators) is essential for the operation of a successful and productive company. In other words, this engagement and recognition goes much beyond just an economic and financial goal.

Further, we consider that companies cannot have effective risk management unless stakeholder relationships have been understood, analysed and properly managed. This applies not only to external relationships with suppliers, customers, shareholders and regulators, but also with regard to relationships with employees, internal audit and partnerships and relationships with other group companies in groups which have holding companies and subsidiaries. The risks may be generated by the actions of external parties, inadequate engagement by the company’s own management team, or a weak relationship between senior management and those holding the client or other stakeholder relationship. In every case, sound relationship management practice will reduce the risks faced by the company.

The Green Paper recognises the need to find new ways for boards to connect with a wider range of interested stakeholder groups, beyond the shareholder base, whilst acknowledging that many companies have constructive practices in this regard.

The concern, as raised in the Green Paper, is that in many cases the intention and meaning of s 172 Companies Act 2006 is not properly understood and applied. There has been debate over the meaning of the words “have regard to” and the level of consideration that should be given to the interests of the stakeholders specified and, indeed, the scope of stakeholders, for instance where the wording refers to “and others”. Although s 414 requires the strategic report to provide shareholders with information that will enable them to assess how the directors have performed their duties under s172, there is a question as to how companies are complying with this requirement beyond the required disclosure on the specific matters mentioned in the section, for instance with regard to environmental and employee matters, as summarised in Appendix B of the Green Paper.

The Green Paper suggests how companies could be encouraged in their decision-making and operations to give more prominence to the interests of all stakeholders, so as build confidence that the provisions of s172 are properly understood and applied. We now comment on these suggestions and make a proposal for an agency with statutory authority to oversee and give guidance on best corporate governance practice.

Option (i) suggests that one or more stakeholder advisory panels could be formed for consultation with the directors on specific topics (for instance directors’ remuneration) or items relevant to those stakeholders, for instance relationships with suppliers. Such panels would need to be properly constituted and operated and given due respect and regard to their views by the board. The scope of their remit and responsibility would have to be established and there would need to be an understanding that individual representatives do not promote their own interests but the stakeholder group as a whole which they represent.

There would be questions as to how members of the panel would be appointed, for how long and how they take views for the stakeholder groups represented. An employee representative group, for instance, could be elected for different levels of seniority of employees for a set term (would the trade unions be involved?). Representatives of suppliers and customers might be harder to find and elect on any continuing basis as the members of both groups might be likely to change regularly. This would of course depend on the nature of the business. Suppliers to a company may compete with each other and therefore forming a cohesive group to represent might be difficult. Some stakeholder groups would be more likely to be cohesive and able to choose and influence a representative, while others would be unrelated individuals. Connected stakeholders would be more easily represented that disparate ones.

The relationship between the board and stakeholder panels would have to be such that the consultation process was not seen as just another formulaic, mechanistic process. This would be supported by a reporting requirement on the activity of the panels, their procedures and process for liaising with the board and how the board takes their views in account on relationship and company matters more generally. The panel and the board would need to keep under review the relationship and dynamics of different stakeholder groups and ensure that all relevant stakeholders are represented.

Option (ii) suggests that existing non-executive directors are designated to ensure that the voices of key interested groups, especially that of employees, are heard at board level.

We see merit in this suggestion in that it would bring a representative voice for the main stakeholders with an interest in the business directly into the board room. However, non-executive directors are not intended to be engaged in detailed operational matters and they only devote part of their time to the non-executive role. The practical aspects of engaging with stakeholders and understanding and promoting their interests in a balanced but effective way, with the time which would be expected to carry this out effectively, seem to be more in the remit of an executive director. A detailed knowledge and understanding of the business and how stakeholders engage with and contribute to the success of the business would be required to carry out the relationship role.

To give this responsibility to an executive director would recognise the significance of stakeholder interests in corporate decision-making and planning at the board level and throughout the business. Creating a post of Stakeholder Relationship Director would send a clear message to the corporate world and society in general that companies will move to a more stakeholder-inclusive approach and away from a narrow finance driven shareholder focus. Such a director would therefore have similar status at board level as, say, the finance director. As with option (i) the stakeholder representative director and the board would need to keep under review the existence and dynamics of stakeholder groups and relationships and those whose interests are represented.

