Written evidence from the Confederation of British Industry (CGV0069)

1. The CBI is the UK’s leading business organisation, speaking for some 190,000 businesses that together employ around a third of the private sector workforce. With offices across the UK as well as representation in Brussels, Washington, Beijing and Delhi, the CBI communicates the British business voice around the world. The CBI welcomes the opportunity to respond to the Select Committee’s inquiry.

2. The CBI believes that business is key in driving fairness across the UK and that business must engage constructively with the wider debate about the different levels of reward and representation across UK business. The issues being examined through this inquiry matter to business – if business is not only doing the right thing but also not seen to be doing the right thing then it can’t make a full contribution through its expertise, investments and ideas to create a more inclusive economy, in partnership with the government.

3. Recent reforms on executive pay have been significant, and in the CBI’s view have rightly put the emphasis on ensuring that shareholders have the right information and the power to hold Boards to account. Fundamental to the success of the UK governance model is the clarity of role between shareholders and Boards. This clarity ensures that Boards are accountable to shareholders for their actions, but remain free to get on with the day-to-day running of the business, while shareholders have the power to makes their views known and to assert them through the annual election of all board members and through advisory votes on pay.

4. While the UK remains a global leader in governance matters, CBI members agree that more can be done to even further improve transparency and accountability. The Government has identified its intention to focus on increased transparency, shareholder empowerment, and an effective employee voice. It is through these means that the UK corporate governance framework will deliver best practice and our members stand ready to work with government to shape the right mechanisms to deliver these aims.

5. As a package, the areas considered by the Select Committee present a significant set of measures which we will consider individually in this submission. Therefore in this response we argue that:

• On Executive Pay: Business is clear that high pay is only ever justified by outstanding performance, and accepts that action is necessary to address the public’s perception that executive pay has become disconnected from employee salaries.
• An effective response should focus on tackling those firms that persist in making payments that shareholders regard as egregious or inconsistent with company performance by providing greater accountability and transparency for shareholders.

• On the Composition of Boards: Diversity of thought throughout a business improves collective decision making;
• Businesses must foster a culture that allows diverse voices to be heard across the firm, including on pay and strategy.
• But the structure of the unitary board system must be maintained so Boards are able to take balanced, clear decisions.

• On Directors’ Duties: When used properly, the UK Corporate Governance system works well and is a vital part of UK competitiveness;
• But driving an improvement in behaviour is about culture change rather than regulation.

Executive Pay:

Business is clear that high pay is only ever justified by outstanding performance, and accepts that action is necessary to address the public’s perception that executive pay has become disconnected from employee salaries.

6. The CBI recognises that it is important that business responds to the public’s concerns about executive pay and accept the need for effective reform that enhances transparency and accountability.

7. The existence of the essential link between executive performance and reward is not always readily apparent from remuneration reports. Nor do remuneration reports always demonstrate proportionality between performance and reward. A lack of disclosure of the linkage between performance and reward remains one of the key reasons for shareholder dissent through the advisory vote.[1] There is also a minority of companies that continue with remuneration practices against shareholder wishes. This gives rise to a perception that there is no direct consequence of losing the advisory vote, and that controversial payments can continue to be made to senior executives, despite shareholder opposition.

8. The CBI has continuously been clear that high reward for mediocre performance, or reward for failure is unacceptable and that high levels of executive pay can only ever be justified by outstanding performance. Investors holding companies to account over exceptional pay for ordinary or poor performance is to be welcomed and encouraged.

9. Shareholders are the ultimate owners of businesses, and as such they should have the final say on pay policy. There is substantial evidence that increasing the role of shareholders by providing them with a ‘say on pay’ has been an effective tool in improving alignment between executive pay and shareholder interests.

10. The ‘say on pay’ and associated more detailed remuneration disclosure requirements have had a positive impact on the remuneration process, including underpinning tougher performance conditions. PwC data shows median CEO compensation in the FTSE 100 last year was down by 3% year on year.[2]

11. It remains too early to determine whether the plateauing of executive pay is the direct result of the introduction of triennial binding votes on future Directors’ Remuneration Policy. However, the direction of travel suggests that companies are increasingly reflecting and acting on the concerns of shareholders and are alert to the importance of their social licence to operate. The last few years have also seen increasing shareholder use of the advisory vote to encourage full retrospective disclosure of annual bonus targets. 

12. Our view is that for the majority of companies the current system provides a set of powers for shareholders that creates an effective feedback loop; companies that lose a remuneration vote generally respond to shareholder concerns in the following year.

13. So we believe that further reforms should focus on addressing the small minority of companies which continue to implement remuneration practices that ignore high levels of shareholder opposition. There are therefore changes which could be made to help reinforce the accountability and transparency of the remuneration system. We outline our thinking below.

An effective response should focus on tackling those firms that persist in making payments that shareholders regard as egregious or inconsistent with company performance by providing greater accountability and transparency for shareholders.

