Out-Law / Your Daily Need-To-Know

Private company governance principles published for consultation

Out-Law News | 15 Jun 2018 | 10:16 am | 4 min. read

A draft corporate governance code for privately-run companies, made up of six high-level principles, has been published for consultation by the Financial Reporting Council (FRC).

The principles have been developed by a group chaired by James Wates, who heads one of the UK's largest privately-run construction companies. They are intended to be in force in time for financial years beginning 1 January 2019, when new corporate governance requirements for large private companies come into force.

The 2018 Companies (Miscellaneous Reporting) Regulations introduce new corporate governance reporting requirements for private companies with more than 2,000 employees; or with more than £200 million in turnover and a balance sheet over £2 billion. These companies will be required to disclose their corporate governance arrangements in their directors' report and on their website, including whether they follow a formal corporate governance code.

Private companies which do not apply an alternative code, such as the UK Corporate Governance Code for listed companies, will be able to meet the new requirement by adopting the Wates Principles. Companies that choose to adopt the principles will be expected to do so on an 'apply and explain' basis. The principles will be overseen by the FRC.

The six principles deal with the company's purpose; board composition; responsibilities; opportunity and risk; executive remuneration; and meaningful engagement with the company's stakeholders. They are intended to be "flexible" and can be applied by private companies of all sizes, not just those caught by the new reporting requirements, according to Wates. Each principle is accompanied by additional, non-exhaustive, narrative guidance, designed to help companies apply the principles in practice.

Corporate governance expert Tom Garbett of Pinsent Masons, the law firm behind Out-Law.com, said that the principles had been "deliberately formulated recognising that there is no 'one size fits all' for corporate governance in large private companies".

"Each principle is a short statement of an optimal position accompanied by non-exhaustive narrative guidance with acknowledgement in the draft preamble that the principles do not provide a checklist but a framework within which to demonstrate outcomes," he said.

"At a much higher level, the principles share the key concerns of the proposed revised UK Corporate Governance Code. Companies which choose to use the principles are encouraged to 'apply and explain': they are expected to provide a supporting statement for each principle that gives an understanding of how that particular company's corporate governance processes operate and achieve the desired outcomes," he said.

Although drafted relatively broadly, the principles capture some of the recurring themes in recent discussions around corporate governance. For example, when considering board composition, companies seek to put in place "a balance of skills, backgrounds, experience and knowledge", with individual directors having sufficient capacity to make a valuable contribution. The accompanying guidance notes that large private companies often face particular challenges due to the "closely held nature of ownership" within them, requiring directors to "have resilience and resolve to maintain objectivity in complex situations".

Companies should "present a fair, balanced and understandable assessment of the company's position and prospects, and make this available to its material stakeholders on an annual basis. The guidance notes that, for many large private companies, the largest 'material stakeholder' will be the workforce. Companies should therefore develop methods that "enable them to engage meaningfully with their workforce and utilise such forms of engagement when taking decisions".

On executive remuneration, boards should promote structures aligned to the company's "sustainable long-term success", taking into account pay and conditions of the wider workforce. The board should "establish a clear policy on the transparency of remuneration structures that enable[s] effective accountability to key shareholders", according to the guidance.

"This echoes some of the provisions in section 5 of the proposed revised UK Corporate Governance Code, underlining the view that executive pay in all companies should be set in the relevant context," said executive remuneration expert Suzannah Crookes of Pinsent Masons.

"The guidance does not give any clear steer on the extent of disclosures around executive remuneration but suggests that the board should establish a clear policy on the transparency of remuneration structures. Boards will need to consider their approach to transparency in light of the particular company's ownership structure, as the aim will be accountability to key shareholders," she said.

Corporate governance expert Martin Webster of Pinsent Masons said that the challenge for all companies caught by the new reporting requirements would be "to establish which code suits their circumstances best and, in the case of the outcomes-focused Wates Principles in particular, what form their reporting will take".

"The Wates Principles will be one option for large private companies to benchmark their practice against in the directors' report: the QCA Code and the UK Corporate Governance Code, for example, provide alternatives," he said. "The option remains, however, for a company not to apply any code, but if it does that it must explain the reasons why and set out what corporate governance arrangements it actually applied during the year."

"These requirements will apply to large subsidiaries of listed companies just as much as to large privately-owned companies, as long as they meet the employee or turnover/balance sheet tests when looked at on their own. The government’s justification for this is that under the 2006 Companies Act the duties of directors are owed to their company, not to the parent company, and so the corporate governance statement needs to be prepared from the perspective of the subsidiary company and its own directors, not the parent and its board. This may prove problematic for many subsidiaries which are used to acting on a group basis. The board of such a company will now be required to report on its own bespoke governance which may be quite different from that of its parent," he said.

The consultation on the Wates Principles closes on 7 September 2018. The FRC intends to publish the final version of the principles in December.