Although certain non-executive directors may have the interest, personality, character and time to understand and represent the interests of stakeholders at board meetings, this is unlikely to be as effective as a director employed by the company with a full-time role to work with the other directors and employees to understand, measure the strength of and promote the interests of those stakeholders who have a close financial and wider interest in working with the company. The appointment of a director with responsibility for stakeholder relationships would avoid an election or other choice for a stakeholder representative panel as described above. Further, the director should have a degree of longevity in the post, whereas panel members may change more rapidly and would in any case devote less time and have less knowledge of current developments in the company.

Option (iii) suggests that individual stakeholder representatives would be appointed to company boards.

For the reasons set out in the Green Paper, we think there are difficulties with the idea that particular stakeholder groups would have a representative on the board. Difficulties over choice and changes in the represented group, as well as the conflict and balance of interests, could undermine what is intended to be achieved.

Option (iv) suggests strengthening reporting requirements related to stakeholder engagement.

This is a key suggestion as the reporting requirements could help to explain what is expected of directors in having regard to the various stakeholder interests mentioned in s 172. As the Green Paper states, there are already some detailed reporting requirements but this could be developed further to widen the range of interests which should be considered and addressed.

There are many examples of disclosures which could be required, in addition to or expanding current requirements. The company could be required to disclose its policy towards stakeholder recognition and relationships, the directors’ approach to measuring the quality of these relationships, how it has engaged with the various groups of stakeholders and how their legitimate interests are met on the basis that this is in the best interests of the company and its shareholders. This we suggest goes further than the ideas proposed in paragraph 2.33 (which are in themselves very positive), as they would require disclosure not only that different stakeholder interests have been given consideration, but demonstrate the approach and action taken by the company to understand and measure the strength and quality of the relationship, the results of such exercise and how it can be developed for the benefit of both parties to a particular relationship and stakeholders generally. In other words, it is not sufficient to report that there is a framework for engagement and measurement in place but the disclosure would have to show that it has been applied in practice and the actions taken as a result. The suggestions in paragraph 2.33 would add to and complement the disclosures about the relationships, their strength and how they can be improved.

Clarity of, and justification for, the remuneration packages of senior executives would be required to be disclosed and a summary of the process which led them to be recommended to shareholders. This would set the scene for their being put to shareholder vote. Disclosure could be required as to how the company engages with the interests of employees beyond current disclosure requirements, for instance how much weekend and overtime work is required, confirmation that share purchase schemes for all employees funded by the company are provided, the minimum pay scales and disclosure in bands of remuneration for all employees and details of any discussion forum with different seniority levels of employees.

With regard to supplier disclosures could be made, for instance, of evidence of building close and understanding relationships, for instance with payment on time or earlier (with no more than a 30-day payment period), help with IT and no penalties or requirement for additional payments for displaying goods. Disclosure would be required of incentives to encourage long-term holdings of shares by investors and engagement with individual as well as institutional shareholders. Clarity would be needed of tax paid and rates in countries where the company’s and group profits are earned, with full disclosure of any schemes or mitigating factors for lower taxes being paid.

If detailed guidance is given as to the disclosure requirements on a variety of aspects affecting companies’ operations, examples of which are given above, this would enable there to be greater scrutiny of their approach to stakeholder groups and their regard to the society in which they operate and from which they benefit. It would also be possible to compare the attitude and performance of companies in the same or similar sectors or across sectors, recognising that businesses may need to approach stakeholder engagement and support in different ways depending on the nature of the business and which stakeholders have a significant interest. Shareholders, analysts and the wider public would then be able to judge the level of responsibility of companies and their legitimacy in the context of their role and responsibility in society. The disclosure exercise would help to set a new standard for acceptable business practice and to help to redefine the identity of the corporate world with values of fairness, inclusiveness and transparency. Companies which meet the standards of acceptable business practice, of which there will be many, will be recognised and encouraged, by attracting goodwill, investors and customers or clients, and this will lead others by example to improve their practices.

In summary, we consider that all listed companies (and non-listed companies of a certain size measured by number of employees or shareholders) should appoint an executive director with responsibility to engage, where practicable, with all relevant stakeholders who work with or for the company or otherwise rely on the company for their livelihood or wellbeing (as well as the local community and society more widely). The director would measure the strength and quality of such relationships, in the context of the business of the company and its responsibility to society, and work with the directors and management more widely to understand and improve the quality of the relationships, as well as ensuring that their interests are taken fully into account in decision-making in the company’s operations, not only at board level but throughout the company (and any group companies) and its management. The director would be responsible to ensure that detailed reporting requirements as to the company’s policy with regard to these relationships and how the company has taken their interests into account (as summarised above) are complied with.