14. Analysis from PwC has found that one in ten FTSE 350 companies have received votes in favour of 80% or less (excluding abstentions) over the last few years. Of those companies, between a fifth and one-quarter received a vote of less than 80% the following year. This research suggests that there is an additional 2% of companies that have persistent low levels of support in addition to the 1% of companies who have had their remuneration reports voted down.[3]

15. The CBI supports efforts to provide shareholders with additional tools to hold companies to account over executive pay practices. The CBI does not support the introduction of an annual binding vote on pay outcomes. Such a move could lead to shareholders being less willing to cast a negative binding vote as opposed to an advisory vote, because of the potential destabilising consequences for CEO motivation and retention. The introduction of annual binding votes would be a disproportionate response that could weaken the feedback loop provided by the current regime.

16. The CBI believes that the government’s intentions would be best served by developing the existing regime to create an escalation mechanism that focuses any additional binding votes on those cases that warrant greater attention.

17. The CBI recommends that a binding vote regime should be triggered if a company loses the shareholder advisory vote on remuneration outcomes or if the company has faced a significant vote against this resolution in two consecutive years.

18. Code Provision E2.3 of the UK Corporate Governance Code outlines an expectation that a company explain what actions it intends to take to understand the reasons behind a significant proportion of votes being cast against a resolution. Similarly, the Directors’ Remuneration Reporting Regulations require listed UK companies to explain, in the remuneration report for the next financial year, the reason for a significant vote against the Directors’ Remuneration Report or the Directors’ Remuneration Policy, and any actions taken by directors to respond to those concerns. Legal & General have defined 20% as representing a ‘large voting opposition’, which is the same level deemed ‘significant’ by the GC100 group.[4]

19. This escalation mechanism represents a proportionate response that focuses attention on companies where shareholders view pay policies as most problematic and shareholders’ actions have been disregarded.

20. Under the CBI’s proposal, a company triggering the binding regime would be required to seek approval for a new policy at the next AGM. Seeking binding approval of remuneration policy provides a company with a licence to operate within that policy. Similarly it ensures that a company that has persistent and significant opposition is forced to come back to its shareholders to renew that licence.

21. This recommendation reflects the same principles adopted by Australia’s ‘two strikes’ system by providing shareholders with the ability to issue ‘one strike’ through the advisory vote with a ‘second strike’ triggering a binding vote. We believe that adopting this recommendation would strengthen the 2013 reforms to the Directors’ Remuneration Regulations and would work with the grain of the current system.   

Composition of Boards:

Diversity of background and experience throughout a business improves collective decision making.

22. There is a strong business case for increasing diversity. Diversity of thought and experience is known to lead to better decision making owing to more careful processing of information than in homogenous groups.[5] 

23. Increasing diversity in the boardroom is also fundamental to a positive corporate image as a visible reflection of the culture of a company. Maintaining a diverse boardroom is therefore key to protecting business reputation – and ultimately protecting the business. Opening the UK’s boardrooms to more women has been a crucial start to accessing the fullest possible talent pool. The CBI welcomed the work started by Lord Davies and continued by Sir Philip Hampton and Dame Helen Alexander. Their voluntary approach has had a significant impact on the trajectory of female representation in the boardroom. There are now no male-only Boards in the FTSE 100 and women hold 26.1% of board positions, compared to 12.5% in February 2011.[6] 

24. The CBI believes that by becoming more inclusive businesses will improve diversity in leadership and at every level. The CBI’s Time for Action report outlines the clear economic and social benefits of inclusive workplaces that are rich in diversity, differences of thought and experience.
25. There is good evidence indicating that committing to diverse leadership has a beneficial impact on performance across a business.[7] The CBI’s Time for Action report highlights that firms with the highest levels of gender and ethnic diversity are 15% and 35% more likely to outperform their rivals.[8] Workplaces that are both diverse and inclusive are also associated with higher individual performance because employees are better able to innovate (+83%) and more engaged (+101%).[9]

Businesses must foster a culture that allows diverse voices to be heard across firms, including on pay and strategy.

26. Businesses accept that more can be done to improve the diversity amongst senior business leaders, and the CBI supports the voluntary approaches being explored by the Hampton-Alexander, Parker and McGregor-Smith reviews.

27. The CBI believes that voluntary targets have a role to play in improving diversity at all levels of business and that they are best set by individual businesses, taking into account that firm’s starting point. These can be supported by national targets set by business-led reviews.

28. Our members were clear that each business faces its own mix of strengths and challenges, so there is no one-size fits-all plan for becoming more inclusive. Each business must first identify the challenges facing their organisation and the appropriate response. The CBI’s Time for Action report highlights a number of measures businesses can take to ensure the employee voice is represented and heard. These are considered below.

29. Our members recognises that low employee engagement risks fuelling disconnect between executives and employees in business on issues like pay. Placing employees on Boards is not a silver bullet to improve employee engagement which needs to be fostered at every level of businesses through leaders’ behaviours and good management. This means leaders that speak with confidence about inclusion and encourage practices to create a culture of openness and businesses with strong internal communication channels with employees at all levels – in both broadcast and receive mode.

