& Securities

This post is part of our occasional series, “A view from abroad,” which looks at key developments around the world which may affect multinational companies or which may influence the development of U.S. law and practice.

In December last year, we reported on some possible significant changes in the U.K. corporate governance system, with specific reference to areas such as executive pay, employee and other stakeholder involvement and the governance of large private companies. The U.K. Government has now received responses to its consultation and has published its plans to implement changes.  As is typical in the U.K., the plans comprise a mix of legislative changes (mainly relating to disclosure) and non-binding codes which will operate on a “comply or explain” basis. The intention is that the changes will apply as from June 2018 to any company which has a financial year ending after that date (for most companies which have a calendar year end this affects the annual report that they will be publishing in the first few months of 2019).

The key changes will be as follows:

Executive pay: Listed companies will be required to publish the ratio of their CEO’s pay to the average pay of their U.K. workforce, along with a narrative explaining changes in that ratio over time. A similar requirement is set to take effect in the U.S. beginning in 2018, despite speculation that the SEC or Congress would take action to delay or repeal the requirement. In addition there are likely to be changes to the U.K. Corporate Governance Code (the “U.K. Code”) requiring Remuneration Committees of boards of directors to engage with the wider workforce in explaining how executive pay aligns with wider company policy on pay.

The U.K. has had “say on pay” shareholder votes for many years now, and the Government’s conclusion is there is no need to change the current system in which there is an annual advisory vote on the historical remuneration report and, in striking contrast to the U.S., a binding vote at least once every three years on the remuneration policy. Companies may not pay board members (which generally in the U.K. include the CEO, the CFO and sometimes the heads of major business units) more than the approved remuneration policy allows.

However, the Government is encouraging further changes to the U.K. Code to set out actions which companies should take when they encounter significant opposition to their executive remuneration policies. At present, it is common for companies which encounter such opposition to replace one or more members of their Remuneration Committee, and to propose a new executive pay policy which meets investors’ concerns. These sorts of steps are likely to be codified. The threshold for “significant opposition” is likely to be set at 20% of votes against the policy. Those companies which have encountered “significant opposition” will be named on a public register (though this information can generally be obtained from public sources already).

Concern was expressed during the consultation process about the large amounts often paid out to senior management under long term incentive plans (“LTIPs”). The Government intends to require companies to provide a clear explanation of the likely outcomes of these plans (e.g. how much the CEO would get if all the targets are hit). The recommended minimum vesting period is likely to be extended from three years to five years. There is already considerable disclosure regarding LTIPs in the annual reports of U.K. companies, but still investors have been surprised by the size of the amounts which senior management receive under these plans.

Employee involvement: The law in the U.K. already requires directors to “take into account” wider stakeholder interests when making decisions, although it retains the primary duty to seek the success of the company for the benefit of its shareholders. The Government proposes to require all companies of a significant size (private as well as public) to explain in their annual reports how the company has taken account of other stakeholder interests. For listed companies, the U.K. Code will be amended to require them to state, on a “comply or explain” basis, whether they have adopted one of three specified employee engagement mechanisms: a designated director representing employees, a director drawn from the workforce or an employee advisory council. This falls short of the Prime Minister’s stated aim of having employees on the boards of major U.K. companies, but the Government has recognised the practical and legal difficulties inherent in achieving that aim.

Large private companies: The Government intends to pursue its proposal to develop a corporate governance code for large private companies, which would operate on a “comply or explain” basis. This will apply to businesses with more than 2,000 employees in the U.K. (whether they are in the form of companies or in other forms such as limited liability partnerships). It appears that this new code would include the U.K. subsidiaries of U.S. and other foreign companies provided the U.K. operation meets the 2,000 employees test.

The changes summarized above will require substantial changes to U.K. company law and the U.K. Code. As always the detail will be important. It remains to be seen whether the overall effect will be to change culture in our largest companies or simply to add more paragraphs to already lengthy annual reports.