The board as a whole will share the responsibility of the appointed director to take the interests of the relevant stakeholders into account in the company’s decision-making and operations as well as in its general approach to its business. In this way, we would expect that a change in culture will take place over time with a recognition of the value of positive and constructive relationships with stakeholders which will lead to a more inclusive, stable and successful model for the company’s operations and responsibility. The directors, employees, shareholders and all others dealing with the company will see the benefit of this to the company, and employees, suppliers, customers and others who are more likely to wish to be employed by, or otherwise engage with, the company.

An analysis of the meaning of relationships and how they can be measured, improved and reported on can be found in The Relational Lens by John Ashcroft, Roy Childs, Alison Myers and Michael Schluter (published by Cambridge University Press 2017).

Question 8: Which type of company do you think should be the focus for any steps to strengthen the stakeholder voice? Should there be an employee number or other size threshold?

Although we consider that all operating companies should adopt an approach which values engagement with stakeholders and puts their interests at the heart of the company and its operations, the suggestion for a director to have responsibility for this and the reporting requirement may be appropriate for companies of a certain size. The threshold could be the number of shareholders (the greater the number the greater the likelihood of shareholders taking less interest and having less say in the operations of the company). Other tests might be applied, for instance turnover and number of employees.

Question 9: How should reform be taken forward? Should a legislative, code-based or voluntary approach be used to drive change?

The framework for additional reporting requirements outlined above could be included in a revised s 414 Companies Act 2006. The additions could presumably be introduced as secondary legislation by statutory instrument, as other changes were recently made to s414 by this means. It may not be appropriate or necessary to legislate for the requirement for a director with responsibility for stakeholder engagement. The Companies Act, for instance, does not include any requirement for listed companies to have a finance director. Perhaps the new role could be set out in an amendment to the UK Corporate Governance Code, which would of course need the support of the FRC. Listed companies would then be subject to the requirement on a “comply or explain” basis. There would therefore be scrutiny to see which companies adopt the new structure and which do not. Pressure through publicity would be put on those which did not and the reasons they give for not doing so.

Corporate governance in large privately-held businesses.

Question 10: What is your view of the case for strengthening the corporate governance framework for the UK’s largest, privately-held businesses?

It is reasonable and proper that all companies should adopt and follow the highest standards of corporate governance. However, many private companies are small and there are issues of scale and cost for such companies in particular as to the level of formal requirements, whether they are through legislation or regulation, which it is reasonable for smaller companies to adopt. We consider that even the smallest companies should adopt through their constitution or by directors’ resolution a responsibility to operate in the interest of all stakeholders, recognising that there is value for the success of the company in doing so. A broader more detailed code could be developed in conjunction with the FRC as a framework to guide larger private companies in matters of governance (for instance remuneration and audit committees). A scale of detailed codes could be developed which would apply to private and public companies depending on size, measured by turnover or number of employees or shareholders. The full Code requirements would apply to listed companies (whether full or AIM listings).

Question 11: If you think that the corporate governance framework should be strengthened for the largest privately-held businesses, which businesses should be in scope?

This question is answered under Question 10 above.

Question 12: If you think that strengthening is needed how should this be achieved? Should legislation be used or would a voluntary approach be preferable?

In order to guide directors of all but the smallest companies as to the meaning of directors’ duties in s172, legislation (by statutory instrument) could adopt some of the disclosure requirements as outlined above by adding to the requirements of s414. Code requirements, as outlined above, could address other issues.

Question 13: Should non-financial reporting requirements in the future be applied on the basis of a size threshold rather than based on the legal form of a business?

As mentioned above, all companies should operate with the highest corporate governance requirements in the interests of all stakeholders. The argument for greater disclosure required for listed companies is that they have the greater “relationship distance” from shareholders, and often a short-term horizon with little engagement between directors and shareholders. The disclosures enable not only shareholders to see how the company matches up to expected standards of corporate behaviour, but also other stakeholders, for instance employees, and society more widely, including analysts and the press. This allows for significant scrutiny of the actions of the directors and opportunities to hold them to account.

As for other companies, there needs to be a balance between encouraging smaller companies to adhere to the necessary requirements and over-burdening them with disclosure requirements. However, it should be possible to introduce requirements of different levels for different sizes of company based on number of shareholders, employees and turnover. There may be little benefit in trying to achieve a consistent threshold for all situations, as circumstances and the reason for the reporting requirements vary.