But the structure of the unitary board system must be maintained so Boards are able to take balanced, clear decisions.

30. Feedback from CBI committees with senior representatives have provided mixed reports about the experience of an employee on their board, reinforcing the idea that it shouldn’t be interpreted as a ‘silver bullet’ solution. Members also noted the difficulty of transferring a practice from one culture, such as the German co-determined supervisory board system, to the unitary board system applied to UK companies.

31. Members were unanimous about the importance of maintaining the principle of a unitary Board system that allows Boards to consider and balance a variety of potentially conflicting interests. A number of members outlined their belief that the current law would prohibit an employee representative from considering the sectional interests of employees. Any change to the law to redress this could potentially have a disruptive impact on the clarity of remit and purpose of a company.

32. Members also raised practical concerns about the proposal, including the selection process for identifying the employee(s), particularly where the majority of profits and employees are drawn from outside the UK.

33. So rather than the government mandating employees on every Board, the CBI advocates an approach that requires firms to report on how they have secured employee engagement on a ‘comply or explain’ basis.

34. A ‘comply or explain’ model would allow a business to make a judgement about the merits of an employee representative based on the suitability of their business practices. This approach would encourage businesses considering having employee representation on the board to adopt this model. But for businesses where other vehicles may be more appropriate, such as employee representation committees or nominating a NED responsible for representing the employee perspective, they would have the flexibility to explain their alternative approaches towards employee representation. We would recommend that this new requirement only applies to companies with 250 employees or more to avoid additional burdens on small or medium sized businesses.

Directors’ Duties:

When used properly, the UK Corporate Governance system works well and is a vital part of UK competitiveness.

35. The UK is widely seen as a world leader in corporate governance. When applied robustly the UK’s corporate governance framework works well. The 2006 Companies Act, which sought to codify the duties of a director, was welcomed by the CBI as an important forward step in helping directors to understand and execute their responsibilities effectively.

36. Under section 172 of the 2006 Companies Act, directors are required to promote the success of the company. Within that section of the 2006 Act, the specific duty on directors to consider the ‘likely consequences of any decision in the long term’ ensures that directors must take a more rounded view as part of their duty to promote the success of the company.

37. As part of their statutory duties directors are also required to have regard to a wide range of stakeholders covering employees’ interests, fostering relationships with suppliers and customers as well as considering the impact of the company on communities, the environment and desirability of high standards of conduct. These duties ensure that directors are required to exercise independent judgement and reasonable care, skill and diligence.

38. The statutory Business Review also requires directors to provide a fair review of the company’s business, including disclosure of the principal risks and uncertainties, and also a balanced and comprehensive analysis of the performance of the business. 

39. CBI members therefore consider that the existing legal and governance obligations placed on directors and UK companies are sufficiently clear and well balanced.

40. On the specific question of whether there should be greater alignment between the rules governing publicly listed and private companies, members felt unable to respond in detail without knowing the specific parts of the UK Corporate Governance Code under reference. Members reflected that while some private companies will have governance structures similar to those of publicly listed companies, others will have very different structures, potentially making the compliance hugely burdensome.

But driving an improvement in behaviour is about culture change rather than regulation.

41. While CBI members are satisfied that the current duties ensure directors act with sufficient foresight and due care, companies are not complacent and reflected in their responses their efforts to strive to improve their business by focusing on company culture.

42. Strong governance underpins a healthy culture, and Boards should demonstrate good practice in the boardroom and promote good governance throughout the business. Good corporate governance is about achieving long-term sustainable value creation while taking proper account of shareholders’ and other stakeholders’ interests. The company as a whole must demonstrate openness and accountability, and should engage constructively with shareholders and wider stakeholders about culture.

43. The FRC have outlined the benefits of connecting purpose and strategy to culture in helping support the right values and drive the correct behaviours within a business. The FRC encourages businesses to align value and incentives to ensure that recruitment, performance management and reward should support and encourage behaviours consistent with the company’s purpose and values. There has been a growing assumption that a strong corporate culture is key to a well-functioning organisation, which has led to many Boards considering how they should assess their own organisational culture. On this the FRC recommends that Boards should give careful thought to how culture is assessed and reported on.[10]

44. The CBI believes that culture change can be best achieved by high-quality engagement between Boards and investors. Codes and the culture of comply or explain have worked well in the UK and are better at driving behaviour change than legislation and more regulation.

45. The importance of maintaining the company’s licence to operate is widely understood by businesses. We firmly believe that investors acting responsibly and policing corporate behaviour with a stewardship mind set, coupled with management acting responsibly and treating strong governance as the bedrock of good corporate behaviour – not a box ticking exercise – could help to strengthen the reputation of business in the community at large.

CBI campaigns team

26 October 2016