UK: PwC report on non-executive directors

PwC has published the 2008 edition of its annual report Non-Executive Director Practice and Fees, which is available for purchase from PwC (see here). A summary of the main findings has, however, been provided in a press release available here. Highlights from the report include (to quote directly from the press release):

Formal review of corporate governance and board effectiveness is becoming increasingly prevalent in UK companies, with 84% of respondents conducting annual performance reviews of their board. In addition, the average [non-executive] director’s time commitment has risen from 15 days in 2003 and 20 days in 2007 to 21 days in 2008.

Fee levels – fee levels continue to be influenced by both company size and time spent doing the job. The increase in fees for directors and chairmen is less pronounced than in previous years (an increase of 15.6% for directors and 25.0% for chairmen in 2008). 

Terms of appointment – there has been little change to policy regarding non-executive director appointments since last year. Most (78%) NEDs are appointed for an initial three-year term. 

Board structure – Analysis of the percentage of non-executives on the main board indicates that a 50/50 ratio of executive/non-executive is the median practice, although larger companies have a higher proportion of non-executives to executive directors (60/40 ratio).

Outside appointments – this year the survey showed a difference of market practice between smaller and larger organisations. In companies with revenues up to £500m, over half (51%) the companies have no executives serving on another companies’ board and are less likely to encourage executives to accept a non-executive appointment. Almost two thirds (62%) of companies with revenues over £500m have executives serving on other companies’ boards. The percentage was 52% and 59% in 2007".

Notes:

[1] The report is based on a survey of 155 companies and information in the most recently available annual reports of 1,500 quoted companies with year ends from September 2006 to February 2008.

[2] An overview of the 2007 report is available here.

UK: non-executives on E&Y's global advisory board

Earlier this year the Audit Firm Governance Code was published. Principle C1 of the Code provides that a firm should:

appoint independent non-executives who through their involvement collectively enhance shareholder confidence in the public interest aspects of the firm’s decision making, stakeholder dialogue and management of reputational risks including those in the firm’s businesses that are not otherwise effectively addressed by regulation".

The Financial Times newspaper reports - see here - that Ernst and Young is to appoint four non-executive directors to its global advisory board and that it is the first of the 'big four' firms to announce plans to do so. Further information is available in E&Y's press release: see here.

UK: the Manifest and MM&K executive remuneration survey

Today's Guardian newspaper reports - see here - the results of the latest remuneration survey conducted by MM&K and Manifest. According to the Guardian's report:

Chief executives of FTSE 100 companies have seen their remuneration rise by 5% to an average of £3.1m since 2008, while earnings per share fell by 1% over the same period ... Over the past 10 years chief executive remuneration has quadrupled while share prices have declined, suggesting little or no link between rewards, performance and shareholder value, according to MM&K and Manifest".

The full survey results are not available free of charge although MM&K have published a short overview, including a useful graph showing the composition of CEO pay over the past 10 years, here (pdf).

UK: corporate governance and AIM companies

Companies listed on AIM - the London Stock Exchange's Alternative Investment Market - are not subject to the "comply or explain" regime of the Combined Code on Corporate Governance.  The LSE AIM Rules for Companies (2007) contain some provisions concerning the conduct of directors but these are not intended as a substitute for the Combined Code. The corporate governance practices of AIM companies have been explored in a recently published PwC report titled "Corporate Governance and AIM - An assessment of the governance procedures adopted by AIM companies". According to the report's executive summary:

...governance procedures adopted by AIM companies vary widely. It is apparent that good governance is not necessarily a function of size of the company or its location, and it is hard to argue that the bigger the company on AIM, the better the governance. This survey shows that the composition of the Board is a particular area of weakness for many AIM companies. The need for strong independent non-executive director representation on the board appears to be something many AIM companies have yet to recognise. Perhaps linked to this, is the fact that only a fifth of the AIM Top 100 reported that they had assessed their Board effectiveness. This fell to only 5% of the smallest AIM companies in our sample. It remains to be seen whether the current voluntary approach to governance is a sustainable model for AIM, especially when the evidence of this survey shows a relatively limited application of best governance practices, across all segments of the market".

