Written evidence from Standard Life (CVG0091)

Introduction

 

  1. Standard Life was established in Edinburgh in 1825. Today it is a global investment company helping people to invest and manage their money. Around 4.5 million customers and clients across 46 countries trust us with their financial future and we are responsible for the administration of £328 billion of their assets.

 

  1. This is a joint response on behalf of Standard Life plc and Standard Life Investments, although it draws primarily on our experience as a major investor on behalf of a broad range of institutional and retail clients. Standard Life plc floated on the London Stock Exchange in 2006 and is now a FTSE 100-listed company. Compliance with all aspects of UK corporate legislation and the UK Corporate Governance Code is seen as an important aspect of achieving the highest standards and meeting the expectations of our shareholders, employees, clients and the society in which we operate.

 

  1. Standard Life Investments has had a team in place to assess and influence the governance of the companies in which it invests since 1992 following the publication of the Cadbury Report. In recent years this work has extended to cover risks relating to environmental and social aspects of a company’s business and increasingly to include investments outside the UK.

 

  1. Standard Life plc and Standard life Investments recognise the importance of transparency and accountability and therefore endeavour to disclose in full how we achieve the standards expected of us. As an example, our 2015 Annual Governance & Stewardship Review can be accessed here:

 

http://www.standardlifeinvestments.com/exported/pdf/Governance_Stewardship_Review/Governance_Stewardship_Review_15.pdf

 

Executive Summary

 

 

 

 

 

Directors’ Duties

  1. The general duties of a director as set out in Chapter 2 of the Companies Act 2006 clearly describe the expectations of a company director. Further, additional detail in Section172(1) clearly defines their role in relation to long-term success, employees, wider stakeholders, the community/society, the environment and reputation.

 

  1. We believe that these are the right areas of focus for a director. There are, however, legitimate concerns about what can be expected under the description of having ‘regard’ to these broader aspects. We would suggest that it would be appropriate to state more explicitly that directors ‘must consider and report’ on how they achieve these additional aspects.

 

  1. It is important for companies to provide strong high quality disclosure on how their directors consider the interests of employees, wider stakeholders, the environment and reputation when making decisions to deliver long-term success for their company. Such reporting could be included in the strategic report that forms part of a company’s annual report and therefore also subject to the review of auditors to ensure that the statements are not materially incorrect.

 

  1. This duty is clear in the Companies Act under Section 172(1). It is difficult to envisage how it would be possible to ‘enforce’ a duty to promote long-term success. Directors must make decisions at a point in time using the information available to them. The Act states they must use independent judgement and consider long-term success. It is incumbent on boards and directors to be able to describe how their decisions consider the long-term success of the company. It is the disclosure of how this duty is fulfilled that should be used to ‘enforce’ the duty to promote long-term success.

 

  1. The interests of different stakeholders are best balanced by the board of directors who have a legal duty to do so under the Companies Act. In the UK companies have unitary boards and it is important that a board is composed of individual directors who are able to reflect the views of all stakeholders in their decision making. The nomination committee, through its director selection and succession processes, is key to creating the right balance of board members that will reflect a company’s stakeholders. The additional codes and guidelines that are designed to help boards and directors in achieving their duties are also important in delivering the desired outcomes.

 

  1. We believe that the unitary board provides the most effective method to meet the requirements of Section 172 of the Companies Act. Experience of jurisdictions that use two tier boards and representatives of specific stakeholder groups does not indicate that they provide better outcomes for companies, shareholders or the broader stakeholders represented on the board. The best challenge to executive management is a board acting together focused on the correct outcomes rather than through the use of representatives who concentrate on the interests of one group of stakeholders alone.

 

  1. Boards need to make clear disclosures which explain the processes by which decisions are made. Investors have a role to play in challenging and scrutinising the major strategic decisions made by a board. Certain of these decisions require a shareholder vote and therefore have a mechanism by which they can be influenced.

 

  1. In our view it is questionable whether the inclusion of employees on boards would make it easier to scrutinize and challenge board decisions. We believe in unitary boards and therefore any employee representative would be liable to the same duties as any other director and must make decisions to promote the long-term success of the company.

 

  1. However, we believe boards should take sufficient time to understand and respond to the views of employees and put in place robust mechanisms for doing so. For example, boards could be required to hold formal engagement sessions with employee representatives at least twice a year.

 

  1. As a leading institutional investor, we are aware of previous government concerns about specific corporate decisions not felt to be in the public interest. Institutional investors manage and are stewards of the savings and investments on behalf of beneficial owners, who are themselves individuals and employees of companies, taxpayers and members of society. Institutional investors need to recognise the role they play as stewards on behalf of individuals when scrutinising boards and the companies in which they invest. Although the UK Stewardship Code has raised standards, there needs to be further improvements in the levels of stewardship by institutional investors as a whole and asset owners that represent individual investors. 

