Review of UK Corporate Governance Code 2016 and Introduction to 2018 Code

1.6 Review of the UK Corporate Governance Code 2016

• Main Sections and Principles (LEARS Mnemonic):

  • Leadership: Every company should be headed by an effective board which is collectively responsible for the long-term success of the company.

  • Effectiveness: The board and its committees should have the appropriate balance of skills, experience, and knowledge.

  • Accountability: The board should present a balanced and understandable assessment of the company’s position and prospects.

  • Remuneration: Levels of remuneration should be sufficient to attract, retain, and motivate (ARM) directors of high quality.

  • Shareholders: Focus on the board's relations with its shareholders.

• Section A: Leadership:

  • Collective Responsibility: The board is responsible for the long-term success of the company.

  • Division of Responsibilities: There should be a clear division of responsibilities at the head of the company.

  • No Unfettered Power: No single individual should have unfettered powers of decision-making.

  • Chairman's Role: The chairman is responsible for leading the board and ensuring its effectiveness across all roles.

  • Non-Executive Directors (NEDs): As part of a unitary board, NEDs should constructively challenge and help develop proposals on strategy.

• Section B: Effectiveness:

  • Composition (KIES): The board and its committees should have the appropriate balance of Knowledge, Independence, Experience, and Skills.

  • Appointments: There must be a formal, rigorous, and transparent procedure for appointing new directors, typically involving a Nominations Committee and a formal policy.

  • Time Commitment: All directors should be able to allocate sufficient time to the role.

  • Development: All directors should receive an induction upon joining and should regularly update/refresh skills through Continuous Professional Development (CPD).

  • Information: Information must be supplied to the board in a form and of a quality appropriate for them to understand.

  • Evaluation: The board must undertake a formal and rigorous annual evaluation of its own performance, as well as that of committees and individual directors.

  • Re-election: All directors should be submitted for re-election at regular intervals. For FTSE $350$ companies, this happens yearly.

• Section C: Accountability:

  • Financial Reporting: The board must present a balanced and understandable assessment of the company's position and prospects.

  • Risk Appetite: The board is responsible for determining the nature and extent of significant risks it is willing to take to achieve strategic objectives.

  • Internal Control: The board should maintain sound risk management and internal control systems.

  • Audit Relationship: Establish formal and transparent arrangements for corporate reporting, risk management, internal control principles, and maintaining an appropriate relationship with the company's auditor.

• Section D: Remuneration:

  • Incentive (ARM): Remuneration should be sufficient to Attract, Retain, and Motivate directors of the quality required, while avoiding paying more than is necessary.

  • Performance Alignment: A significant proportion of executive remuneration should link rewards to corporate and individual performance.

  • Formal Procedure: There should be a transparent procedure for developing remuneration policy and fixing packages. No director should decide their own remuneration.

• Section E: Relations with Shareholders:

  • Dialogue: Based on mutual understanding of objectives.

  • Board Responsibility: The board as a whole is responsible for ensuring satisfactory dialogue takes place.

  • AGM: The board should use the Annual General Meeting to communicate with investors and encourage participation.

• FRC Review Conclusions ($2010$):

  • Spirit vs. Letter: More attention must be paid to following the "spirit" of the Code rather than just the literal text.

  • Shareholder Interaction: The impact of shareholders in monitoring the Code should be enhanced through better interaction with boards.

  • Board Thought Process: Boards must think deeply, thoroughly, and on a continuing basis about overall tasks and member roles. This requires leadership from the chairman, support to/from the CEO, and frankness/openness among all directors.

1.7 Introduction to the 2018 UK Corporate Governance Code

• Evolutionary Timeline of Corporate Governance:

  • Cadbury ($1992$): General Corporate Governance.

  • Greenbury ($1995$): Directors' pay and Remuneration Committees (Mnemonic: "Greenbacks" = money).

  • Turnbull ($1998$): Risk and internal control (Mnemonic: Risk of a "bull" in a china shop).

  • Smith ($2003$): Audit committees.

  • Higgs ($2003$): Role of Non-Executive Directors (NEDs).

  • Combined Code ($2010$): Evolution toward the current versions.

• Definition of Corporate Governance (Cadbury Committee $1992$):

  • "The system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place."

  • Governance is a long-term "corporate culture" of respect, not a once-off activity.

• The "Comply or Explain" Principle:

  • The Code offers flexibility rather than rigid rules.

  • Application involves principles, "comply or explain" provisions, and supporting guidance.