Germany: corporate governance developments

A the end of June, at the 7th German Corporate Governance Code Conference, Dr. Gerhard Cromme delivered his final speech as chairman of the Government Commission on the German Corporate Governance Code. In his speech, Dr Cromme discussed the development of the Code - widely known as the Cromme Code - and reflected on the German two-tier board model and issues associated with the transparency of business decisions and executive pay.  Regarding the latter, Dr Cromme observed:

In connection with cases of excessive severance payments, there were calls to shorten the term of management board contracts from five years to, say, three years. This would have limited the amount of potential several payments without introducing a severance payment cap. However, we came to the conclusion that the five-year term of office is the greater good - for reasons of planning and reliability alone, but also in the interest of a long-term corporate strategy. Only first time appointments should generally be made for a shorter term. Instead of shortening management board contracts, we introduced suggestions on the severance payment cap in 2007. At the start of this month we took this a logical stage further and upgraded the suggestions to recommendations. This means that non-compliance with this rule has to be disclosed in the annual declaration of conformity. This is transparency which will bear fruit in the long-term and change patterns of behaviour".

Further information about the recommendation on severance pay is available here and a video of the conference is available here. Interestingly, the UK's Financial Times newspaper has reported, in a piece titled "Berlin plans to curb excessive executive pay" (online edition, July 10):

Berlin is poised to crack down on what it considers 'excessive' executive pay in a move that could curtail the use of stock options in Germany. The Christian Democratic Union of Chancellor Angela Merkel has set up a working group that will start work in September on concrete proposals. These are likely to include a tightening of corporate governance rules and corporate taxation possibly as soon as the end of this year. The proposals, to be finalised in the autumn, are likely to make it into law since the CDU has the support of its coalition partner the Social Democratic party. The CDU initiative is intended to target DAX-listed companies, but would also affect executives of foreign companies who live in Germany".

NB:

[1] In the UK, under Section 188 of the Companies Act (2006), directors' service contracts exceeding 2 years (or those with any fixed or rolling notice period exceeding 2 years) require shareholder approval. This provision applies to all companies.

[2] The UK Combined Code on Corporate Governance (June 2008) provides:

B.1.6 Notice or contract periods should be set at one year or less. If it is necessary to offer longer notice or contract periods to new directors recruited from outside, such periods should reduce to one year or less after the initial period.

Australia: directors' guidance - CAMAC report published

Last year the Corporations and Markets Advisory Committee was asked by the Government (see here, pdf) to undertake a project concerning directors' role and responsibilities. CAMAC was asked to examine, amongst other things, whether directors' performance would be enhanced by the introduction of guidance for directors, through, for example, a code of conduct or best practice guidance, by a relevant regulator, and if so what form that guidance should take.

CAMAC published its findings and report this week: see here (pdf). The Committee rejected the case for a new code of conduct for directors but nevertheless stated that efforts to assist directors to understand their role and responsibilities should be pursued. The Committee also recommended that the Australian Securities Exchange should review its corporate governance principles and recommendations in the light of international developments.

It should be noted that CAMAC did not undertake empirical research to assess whether directors in Australia understand their role and responsibilities.

UK: the Bank of England and banking regulation

The Chancellor, Alistair Darling, has written to the Treasury Select Committee explaining his proposals for banking regulation reform and the governance of the Bank of England. In his letter, the Chancellor explains that financial stability will become a statutory objective of the Bank of England. The Bank's role in this regard will be overseen by a new Committee of the Bank's Court of Directors. Changes to the Court are also proposed: its size will be limited to a maximum of 12 members, the majority of whom will be non-executive.

Ireland: directors' duties and corporate groups

Ireland's court of final appeal - the Supreme Court - delivered its judgment in Mitek Holdings Ltd & The Companies Acts [2010] IESC 31 last week. The Supreme Court unanimously upheld an order restricting two individuals from acting as company directors for a period of five years. The order was made by the High Court in May 2005 on the application of the liquidator of five companies in liquidation, following the judgment Grace (Liquidator) v. Kachkar & Ors [2005] IEHC 63, under Section 150(1) of the Companies Act (1990).

In upholding the restriction order, the Supreme Court considered directors' duties, the increased expectations placed on non-executive directors and the conflicts that can arise in corporate groups. With regard to directors' duties, the famous propositions in Re City Equitable Fire Insurance Ltd. [1925] Ch 407 - including the statement that directors' responsibilities were of an intermittent nature - were described by the court as reflecting "the more relaxed standards of business in another age" (para. [73]).

The court made clear that where a company is part of a group, its directors must consider and act in the interests of each company. With regard to "group policy" in such structures, the court stated (para. [89]):

It may indeed be normal and permissible, within a group of companies, to take account of group policy. That does not mean that the property of one company can simply be transferred, at the behest of the parent, to another company in the group. That would be to ignore entirely the separate existence of each company".