Other issues.

Question 14: Is the corporate governance framework in the UK providing the right combination of high standards and low burdens? Apart from the issues addressed specifically in the Green Paper can you suggest any other improvements to the framework?

In addition to the suggestions above which involve internal company practices, we suggest that a statutory agency be established with responsibility to monitor the corporate governance standards of listed and large unlisted companies. It would be an independent body which would assist companies to understand their responsibility to stakeholders including society at large and would advise on the measuring and reporting of the quality of stakeholder relationships and on other aspects of corporate governance and reporting.

South Africa King IV Code.

We consider that, as part of the consultation exercise, there would be merit in considering the Report on Corporate Governance for South Africa which was published by the Institute of Directors in Southern Africa on 1st November 2016, incorporating the King IV Code on Corporate Governance. It takes a different approach in a number of respects to the UK Code. It includes extensive narrative explaining the background to and reasons for the latest version of the Code, following earlier versions, developed under the chairmanship of Professor Mervyn King. Corporate governance is considered as the exercise of ethical and effective leadership by the governing body towards achievement of the following governance outcomes:  an ethical culture, good performance, effective control and legitimacy.

It sees the governing body’s primary governance role and responsibilities as steering the organisation and setting its strategic direction, approval of policy and planning to effect the strategy and direction, ensuring accountability by, for instance, reporting and disclosure, and it oversees and monitors implementation, execution and management. Its underpinning philosophy of sustainable development includes integrated thinking (connectivity and interdependence), the company as an integral part of society, corporate citizen status and stakeholder inclusivity.

The 17 principles of the Code reflect requirements, amongst others, in respect of: ethical and effective leadership by the governing body; an ethical culture; the need to be a responsible corporate citizen; appreciation of the inseparable elements of value creation (core purpose, risks and opportunities, strategy, business model, performance and sustainable development); the quality of reporting; composition of the board (executive and non-executive); evaluation of its performance; committee appointments; opportunities and risk; technology and information governance; remuneration policy;  and investment responsibilities of institutional investors. The requirement for compliance with the Code is on a “apply and explain” basis, in contrast to the “comply or explain” basis of the UK Code.

Stakeholder-inclusive approach.

There is a particular emphasis on the stakeholder-inclusive approach which recognises that there is an interdependent relationship between the organisation and its stakeholders. Its ability to create value for itself depends on its ability to create value for others. Pursuant to this approach the governing body takes account of the legitimate and reasonable needs, interests and expectations of all material stakeholders in the execution of its duties, in the best interests of the organisation over time. Instead of prioritising the interests of the providers of financial capital, the governing body gives parity to all sources of value creation, including social and relationship capital as embodied by stakeholders.

The concept involves the balancing of interests over time by prioritising and trading off interests in some cases, in the best interests of the organisation over the longer term. The stakeholder-inclusive approach means that the best interests of the company are not necessarily always equated to the best interests of shareholders, so shareholders do not have a predetermined precedence over other stakeholders. It is an inclusive, stakeholder- centric approach in contrast to a shareholder-centric approach.

Paragraph 16 of the South Africa Code.

The stakeholder-inclusive approach is reflected in Principle 16 of the Code requiring the governing body to adopt the approach that balances the needs, interests and expectations of material stakeholders in the best interests of the organisation over time. There is a requirement for the governing body to take responsibility for the governance of stakeholder relationships by setting the direction for how they should be approached and conducted. The body would oversee stakeholder relationship management which results in management of stakeholder risk as an integral part of organisational-wide risk management, mechanisms for engagement and communication with stakeholders and also measurement of the quality of material stakeholder relationships and appropriate responses to the outcomes.

Although there are disclosure requirements including an overview of arrangements for governing and managing stakeholder relationships, actions to monitor the effectiveness of stakeholder management and how outcomes were addressed, they do not extend to disclosure of the results of the measurement of the quality of material stakeholder relationships.

Conclusions with respect to King IV.

Although the stakeholder-inclusive approach of the South African Code may not be considered appropriate in detail for the UK, the recognition of the value of stakeholder engagement and relationships is aligned to the overall approach to this aspect contained in the Green Paper.  It is suggested that a detailed analysis of the South African Code and its background and operation could yield value as part of the consultation exercise addressed by the Green Paper.