  • Boards must use this flexibility wisely; a departure from a Code provision does not inherently mean non-compliance with the Code's principles.

• Overview of the $2018$ Code:

  • Published by the Financial Reporting Council (FRC).

  • This is the version currently examinable.

  • Represents a "substantial" rewrite, simplification, and reduction rather than a minor tweak.

  • Application Date: Financial periods commencing on or after $1$ January $2019$.

  • Mandatory For: Public Limited Companies (PLCs), specifically Premium listed companies on the London Stock Exchange and Main market listed companies on the Euronext Dublin.

• Introduction and Reporting Guidance:

  • Emphasizes company culture and the importance of valid board duties.

  • Addresses high-profile scandals and the nature of the governance framework.

  • Notes that effective application of Principles should be supported by high-quality reporting on Provisions.

  • Avoid a "tick-box approach."

Structural Comparison between $2016$ and $2018$ Codes

• 2016 Structure:

  • Sections: Leadership, Effectiveness, Accountability, Remuneration, Relations with Shareholders.

  • Main Principles.

  • Supporting Principles.

  • Code Provisions.

• 2018 Structure:

  • Sections: Board Leadership & Company Purpose; Division of Responsibilities; Composition, Succession and Evaluation; Audit, Risk and Internal Control; Remuneration.

  • Principles.

  • Provisions.

Section 1: Board Leadership and Company Purpose

• Characteristics: This section contains the most changes in the revised Code.

• The $5$ Main Principles:

  • A: A successful company is led by an effective and entrepreneurial board. Its role is to promote long-term sustainable success, generating value for shareholders and contributing to wider society.

  • B: The board establishes company purpose, values, and strategy, ensuring alignment with culture. Directors must act with integrity and lead by example.

  • C: The board ensures necessary resources are available to meet objectives and measure performance. It establishes a framework of prudent and effective controls for risk assessment and management.

  • D: The board ensures effective engagement with and encourages participation from shareholders and stakeholders.

  • E: Board ensures workforce policies and practices are consistent with values and support long-term success. The workforce must be able to raise concerns.

• Related Provisions: There are $8$ related provisions in this section.

Section 2: Division of Responsibilities

• Overview: Details the importance of specific roles in the governance process.

• The $4$ Main Principles:

  • F: The Chair leads the board, demonstrates objective judgement, promotes a culture of openness/debate, and facilitates NED contributions.

  • G: The board should include an appropriate combination of Executive and Non-Executive (especially independent) directors so no one dominates. There must be a clear division between board leadership and executive leadership.

  • H: NEDs must have sufficient time for responsibilities. They provide constructive challenge, strategic guidance, and specialist advice while holding management to account.

  • I: The board, supported by the Company Secretary, ensures it has the policies, processes, information, time, and resources needed to function effectively.

• Related Provisions: There are $8$ related provisions in this section.

Section 3: Composition, Succession and Evaluation

• Overview: Focuses heavily on independence and rigorous board selection.

• The $3$ Main Principles:

  • J: Appointments must be formal, rigorous, and transparent. Succession plans should be based on merit and objective criteria, promoting diversity (gender, social, ethnic, cognitive, and personal strengths).

  • K: The board and committees must have a combination of skills, experience, and knowledge. Membership should be regularly refreshed.

  • L: Annual evaluation should consider composition, diversity, and collective effectiveness. Individual evaluations must show that each director continues to contribute effectively.

• Characteristics of an Effective Board:

  • Experience and Qualification.

  • Independence (Executive vs. NED).

  • Vision (Short-term and long-term).

  • Communication and Strategic Skills.

  • Robust discussions led by a strong chairman.

• Related Provisions: There are $7$ related provisions in this section.

Section 4: Audit, Risk and Internal Control

• Overview: A highly topical and important aspect of the new core subject.

• The $3$ Main Principles:

  • M: Establish formal and transparent policies/procedures to ensure independence and effectiveness of internal and external audit. Satisfy integrity of financial and narrative statements.

  • N: Present a fair, balanced, and understandable assessment of position and prospects.

  • O: Establish procedures to manage risk, oversee internal control, and determine the nature/extent of principal risks the company is willing to take.

• Related Provisions: There are $8$ related provisions in this section.

Section 5: Remuneration

• The $3$ Main Principles:

  • P: Policies and practices should support strategy and promote long-term success. Executive remuneration should be aligned with purpose/values and linked to strategy delivery.

  • Q: Formal and transparent procedures for policy development. No director involved in deciding their own remuneration.