With regard to non-executive directors, the court stated:

... non-executive directors of companies must be increasingly conscious in the times we live in that they cannot be mere ciphers or purveyors of votes at the whim of management. There was a time when even such a distinguished text as Gower (The Principles of Modern Company Law 3rd Ed. Stevens, London 1969 page 549) could state: 'public opinion has come to recognise that directorships are little more than sinecures, requiring, at the most, attendance at occasional board meetings.' The Act of 1990 itself evinces public concern that directorships involve real responsibility and that persons who do not conform at least to some generally acceptable minimum standards either should not, in the public interest, be permitted or should be restricted in regard to future holding of directorships".

Executive pay

Several recent posts on this blog (here and here, for example) have highlighted the debate about executive pay in America and Europe. This debate is considered in a couple of articles in this week's Economist. In the first, "Let the fight begin", it is argued that shareholder "say on pay" votes should become the norm and are preferable to Government intervention (it would be surprising if The Economist argued otherwise). In the second, "Pay attention", there is discussion of the debate about executive pay in Europe and the development of "say on pay" rules within the European Member States. The article notes:

By law in the Netherlands, Sweden and Norway, shareholders get a binding vote on compensation packages; in Britain they get a non-binding vote. Some Spanish and Swiss firms are voluntarily starting to offer shareholders a vote".

UK: election 2010 - women on company boards - more from the Conservatives

With election day fast approaching, the Conservative Party has today pledged to introduce "new rules" to "get more women onto boards of public companies". The Party is not proposing that a certain proportion of board directors should be female but is instead proposing - in its Contract for Equalities document, available here (pdf) - that:

We will require the long list for directorship appointments to include 50 per cent female candidates. This will help ensure that companies recruit from a diverse pool of candidates. It will apply to executive directors as well as non-executive directors. We will require all non-executive director positions to be advertised to ensure that talented potential candidates have the chance to apply for boardroom vacancies".

Some questions and observations: do the Conservatives mean public companies or listed companies? What form will these rules take (board diversity is something being considered by the Financial Reporting Council as part of its review of the Combined Code)? Main Principle A.4 of the Combined Code provides that "[t]here should be a formal, rigorous and transparent procedure for the appointment of new directors to the board". It does not, however, follow that board posts are advertised, a point recognised by Principle A.4.6:

A separate section of the annual report should describe the work of the nomination committee, including the process it has used in relation to board appointments. An explanation should be given if neither an external search consultancy nor open advertising has been used in the appointment of a chairman or a non-executive director".

Ireland: proposed corporate governance standards for banks and insurers

The Financial Regulator has published for consultation minimum corporate governance standards for banks and insurance companies: see here (pdf).

Amongst the proposals are the following (to quote directly from para. 1.5 of the consultation paper):

• Impose requirements in terms of the minimum number of directors on the Board.
• Limit the number of directorships which directors may hold so as to ensure they can comply with the expected demands of Board membership of an institution.
• Require that Board membership is reviewed at a minimum every 3 years.
• Require clear separation of the roles of Chairman and CEO and preclude an individual who has been CEO, director or senior manager during the previous five years from becoming Chairman of that institution.
• Set out clearly the role of the independent non-executive directors.
• Require the Board to set the risk appetite for the institution and to monitor adherence to this on an ongoing basis.
• Set out the minimum requirements for Board committees.
• Require annual confirmation of compliance to the Financial Regulator.

UK: ICSA review of the Higgs guidance - Company Law Committee response

The City of London Law Society Company Law Committee has published its response to ICSA's review of the Higgs guidance: see here (pdf). The Committee agrees with the aim of the review ("to offer guidance which, without being prescriptive, assists boards in understanding and implementing the purpose of the Code and, in so doing, delivers practical advice to boards on how they can apply the Code to enhance their effectiveness").

In section 1.1 of the first consultation paper (here, pdf) published as part of ICSA's review it was stated that the revised guidance would "refer to ethical sensitivity, and the need for the board to take account of ethical issues in setting business strategy and the manner in which business is undertaken". The Committee takes the view that this would not be useful for several reasons including the fact that including material on ethical issues may put at risk the largely uncontroversial nature of the Higgs guidance.