Jonathan Rushworth is a retired solicitor, whose legal career was at a major City of London law firm. He was a partner in the firm with a broad ranging company and finance practice. In addition to pursuing charity and history interests since retiring from legal practice, he has worked with Michael Schluter and others on the analysis and practical approach to put relationships and the interests of others at the heart of society rather than a focus on the rights and interests of the individual with a narrow materialistic approach. He co-authored with Michael Schluter ‘Transforming Capitalism from Within’ (2011).

Dr Michael Schluter trained as an economist before working as a research fellow with the International Food Policy Research Institute, and as an economics consultant with the World Bank in East Africa. Michael has launched many charities whose work includes international peace-building (Concordis International), alternative finance (Allia) and social policy (Credit Action). He is co-author of The R Factor (1993), The Relational Manager (2009), Transforming Capitalism from Within (2011, with Jonathan Rushworth) and The Relational Lens (2016). He is an experienced speaker who has addressed audiences all over the world, and was awarded a CBE in the Queen’s new year honours in 2009.

Relational Research Ltd, Future Business Centre, King’s Hedges Road, Cambridge CB4 2HY.

15th February 2017

06 Mar

Mind the Wage Gap

Mind the gap

What do you think is the pay differential between the CEO of a company and its lowest skilled worker? And what do you think should be the pay differential?

In research published last November in ‘Perspectives on Psychological Science’, Kiatpongsan and Norton investigate what pay differentials people desire and whether these differentials are consistent among people from different cultures. Gretchen Gavett has written a helpful article summarising their research. You can read it here.

Norton says:

“My coauthor and I were most surprised by the extraordinary consensus across the many different countries in the survey. Despite enormous differences in culture, income, religion, and other factors, respondents in every country surveyed showed a universal desire for smaller gaps in pay between the rich and poor than the current level in their countries.”

What is also extraordinary from the research is the sheer size of the pay differentials, for example around 350 to 1 in America. And most people are completely unaware of the size of the staggering pay gap.

Gavett writes in her article:

“We’re currently far past the late Peter Drucker’s warning that any CEO-to-worker ratio larger than 20:1 would “increase employee resentment and decrease morale.” Twenty years ago it had already hit 40 to 1, and it was around 400 to 1 at the time of his death in 2005. But this new research makes clear that, one, it’s mindbogglingly difficult for ordinary people to even guess at the actual differences between the top and the bottom; and, two, most are in agreement on what that difference should be.”

Indeed, Norton says: “The lack of awareness of the gap in CEO to unskilled worker pay — which in the U.S. people estimate to be 30 to 1 but is in fact 350 to 1 — likely reduces citizens’ desire to take action to decrease that gap,”

Over the years Relational Thinking developed a tool (Relational Proximity® Framework) that can help people, organizations and businesses to measure the closeness and health of their relationships. For this it looks at five factors or dimensions of a relationship: the fourth of these is power. While inevitably in companies some people will have greater power than others, the goal should be parity, so that people will be treated fairly and with mutual respect and understanding. As the research shows, everyone agrees that the huge pay gaps of the kind we see today are unfair. There is no parity between the low paid in the company and CEO at the top.

In ‘Transforming Capitalism From Within’, Jonathan Rushworth and Michael Schluter write “If, for instance, senior executives are paid more than 100 times the amount paid to lower-paid employees, which is not unusual, this can be seen as suggesting that the lower-paid employees have a worth to the business of less than one percent of the highest paid employee. Is it fair that the contribution to the business of the lower-paid employees is regarded as so insignificant as to be valued in this way?”

There are also wider relational consequences outside of the workplace  in undermining social cohesion. The highly paid will live in different locations, use different means of transport and different shops and go to different countries on holidays.

Higher rates of remuneration are certainly justified to reward greater responsibility and experience, longer working hours and often longer training, but there should be a regard for others. The key is not the same pay, but fairness.

In ‘Transforming Capitalism From Within’, the authors argue for a Relational Business Charter, which sets out ten principles which in a practical way provide a framework to indicate whether companies are being managed and operated in a Relational manner in the interests of all stakeholders. The sixth principle is that “[t]he dignity of all employees is respected by minimising remuneration differentials within the business”.  They recommend a maximum pay differential of 1:20, so that there is parity within the company. And as Kiatpongsan and Norton’s research  shows, most people would agree.

What are the pay differentials in your organisation? How can you encourage greater parity within your organisation? How can you improve its relationships?

To find out more, you can buy Transforming Capitalism From Within as hard copy here or here as an ebook.

Photo: Mind the Gap by gmacfadyen.