As companies are owned by shareholders but managed by directors and management teams, there is always a danger that the interests of these stakeholder groups are not aligned, so good corporate governance is essential to minimise and control the risk of potentially damaging conflicts of interest. Here’s our guide to the practice of corporate governance.
- What is corporate governance?
- Basic principles of corporate governance
- What is the UK Corporate Governance Code?
- Who does the UK Corporate Governance Code apply to?
- What are the types of internal control activities for corporate governance?
- What are the new corporate governance reporting requirements?
- What do you need to include in your corporate governance policies?
What is corporate governance?
Corporate governance describes the way in which companies are controlled and run. Corporate governance laws and principles recognise that individuals and organisations participating in a company have different roles, rights and duties, and aim to make sure that these are identified and protected. Corporate governance also attempts to ensure that companies pursue their commercial objectives in a fair and ethical way by monitoring decision making, actions, policies and practices.
The key piece of UK legislation that regulates company practice in the context of corporate governance is the Companies Act 2006. In addition, companies that are listed on the UK stock exchange have to follow the Listing Rules, the Disclosure Guidance and Transparency Rules, and are subject to the UK Code on Corporate Governance (‘the Code’), although these latter rules are not mandatory. Unlisted larger companies have a similar code of corporate governance: the Wates Corporate Governance Code for Larger Companies (‘the Wates Code’). Certain common law principles also reflect corporate governance, such as director’s fiduciary duties to the company.
Neither the Code nor the Wates Code are legally binding on companies, but if a company isn’t following the principles in those documents, it needs to explain as such and justify the decision in its annual reports.
The corporate governance principles in the Companies Act are binding on all companies, whatever their size, and are found in the company’s Articles of Association. These cover how directors are appointed, removed and rewarded, and also contain various reporting requirements like the publication of the company’s annual set of accounts.
Finally, a new set of regulations (the Companies (Miscellaneous Reporting) Regulations 2018) will require large and some medium-sized companies in the UK to produce a corporate governance statement and comply with new reporting requirements.
Basic principles of corporate governance
The Wates Code (summarised below) is applicable to larger companies and is a useful guide to the basic principles of good corporate governance. Indeed, the working group that developed the code expressed the hope that all companies, whatever their size, would adopt them in order to show that they followed good corporate governance practices.
The Wates Code contains six guiding principles for company boards of directors covering:
- Corporate purpose and leadership
- Board composition
- Director responsibilities
- Opportunity and risk
- Stakeholder relations and engagement
Purpose and leadership
“An effective board develops and promotes the purpose of a company and ensures that its values, strategy and culture align with that purpose.”
Directors should promote the company’s success and act with integrity. The board should share the company’s purpose and their decision-making process should align with its purpose to achieve long-term success for the company. The company’s purpose and values should also be reflected in the culture of the company, and be monitored via employee surveys, trade union engagement, employee interviews and board feedback. The board should develop a strategy for long-term sustainable value, and disseminate this throughout the company. Companies should have whistle-blowing policies and practices and balance short-term targets with long-term goals.
“Boards should have an effective chair, and directors should have a balance of skills, backgrounds, experience and knowledge. The size of the board should reflect the size and complexity of the company.”
The chair should promote open debate and constructive discussion, ensuring directors have appropriate information and enough time for discussion. Ideally, the Chair and Chief Executive shouldn’t be the same person. Boards should be diverse, and have regard to the Equalities Act. When deciding the size and structure of the board, companies should make sure it is the right size to suit the company’s needs, and should consider appointing non-executive directors to offer constructive challenges. If companies are large, they may consider delegating some functions like risk and remuneration to committees. Companies should commit to professional development of the board and conduct board evaluations regularly, on which the Chair should act if necessary.
“The board and individual directors should have a clear understanding of their accountability and responsibilities. The board’s policies and procedures should support effective decision-making and independent challenge.”
There should be clear lines of accountability and responsibility for effective decision-making, and internal policies should describe directors’ roles, the scope of their authority, how they should conduct themselves and to whom they are accountable. Systems should identify and manage conflicts of interest. The Chair and Company Secretary should review these rules regularly. Any committees should have also be subject to terms and authorities that govern their conduct. Independent challenge in board meetings reduces the risks of directors have unchecked powers. Boards should ensure that directors have access to good information to help them make decisions, covering such things as:
- financial reporting
- key performance indicators
- workforce data
- environmental data
- feedback on stakeholder engagement and
- consumer data
Opportunity and risk
“A board should promote the long-term sustainable success of the company by identifying opportunities to create and preserve value and establishing oversight for the identification and mitigation of risks.”
Boards should consider both tangible and intangible sources of value and stakeholder contribution, including opportunities for innovation and entrepreneurship. Boards should be responsible for the company’s approach to risk management and have internal controls to regulate risk. The board should establish an internal control framework, to include for example:
- Creating risk management systems which enable the board to identify emerging and established risks and make informed and robust decisions.
- Determining the nature and extent of principal risks and the risk appetite of the company.
- Coming to an agreement on how and over what timeframe the most significant risks should be managed or mitigated.
- Setting up internal and external communication channels to identify risk factors and agreeing a monitoring and review process.