UK: Ernst & Young Corporate Governance Survey

Ernst & Young has published the results of its annual corporate governance survey. According to E&Y's press release:

"The annual Ernst & Young Corporate Governance survey, conducted by Ipsos MORI among the UK’s leading 500 companies, found that 35% of respondents claimed that regulation and governance will be the number one challenge facing non executive directors in the next 12 months – followed by general economic conditions (13%) and legal challenges and accountability (13%). Environment made it onto the list of the biggest challenges faced by non executives – the first time it has been identified as a major priority for this influential group of company directors. Gerald Russell a senior partner at Ernst & Young comments, 'Environmental and social issues have been pushed up company agendas in recent years – pressure is mounting for organisations to demonstrate responsibility in such areas as climate change and ethical sourcing. Finance and business leaders are being called upon to provide oversight on this emerging area. It is encouraging to see that they are finally waking up to the need to account for sustainability'".

NB: Should we be surprised that non-executive directors are now citing environmental issues given that Section 172 of the Companies Act (2006) provides that directors must have regard to the impact of the company's operation on the environment as part of their duty to promote the success of the company for the benefit of the company's shareholders?

UK: Building societies and corporate governance

The Financial Services Authority's Chief Executive, Hector Sants, delivered a speech titled "The future of financial regulation" on 7 May at the Building Societies Association Conference. During his speech, Mr Sants identified areas of weakness in the governance of some building societies:

"I would like to finish with a few words about corporate governance. There are three reasons for doing this. Firstly, we have seen inadequate review, assessment and challenge of proposed new initiatives. As I have already highlighted, we have particularly found this around the liquidity and funding issues with which societies have been confronted. Some societies have been very slow to appreciate the nature and scale of the market turbulence or react prudently.

Secondly, if a building society is to survive, prosper, and bring real benefits to its members, it must have a good quality board. A board, together with the senior management team, has to lead their society through these challenging, competitive and more complex times.

And thirdly, because, as you will be aware, we have maintained the guidance that says that building societies should have regard to the Combined Code when establishing and reviewing their own corporate governance arrangements. To this point may I highlight two matters that are set out in the Combined Code: That the board should undertake a "formal and rigorous" annual evaluation of individual directors and that non-executive directors should scrutinise the performance of management in meeting agreed goals and objectives.

I would ask you to consider whether this is a process which is well established at your society; and, in particular, is it "formal and rigorous". Do your Boards act on the results of the evaluation? In most cases there may only be behavioural changes to make. But in exceptional cases this might mean going further and questioning whether the person is still right for the role. Most societies do evaluate their executive directors, and many have processes that could be regarded as clearly demonstrating best practice, but in some cases we have seen this does not involve a structured process with, for example, agreed objectives and performance criteria against which the assessment is made. Such processes look neither "formal" nor "rigorous".

I would now like to say a few words about succession planning. This is, I am afraid, another area where we believe improvements should be made. I am sure you will agree it is vitally important for the long term health of a society that it has management depth and a credible management development and succession planning process. I am afraid that we do not believe that the practice in this area is always at the level we would expect.

Such deficiencies can carry considerable risk for a society, not least of which is the risk of stagnation and lack of focus which can result from a lengthy transitional period. May I thus use this opportunity to remind boards and non-executives in particular of their responsibilities in this area. This will be a theme we shall be returning to in the future.

In conclusion on governance, I would just like to underline the importance of boards focussing on what we say in the Building Society Regulatory Guide, namely “Society boards and management have a special responsibility to protect the interests of their members through the highest standards of corporate governance.” Public companies have the added pressure of institutional shareholders you are not subject to this additional scrutiny and thus must be extra diligent. I am sure you are all aware of this point, but I feel it bears repeating".

UK: FRC consultation on changes to the Combined Code

The Financial Reporting Council has today published a final report following its review of the Combined Code on Corporate Governance. A consultation paper has also been published setting out proposed changes to the structure and content of the Combined Code, including the recommendation that it should be renamed the UK Corporate Governance Code. 

A copy of the proposed new Code is included in the consultation paper. It contains new sections on leadership and accountability and a greater emphasis is given to the long-term success of the company. For example, the recast preamble/introductory section begins:

The purpose of corporate governance, supported by the Code, is to facilitate efficient, effective and entrepreneurial management that can deliver growth in shareholder value over the longer term".

Amongst the FRC's other proposals are:

• the annual re-election of the chairman or the entire board
• new principles concerning leadership by the chairman and the role, skills and independence of the non-executive directors (including their time commitment)
• board evaluation reviews should be externally facilitated at least every three years
• the chairman should hold regular development reviews with each director
• new principles on the board's responsibility for managing risk.
  