 

  1. It is the owners of the equity of a company who have a role to play as stewards. Private companies may not have the broad spectrum of shareholders that perform a role in holding the management of public companies to account, but they do have equity owners who should fulfil the same function. Private companies operate within broader society and take decisions which impact on employees, the community and the environment in the same way as those of public companies. Legislation requiring the consideration of these stakeholders should apply to all companies, although there could be allowances so that requirements are proportionate to the size of companies.

 

 

 

  1. We believe that there are too many intermediaries involved in the stewardship chain. The use of advisors has become too commonplace and the incentives of many of these advisors are not aligned with good outcomes for companies, shareholders, employees or broader society. We are concerned that the use of advisors can be detrimental to clear communication and engagement between companies and their shareholders.

 

  1. The use of advisors does not alter the requirements of directors under the Companies Act and therefore their reporting still needs to demonstrate how they have met their responsibilities under the Act.

 

  1. In our input to the Kay Review we expressed the view that corporate finance advisors are not currently rewarded in a manner that aligns their interests with the long-term development of their clients’ business. We therefore suggested that a code of conduct should be implemented for investment banking and other advisors. As stated previously, companies need to disclose how decisions and transactions are aligned with the long-term success of the company and how they have had regard to the views of employees and the wider community. If this was the case, additional reporting on the role of advisors would not be necessary.

 

  1. The UK Corporate Governance Code has developed significantly since 1992, while still retaining the principles which were part of the original Cadbury Report. Some of these developments have been as a post-event reaction to corporate failures. The initial principles related to the appointment of Non-Executive Directors, Board Committees, the separation of the roles of Chairman and Chief Executive and the concept of ‘comply or explain’. These have strengthened the governance, decision-making and accountability of boards and are fully embedded in board practices.

 

  1. However, to be effective a governance framework must be complemented by the appropriate behaviours of those it applies to. The recent practice of regular and detailed amendments to particular sections of the Code means the focus of boards may be on demonstrating line-by-line compliance rather than on living by the high-level principles.

 

  1. Standard Life Investments invests on behalf of a broad range of institutional and retail clients. Since 1992 when it was established, our corporate governance team has been engaging with the non-executive directors of the companies in which we invest. This activity provides the opportunity to understand better the oversight of executives by independent non-executive directors. It is our belief that as stewards of the assets entrusted to us by our clients we have a role to play in assessing, understanding and holding to account those to whom we have allocated our clients’ capital.

 

  1. We believe that holding directors and companies to account is a vital aspect of the comply or explain principle and so, as mentioned in our answers to other questions, further improvement in the levels of stewardship is needed to ensure sufficient scrutiny over compliance and explanation. In addition, the audit industry has a role to play in assessing compliance and explanations in their review of the strategy and corporate governance sections of annual reports.

 

  1. Legislation is already in place through the Companies Act. Alongside this, the UK Corporate Governance Code provides the basis for UK companies’ governance and, linked to the Stewardship Code, their interaction with shareholders. We believe this existing legislation and the codes provide the best basis on which to continue to build and deliver the desired outcome of long-term successful companies.

 

  1. We are of the view that further improvements are needed in respect of the ‘stewardship chain’. We therefore recommend that the framework of legislation and codes should remain as currently in place, but there needs to be continued activity by regulators such as the Financial Reporting Council to encourage improved applications of the Corporate Governance and Stewardship Codes.

 

Executive pay

  1. Much has changed in UK businesses over the last 30 years. Many are now firms with truly global footprints; reportedly approximately 80% of the revenue of FTSE100 companies now comes from abroad and there is increasing overseas ownership of UK companies’ market capitalisation, which stood at 54% on 31 December 2014 according to ONS data. These large, multinational firms employ people globally and need to be able to attract the talent they require to run their businesses and to be successful in what are increasingly complex senior roles. More junior positions tend to be filled locally where competition to attract talent has not had the same impact on levels of pay. This global competition for the best talent is one of the reasons for the relative increase in executive pay when compared to more junior roles.

 

  1. However, there have also been business changes that have resulted in the upward pressure on executive remuneration and, as an institutional investor, we believe that there are instances of excessive pay and there is an impression that in some cases remuneration committees have been working for CEOs rather than shareholders.  Remuneration committees have a key role to play in demonstrating how remuneration policies attract and retain the talent required, incentivise the behaviours and decision making needed to deliver the strategy and align incentives to the creation of the long-term successful companies that are sought by all stakeholders, including shareholders.