  • R: Directors exercise independent judgement and discretion, taking account of company/individual performance and wider circumstances.

• Related Provisions: There are $10$ related provisions in this section.

1.13 The Irish Corporate Governance Annex

• Applicability: Applies specifically to students in the Republic of Ireland (ROI).

• Target: Companies with a primary equity listing on EuroNext Dublin.

• Consistency: Does not contradict the UK Code but adds specific requirements.

• Specific Provisions Included: Board composition, appointments, evaluation, re-election, audit committee, and remuneration.

• Required Identifications/Explanations:

  • Explanation of why the number of NEDs is deemed sufficient.

  • Description of skills, expertise, and experience of each director.

  • The process for selecting/appointing new directors.

  • Methodology for annual evaluations (individual and collective).

  • Factors used to determine director independence.

  • Description of Audit Committee work regarding risk oversight.

  • Description of remuneration policy, including how performance elements are deferred and clawback arrangements.

Banks and Insurers in Ireland

• Statutory Requirements: These entities follow separate requirements issued by the Central Bank of Ireland (CBI) in $2016$.

  • Corporate Governance Requirements for Credit Institutions $2015$.

  • Corporate Governance Requirements for Insurance Undertakings $2015$.

• Mandatory Status: These are mandatory requirements; the "comply or explain" approach does not apply.

• Key CBI Requirements:

  • Board Size: Minimum of $7$ directors in major institutions; minimum of $5$ in all others.

  • Independent NEDs: Strict requirements on roles, numbers, evaluation, training, and support.

  • Directorship Limits: Limits on the number of other directorships a director may hold to ensure sufficient time for the institution.

  • Role Separation: Clear separation of Chair and CEO roles.

  • Cooling-Off Period: An individual cannot become Chair if they were CEO, director, or senior manager of the institution in the previous $5$ years.

  • Review Period: Board membership must be reviewed every $3$ years at minimum.

  • Risk Governance: The board must set the risk appetite and monitor it continuously.

  • Audit/Risk Committee: Minimum of $3$ members per committee. The audit committee must have relevant financial experience and one member with an appropriate qualification.

  • Official Attendance: Annual confirmation of compliance must be submitted to the CBI. Videoconferencing is allowed when a director cannot attend physically.

  • Chief Risk Officer (CRO): Credit Institutions must appoint a CRO to oversee the risk management function.

  • Diversity Policy: The nomination committee must establish a written diversity policy for board appointments.

1.14 Stakeholder Mapping

• Definition: Stakeholders are those who can affect or be affected by the organization.

• 2018 Code Shift: Increased focus on wider stakeholders, moving beyond just shareholders. Boards must describe in the annual report how stakeholder interests were considered in decisions.

• Mendelow’s Power and Interest Matrix:

  • Low Interest, Low Power: Minimal Effort (Inform via general communications like websites/newsletters).

  • High Interest, Low Power: Keep Informed / Show Consideration (Potential supporters/goodwill ambassadors; keep informed of interest areas).

  • Low Interest, High Power: Keep Satisfied / Meet Their Needs (Engage and consult; try to increase their interest to move them into the "Key Player" category).

  • High Interest, High Power: Key Players (Focus efforts here; involve in governance and decision-making; consult regularly).

• The IAMP Mapping Process:

  1. Identifying: Listing relevant groups, organizations, and people.

  2. Analyzing (VWii): Understanding perspectives using the following criteria:

     • Value (Contribution): Does the stakeholder offer information, expertise, or power?

     • Willingness: How willing is the stakeholder to engage?

     • Influence: How much influence do they have and over whom?

     • Involvement: Could they help or derail the process if included or excluded?

  3. Mapping: Visualizing relationships to objectives.

  4. Prioritizing: Ranking relevance and identifying key issues.

• Stakeholder Dispositions:

  • Against: The Enemy (undermines efforts) or The Cynic (tests resolve with cheap shots).

  • Neutral: Fence Sitter (not engaged, waiting to see results).

  • For: Change Champion (takes personal responsibility for success) or Willing Helper (anxious to lend a hand).

1.15 Corporate Culture

• Board Mandate: The board should assess and monitor culture. If management behavior is not aligned with purpose and values, the board should seek assurance of corrective action.

• Significance: Increasingly critical for entities in the public eye and for attracting human talent (e.g., Google, Facebook).

• Incentives: The $2018$ Code emphasizes aligning incentive schemes and rewards with culture to drive behaviors consistent with strategy and values.