Sir Derek Higgs

Some sad news: the death of Sir Derek Higgs has been announced. Sir Derek was the author of what became known as the Higgs Report (a.k.a. "Review of the role and effectiveness of non-executive directors"). Today, the composition of the largest UK companies' boards owes a great deal to the Higgs Report (see here). The Report stressed the importance of non-executive directors in corporate governance: it recommended that at least half of the members of the board, excluding the chairman, should be independent non-executive directors. This is now a provision within the UK's Combined Code (A.3.2), although one that applies only to FTSE350 companies.

Obituaries have been published in The Daily Telegraph, The Guardian, The Financial Times, The Times and The Independent newspapers.

UK: the Walker Review of bank governance - final recommendations published

Sir David Walker has this morning published his final recommendations following his review of the governance of banks and other financial institutions. An overview is available in the accompanying press release. Amongst Sir David's 38 recommendations are the following:

• Institutional shareholders to sign up to a Stewardship Code, sponsored by the Financial Reporting Council with compliance monitored by the Financial Services Authority (the Code on the Responsibilities of Institutional Investors prepared by the Institutional Shareholders’ Committee will become the Stewardship Code)
• Annual re-election for the chairman of the board
• The chairman of a major bank should be expected to commit a substantial proportion of his or her time, probably around two-thirds, to the business
• An expanded role for the remuneration committee with regard to firm wide remuneration policy and "high end" employees
• Disclosure, within remuneration bands, of the number of "high end" employees (including executive directors)
• Deferral of incentive payments should provide the primary risk adjustment mechanism to align rewards with sustainable performance for executive board members and “high end” employees
• If the remuneration report receives less than 75% of the votes cast the remuneration committee chair should stand for re-election in the following year
• Greater expectations placed on non-executive directors regarding time commitment and tougher scrutiny by the Financial Services Authority
• Banks should have a board level risk committee chaired by a non-executive director
• The chief risk officer should have a reporting line to the risk committee and his or her removal should require board approval

Sir David proposes that most of his recommendations should be enforced through inclusion in the Combined Code on Corporate Governance or a separate Stewardship Code for institutional investors, both of which operate on a 'comply or explain' basis. The recommendations on pay disclosure will be included in the Financial Services Bill currently before Parliament.

Related video and audio resources: Sir David discussed his recommendations on the Radio 4 Today programme this morning: listen here. The BBC News website has a short video of Sir David discussing remuneration here. A video of Sir David's appearance before the Treasury Committee, where he was questioned on his review, appears here. 

Other materials: FSA statement | FRC statement | Government statement | 

Hong Kong: the HKEx Listing Committee report

The Hong Kong Stock Exchange Listing Committee has recently published its 2009 report: see here (pdf). The report notes (pp. 5-6):

The Listing Committee has formed a sub-committee to consider whether issuers should set up a corporate governance committee and how the role of the company secretary may be further enhanced. The sub-committee is also taking the opportunity to review other issues relating to the Code on Corporate Governance Practices (“CG Code”) as well as items pertaining to corporate governance that have arisen in the course of our administration of the Listing Rules in recent years. The objective is to make possible enhancements to the CG Code that is benchmarked against international standards. Topics covered include disclosure of information on directors, shareholders meetings and matters relating to directors, in particular, independent non-executive directors".

The report states that the enhancement of listed issuers' corporate governance standards is a priority for 2010. Specifically, the following are amongst the issues to be considered: the development of a corporate social responsibility code for listed companies; a review of the role of company secretaries; contributing to the Companies Ordinance rewrite; and the continuation of the Corporate Governance review (noted above).

India: Listing Agreement Changes

The Securities and Exchange Board of India (SEBI) has announced in press release 95/2008 several changes to the Listing Agreement. The following mandatory provisions have been added:

1. If the non-executive Chairman is a promoter or is related to promoters or persons occupying management positions at the board level or at one level below the board, at least one-half of the board of the company should consist of independent directors.

2. Disclosures of relationships between directors inter-se shall be made in specified documents/filings.

3. The gap between resignation / removal of an independent director and appointment of another independent director in his place shall not exceed 180 days.

4. The minimum age for independent directors shall be 21 years.

In addition, the following non-mandatory provision has been added:

The company shall ensure that the person who is being appointed as an independent director has the requisite qualifications and experience which would be of use to the company and which, in the opinion of the company, would enable him to contribute effectively to the company in his capacity as an independent director.

UK: decline in number of FTSE100 non-executive directors

Today's Financial Times reports, citing research by Reward Technology Forum, that the "... number of non-executive directors on the boards of FTSE 100 companies has fallen by 16 per cent over the past year ... in 2007-08 there were 753 non-execs on the boards of FTSE 100 companies, but in 2008-09 that number dropped to 631".