 

  1. Board Committees also need to consider individual factors that contribute to upward pressure on executive remuneration.  Nomination Committees, for example, have an important role in succession planning, as it has been seen that external rather than internal executive appointments can have an upward impact on executive pay.  Remuneration committees should review the use of benchmark data and carefully select the most appropriate benchmarks for the incumbent, considering the role and industry, and balance the use of this data with consideration of performance levels.

 

  1. There are a number of ways that pay can be linked to long-term corporate performance, from the use of share price to the various financial metrics that are considered to be aligned with the delivery of the strategy and the long-term success. It is not possible to define a single method of how pay should take account of long-term performance, but in designing pay policies companies should seek to create incentives that encourage the executive to make decisions based on the long-term success of the company rather than financial measures which risk being impacted by short-term decisions.

 

  1. In particular, consideration should be given to aligning executive wealth, as well as income, at risk to the experience of the shareholder through the building and maintenance of a shareholding level which brings exposure to share price movements and dividends over a period beyond the end of the performance period of traditional long-term incentive plans. 

 

  1. As previously described, executive pay policies are important in attracting the talent required to operate a successful global business. The recruitment, decisions and succession of senior executives, especially the CEO, have a direct impact on shareholder value. We do, however, believe it is important that all employees are paid at a level which reflects their performance, skills and experience and we should seek remuneration schemes that incentivise and align the whole of a company’s workforce to the success of the business. As such, we support employee share save, profit participation and similar schemes. In the past, tax policy has benefitted the use of such schemes and we suggest that a review of the role of policy in encouraging share save and profit participation schemes for all employees would be worthwhile.

 

  1. There have been a number of occasions where Standard Life Investments has taken voting action on behalf of our clients in relation to remuneration outcomes. These were mainly in situations where we believed that the pay outcomes were not reflective of the corporate performance; however there is at least one occasion where our main concern was quantum. We do not believe that government should seek to control pay, but we do believe it has a role to play in putting in place legislation that creates the framework for those responsible for setting executive pay to be held to account.  Further mandatory disclosure requirements could be considered to provide information which would assist shareholders in their evaluation of quantum and how this is aligned to corporate performance.  

 

  1. Recent actions demonstrate that shareholders are willing to use their votes where they believe that remuneration policies or outcomes have been inappropriate. We also believe that the significant votes against, even when solely advisory, have led to companies taking action to understand the concerns of shareholders in order to try and address them in the future. The recent voting season demonstrates that the framework is bedding in effectively but there is some way to go in creating an environment where companies’ remuneration is entirely aligned with the views of shareholders.

 

 

  1. We are not convinced that increasing the role of shareholders would improve current remuneration outcomes. The proposed use of an additional annual binding vote creates significant issues, for example multiple votes may be required to cover various pay decisions for different executive directors and the vote would be required to be on pay that has already been made to executives, thus creating uncertainty and possible recruitment difficulties. 

 

  1. It may be beneficial for there to be additional opportunities for companies to engage with collective groups of shareholders and employees in advance of AGMs in order to gather clear views on remuneration plans.

 

Composition of Boards

  1. There are a number of pieces of research available on the impact of gender diversity on boards. The most recent we have encountered is at the following link:

 

http://publications.credit-suisse.com/tasks/render/file/index.cfm?fileid=5A7755E1-EFDD-1973-A0B5C54AFF3FB0AE

  1. When meeting with board directors as an institutional investor, they often comment on the positive impact of gender diversity on boards, particularly in relation to the decision making process.

 

  1. We support the principle that due regard should be had for the benefits of diversity when undertaking a search for board candidates, both executive and non-executive. We recognise that diversity can bring insights and behaviours that may make a valuable contribution to an effective board. We believe that a board should have a blend of skills and attributes amongst its individual members that are appropriate to its needs. There has been significant improvement in the recent past to the disclosure of diversity within companies. This should continue to be a focus, particularly in relation to gender diversity. When disclosing on diversity matters companies should consider the aspects of diversity that are important to them as a business and report accordingly.

 

  1. As previously highlighted, boards are required to have regard for the interest of employees. We do not believe that it is necessary for there to be employee representation on boards for this to be delivered effectively. Indeed, as stated, we believe in unitary boards and therefore any employee representative would be liable to the same duties as any other director and must make decisions to promote the long term success of the company. Boards must, however, be able to demonstrate and report on how they have had regard for the interests of employees in their decision making process. This could include, for example, boards meeting with employee representatives on a formal basis at least twice a year.

 

  1. Companies and shareholders should continue to support initiatives that are designed to increase the number of women in senior management and executive positions. We believe that there is already broad agreement on the benefits of gender diversity and that initiatives designed to maintain focus on the importance of gender diversity are useful in further increasing the number of women in senior management roles.

 

 

 

26 October 2016

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