FRC criticises listed companies for minimalist approach to governance changes

The Financial Reporting Council (FRC), the UK’s boardroom regulator, has said that listed companies are only “paying lip service” to changes that were made to corporate guidelines last year.

In its annual review of the UK corporate governance code, which is set by the FRC, the regulator found that many large companies are failing to improve their corporate culture, diversity or take the views of shareholders and the public into consideration, favouring “strict compliance” instead.

Jon Thompson, the FRC’s Chief Executive, said: “While there are examples of high?quality governance reporting from ‘early adopters’, looking ahead we expect to see much greater insight into governance practices and outcomes reporting on a range of key issues from diversity to climate change.

“Concentrating on achieving box-ticking compliance, at the expense of effective governance and reporting, is paying lip service to the spirit of the code and does a disservice to the interests of shareholders and wider stakeholders, including the public.

“Where companies depart from the Provisions of the Code they need to provide compelling explanations for why non-compliance is the right approach for their particular company.”

The FRC said that the 2018 updates to the UK Corporate Governance Code were made to help build trust in businesses by forging strong relationships with key stakeholders.

The recent review compared reporting against the 2016 UK Corporate Governance Code and FTSE 100 companies that adopted the 2018 code early. The regulator’s analysis found:

• Some good examples of reporting by companies who are increasingly using incentives relating to non-financial matters and are grounded in long-term strategy.
• Many companies are grappling with defining purpose and what an effective culture means with too many substituting slogans or marketing lines for a clear purpose.
• There is insufficient consideration of the importance of culture and strategy, or the views of stakeholders. Following the FRC’s 2016 report on culture, companies should be commenting on culture and now explain how they are monitoring and assessing it.
• Limited reporting on diversity. Those companies that did report well had clear plans to meet targets – beyond just gender – and understood the long-term value of diversity.
• The use of engagement surveys was portrayed by many as an effective tool to achieve insight on employee engagement and culture. While these can help, they should not be used in isolation. Companies must be able to demonstrate that the engagement methods used are effective in identifying issues that can be elevated to the board and how this affects company decisions.

Commenting on the review, Anthony Carey, Partner and Head of Board Practice at Mazars said: “The review by the FRC on how companies are implementing the new UK Corporate Governance Code is a wake-up call for FTSE350 and other listed boards.

“The changes to the code around purpose, culture, stakeholder engagement and focussing on sustainable success were more radical than many realised at the time and it is clear that implementing the spirit of the new code needs to be high on boardroom agenda in the coming months.

“Implementing the new code wholeheartedly, rather than adopting a minimalist compliance approach, will yield far better returns for the business as well as its range of stakeholder’s.”

Explanations

While the code is not mandatory, it states that companies must include “clear and meaningful” explanations when a one of the provisions of the code has not been met, so that shareholders can understand why, and judge whether they are happy with the approach taken by the company.

The FRC has said that good quality explanations are those specific to individual companies, improve transparency, provide important insight into a company and how it is run and explain risks and mitigating actions.

The regulator sounded out a small number of companies for poor explanations that continually failing to meet the Code’s provision for board composition in terms of director independence.

Looking to the future, the FRC has said that “companies also need to ensure they apply the Code’s principles in a manner shareholders’ can more easily evaluate with a much greater focus on activities and outcomes reporting.

“This should set out the effectiveness of the board in decision-making, and how this has led to sustainable benefits for shareholders, employees and wider stakeholders.”

Carey believes that boards can no longer only focus on maximising profits, saying: “The days of only being interested in maximising profits are long gone, not least because it does not achieve its goal.

“Successful businesses need to be able to recruit the most talented team members and then motivate them, in order to achieve their full potential. This, among many things, requires an inspiring purpose on how the business will help meet the needs of all its stakeholders and wider society.”

Increased pressure on FRC

Following a string of corporate scandals, such as the collapse of Carillion and instances of uncontrolled executive pay as with Thomas Cook, the FRC has been under increased pressure to improve boardroom culture.

In 2018, it revamped the corporate governance code and introduced guidelines for boardrooms to work closer with employees, better investigate concerns with conditions, harassment, pay, and scrutinise corporate culture.

Boards were also urged to put greater pressure on management to act when it finds company culture clashing with a company’s strategy. It also set out new remuneration committee requirements.

The FRC also set a “comply or explain” provision for more than 60 listed companies that have chairs who have held their role for over 9 years. These companies must explain why they have gone over that limit.

The FRC is due to be replaced by the Audit, Reporting and Governance Authority (ARGA), and was alluded to in The Queen’s Speech at the start of the year. The intention is for ARGA to have a stronger mandate, new leadership and stronger statutory powers, although there is debate around how its remit will differ from the current one held by the FCA.

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