“A board should promote executive remuneration structures aligned to the long-term sustainable success of a company, taking into account pay and conditions elsewhere in the company.”
Appropriate and fair pay enables companies to attract and keep high-quality directors, management and employees. Pay should align with performance and achievement of the company’s purpose. When setting senior pay, regard should be had to the levels of pay in the workforce as a whole. Clear pay policies should ensure accountability to shareholders, and non-executive directors are helpful additions to remuneration committees.
Stakeholder relationships and engagement
“Directors should foster effective stakeholder relationships aligned to the company’s purpose. The board is responsible for overseeing meaningful engagement with stakeholders, including the workforce, and having regard to their views when taking decisions.”
Sustainable businesses have a responsibility to consider the impact of the company’s activities on present and future stakeholders and the environment. Dialogue with stakeholders helps boards to understand the impact of company policies and practices, predict future trends and re-align strategy. Companies should prioritise stakeholder relationships. As well as the workforce, customers and suppliers, stakeholders can also include regulators, governments, creditors, pensioners and community groups. The largest material stakeholder group for many private companies is their workforce. There should be a range of formal and informal channels to engage in a meaningful two-way dialogue, which may include engagement with unions and focus or consultation groups. Workforce policies should align with the company’s purpose and values, be reviewed regularly and establish clear procedures for raising concerns, such as whistleblowing policies. Boards should show how engagement with stakeholders has been considered in its decision-making.
What is the UK Corporate Governance Code?
The UK Corporate Governance Code is a set of corporate governance recommendations for all companies with a premium listing on the UK stock exchange. It is applied on a ‘comply or explain’ approach and the latest version, the 2018 Code, applies to financial years beginning on or after 1 January 2019.
The first version of the Code was produced in response to certain company failures in the 1980s that were caused by insufficient oversight and control by boards of directors of actions of the company.
Although the Code only applies to premium listing companies, it is also followed by smaller companies who wish to demonstrate that they follow good corporate governance.
Who does the UK Corporate Governance Code apply to?
The Code applies to all companies with a premium listing on the UK stock exchange. A premium listing means the company is expected to meet the UK’s highest standards of regulation and corporate governance.
What are the types of internal control activities for corporate governance?
These are examples of corporate governance control of companies and other organisations:
- Internal audit and internal policies and procedures governing conduct and the division of responsibility and accountability within the company
- Monitoring by the board of directors
- Maintaining an appropriate balance of power between the various company stakeholders by a system of review and checks and balances
- Monitoring and control of remuneration
- Monitoring by shareholders and other stakeholder groups
The board of directors of the company should monitor corporate governance as part of its normal duties. In addition, the board monitors:
- Corporate strategy and its alignment with the company’s purpose
- Major decisions and expenditure
- Acquisitions and disposals
- Governance policies and procedures
- Appointment and removal of senior managers and their compensation
- Corporate performance
- Budgets and business plans
- Board remuneration
The company’s external auditors will assess certain aspects of corporate governance as well as the overall financial health of the company. Internal auditors may often also carry out investigations to ensure the company is complying with corporate governance obligations.
In certain cases, disgruntled shareholders may monitor and make objections to the management’s performance.
What are the new corporate governance reporting requirements?
For the financial years beginning on or after 1 January 2019, certain companies need to include new content in their annual reports under the Companies (Miscellaneous Reporting) Regulations Act 2018 as follows:
|Directors’ report||What type of company?||What must it say?|
|Statement of corporate governance arrangements||UK companies with either: 2,000+ global employees or a turnover of over £2,000 million globally and a balance sheet total of £2 billion globally|
|Statement of engagement with employees||All UK companies with an average of 250+ employees||
Directors’ report must contain a statement:
|Statement of engagement with suppliers, customers and others doing business with the company||
All large UK incorporated companies that have at least two out of three of the following:
||Directors’ report must include a statement summarising:
Companies may choose to make the statement in the strategic report instead of the directors’ report
|Section 172(1) statement||
All UK incorporated large companies that have at least two out of three of the following:
|| Strategic reportmust include a separate statementdescribing how the directors have had regard to the matters set out in section 172(1)(a) to (f) of the Companies Act 2006 when performing their duty under section 172 |
These matters are “the likely consequences of any decision in the long term; the interests of the company’s employees; the need to foster the company’s business relationships with suppliers, customers and others; the impact of the company’s operations on the community and the environment; the desirability of the company maintaining a reputation for high standards of business conduct; and the need to act fairly as between members”
Unquoted companies to publish section 172(1) statement on a company website and keep it available until the next financial year
What do you need to include in your corporate governance policies?
What you should include in your corporate governance policies depends on the size of your company, and the corporate governance regime that applies to you, whether that be the Code, the Wates Code, or any other similar code you choose to follow.
As a matter of basic corporate governance, even SMEs should consider written policies on such matters as:
- How directors are appointed to the board
- How many executive and non-executive board members there should be
- Disclosure of up-to-date information on the financial health and operations of the company and consultation with stakeholders such as employee groups
- The makeup and operation of audit, directors’ appointment and remuneration committees
- Executive remuneration
- The conduct of board meetings and decision-making processes
- Shareholder rights