Consultation on Corporate Governance Principles for Large Private Companies

 

Background

In response to the BEIS green paper on corporate governance reform, the government invited the Financial Reporting Council (FRC) to work with a coalition group to develop a voluntary set of corporate governance principles for large private companies under chairmanship of James Wates CBE (the Wates Corporate Governance Principles for Large Private Companies (the Principles)). On 13 June 2018, consultation on corporate governance principles for large private companies was published by the FRC.

Under the new 2018 Companies (Miscellaneous Reporting) Regulations, which were published in draft form on 12 June 2018, qualifying companies are required to provide a statement of corporate governance arrangements in relation to that year. Qualifying companies are those which either have more than 2,000 employees, or have turnover of more than £200 million and balance sheet assets of more than £2 billion in a given financial year. Companies will be able to voluntarily adopt the Principles as an appropriate framework when making a disclosure about their corporate governance arrangement under the new reporting requirements.

The consultation is open for comment until 7 September 2018 and the final version of the Principles will be published in December 2018 to align with the coming into force of the 2018 regulations (expected to occur on 1 January 2019).

Application: 'Apply or Explain' Aapproach

Large private companies have differing management and ownership structures, so a one-size fits all approach to corporate governance is not appropriate. The draft Principles accommodate this by introducing a high-level approach which can be applied to any large company, while allowing sufficient flexibility for companies to explain the application and relevance of their corporate governance arrangements.

Companies that adopt the Principles are expected to:

• apply them fully;
• use an ‘apply or explain’ approach; and
• provide a supporting statement for each principle that gives an understanding of how their corporate governance processes operate and achieve the desired outcomes.

If a company adopts the Principles, it will need to explain through its directors’ report and on a website how corporate governance outcomes have been improved through application of the Principles. For example, draft Principle three states that a board should have a clear understanding of its accountability and terms of reference. Its policies and procedures should support effective decision-making and independent challenge. The consultation explains that this could be applied and explained in different ways, eg a large family owned company might seek to appoint an independent director to its board to introduce independent challenge. It could explain how the appointment of this director has delivered improved outcomes to its board’s decision making processes by identifying an example where the provision of independent challenge from the independent director has improved board decision making.

The 6 Principles

The Principles are broken down into 6 main Principles, supported by guidance for consideration. Each Principle, plus a summary of the guidance is set out below:

1. Purpose: An effective board promotes the purpose of a company, and ensures that its values, strategy and culture align with that purpose. Guidance for consideration:

• Key shareholders and the board should work in partnership to ensure the company operates with a clear sense of purpose.
• An effective board:- promotes and develops its vision of the company’s purpose;- can identify and explain how events/developments affecting the company’s long-term success have been addressed;- is responsible for ensuring that its strategy is clear and implemented throughout the organisation; and- is responsible for fostering and maintaining the company culture
• A company’s values should be integrated into the different functions and operations of the business.

   2. Composition: Effective board composition requires an effective chair and a          balance of skills, backgrounds, experience and knowledge, with individual              directors having sufficient capacity to make a valuable contribution. The                size of a board should be guided by the scale and complexity of the                          company.

Guidance for consideration:

• The chair leads the board and is responsible for its overall effectiveness.
• A balanced effective board:- embraces diversity;- promotes accountability; and- incorporates objective thought that promotes appropriate constructive challenge and effective decision-making.
• Companies should demonstrate a commitment to the ongoing professional development of their board, and directors should engage with such opportunities.
• A board should give careful consideration to its size and structure so that it is sufficient to meet the strategic needs and challenges of the organisation.

3. Responsibilities: A board should have a clear understanding of its accountability and terms of reference. Its policies and procedures should support effective decision-making and independent challenge.

Guidance for consideration:

• An effective board:- should establish and maintain corporate governance practices;- provide clear lines of accountability and responsibility to support effective decision-making; and- should have constitutional documents setting out policies and procedures that govern the internal affairs of the company.
• Effective corporate governance practices should mitigate the risk of unfettered powers vested in individuals. Companies should consider:- the value that independent representation can deliver in the context of overall board composition and company structure; and- seek opportunities to promote independent thought in the decision-making process.
• A board should have confidence in the integrity of the information used for decision-making and reported by a company. This will require the design and implementation of appropriate internal control systems (such as internal audit function).

4. Opportunity and Risk: A board should promote the long-term success of the company by identifying opportunities to create and preserve value and establish oversight for the identification and mitigation of risk.

Guidance for consideration:

• A board should consider and assess:- how the company creates and preserves value over the long term.- this should include an assessment of risk mitigation, as well as identifying opportunities for innovation and entrepreneurship.
• A board has responsibility for an organisation’s overall approach to strategic decision-making and risk management. This requires oversight of risk and appropriate accountability to stakeholders.

5. Remuneration: A board should promote executive remuneration structures aligned to sustainable long-term success of a company, taking into account pay and conditions elsewhere in the company.

Guidance for consideration:

• Appropriate and fair levels of remuneration are imperative to enable companies to secure high-quality directors and senior management. Alignment between the remuneration of directors and senior management and company performance should demonstrate a shared purpose and common objectives.
• Director and senior management remuneration should be developed around principles that align with the company’s culture, values and long-term success.
• The board should establish a clear policy on the transparency of remuneration structures that enable effective accountability to key shareholders.

6. Stakeholders: A board has a responsibility to oversee meaningful engagement with material stakeholders, including the workforce, and have regard to that discussion when taking decisions. The board has a responsibility to foster good relationships based on the company’s purpose.

Guidance for consideration:

• The board 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.
• A company should identify the stakeholder relationships that are integral to its ability to generate and preserve value. A board should demonstrate how the company has undertaken effective engagement with material stakeholders and how such relationships have been taken into account in its decision-making.
• For many large private companies, their largest material stakeholder is their workforce. Companies should develop methods that enable them to engage meaningfully with their workforce and utilise such forms when taking decisions.