UK listed companies to look further forward than one year in updated Corporate Governance Code

Out-Law News | 18 Sep 2014 | 3:45 pm | 3 min. read

UK listed companies will be required to look further forward than just the next year and to ensure that executive pay is designed to promote the company's "long-term success" under changes to the Corporate Governance Code.

The latest version of the code (32-page / 494KB PDF) will apply to companies with accounting periods beginning on or after 1 October 2014. It will require boards to incorporate a 'viability statement' covering the company's long-term solvency and liquidity in their reports to investors, which should cover a period "significantly longer than 12 months". Executive pay policies will have to contain clearer links between pay and the company's long-term success, and should enable the company to recover or withhold variable pay when appropriate to do so.

"The changes to the code are designed to strengthen the focus of companies and investors on the longer term and the sustainability of value creation," said Stephen Haddrill, chief executive of the Financial Reporting Council (FRC), which oversees the code.

"The changes also reflect and have benefitted from extensive consultation. Recognising their different circumstances, companies are allowed to choose the period over which they look forward but we are clear this should be more than a year and reflect the nature of the business. Crucially, the directors should explain their reasoning to investors. The changes on remuneration also focus companies on aligning reward with the sustained creation of value," he said.

The UK Corporate Governance Code sets out standards of good practice in relation to board leadership and effectiveness, remuneration, accountability and shareholder relations. The Listing Rules, set by market regulator the Financial Conduct Authority (FCA), require all companies with a premium listing of equity shares on the London Stock Exchange to report on how they have complied with the code in their annual report and accounts, and to explain where they have not applied it. There is no legal requirement for private companies to comply with the code, although they are encouraged to do so.

The new code requires companies to "robustly assess" their principal risks and explain how they are being managed or mitigated. Companies should regularly monitor their risk management and internal control systems and review their effectiveness at least annually. Details of that review should be provided in the annual report.

Companies should state whether they consider it appropriate to adopt the 'going concern' basis of accounting, and include in their report any material uncertainties that could affect their ability to continue to do so. They should state whether they believe they will be able to continue in operation and meet their liabilities over an "appropriate" long-term period, taking account of their current position and principal risks. Risk and viability disclosures can be included anywhere in the report, but will be covered by the Companies Act 'safe harbour' provisions which protect directors from compensation claims if included in the directors' strategic report.

On remuneration, the code replaces the previous requirement that it should be enough to "attract, retain and motivate directors of the quality required" with one that it should be "aligned to the long-term success of the company and demonstrate this more clearly to shareholders". Companies should consider appropriate vesting and holding periods for deferred remuneration, and put in place 'clawback' arrangements enabling them to recover or withhold variable pay when appropriate to do so. They should also explain when publishing general meeting results how they intend to engage with shareholders when a significant percentage votes against any resolution.

Share plans and incentives expert Matthew Findley of Pinsent Masons, the law firm behind Out-Law.com, said that the changes to the code reflected some of the themes that had emerged from the first year of the application of the directors' remuneration regulations.

"The focus on linking pay to the long-term success of the company is consistent with the wider pay debate and the call for transparent performance conditions comes from increasing investor disquiet about inadequate disclosure in this area," he said. "The toughening up of the requirement for clawback reflects the reality that listed companies in practice must now include such provisions in executive bonuses and share schemes."

"One of the biggest areas of contention on the horizon is the issue of post-vesting holding periods, possibly extending after departure. Remuneration committees are only required to consider imposing such conditions, albeit for the first time - but some will suspect that this will be toughened in due course. Many companies are resistance to the imposition of such provisions, seeing them as unnecessary given the extensive share ownership requirements already imposed on executives and also given the difficulty executives have in selling shares because of the negative message it may send out to the market," he said.

Announcing the changes, the FRC also indicated that its 2016 review of the code would consider the need to consult on boardroom diversity, including gender and race as well as "difference of approach and experience". The FRC is considering diversity as part of its ongoing review of board succession planning, it said.