Holding big businesses to account: pay gap reporting

Yes, yet more corporate governance reforms are coming. This time the Government is to introduce legislation which will require listed companies with 250+ employees to publish annually the pay difference between chief executives and staff.

Why?

Concerns were raised following the Government’s corporate governance review that many executives at big firms are receiving salaries well beyond what is reasonable when compared with company performance.

The new legislation, due to be laid before Parliament this week, will give employees a greater voice at boardroom level and will hold businesses to account for the salaries they pay to higher placed executives.

The Government is keen to maintain the UK’s reputation for being a dependable and confident place to do business. Requiring companies to publish pay gaps will help to improve transparency and boost accountability – both of which are key components in ongoing corporate governance reform.

High pay is justified by outstanding performance and an excessive salary which rewards poor performance is deemed to be unacceptable. The recent collapse of Carillion is a prime example of the bad publicity which can result from bad internal governance: following the collapse it emerged that Carillion’s directors were paid substantial salaries, despite the company’s underperformance. It is scenarios like this that the Government is keen to avoid.

Companies will have to report on pay ratios, comparing the remuneration of chief executives to the average pay of the wider workforce. The company will also need to produce a narrative and explain any changes to the ratio from the previous year, demonstrating how the reported ratio is reasonable when compared with the pay and conditions across the wider workforce.

What else?

As part of wide ranging corporate governance reform we have already seen the introduction of a public register, controlled by the Investment Association, which names listed companies where more than 20% of shareholders have voted against resolutions, which include resolutions on executive pay.

Following the Government’s review, the UK’s corporate governance code is to be revised by the Financial Reporting Council to strengthen aspects relating to employee and stakeholder voice. This new code is likely to be effective from January 2019 with the code being published later this summer.

We are also set to see a corporate governance code for private companies. This code is being drawn up by a group of industry bodies and will be the first set of governance principles to impact on private businesses.

As mentioned in a previous post the Government is keen to strengthen three key areas of corporate governance:

• employee and other stakeholder voice;
• governance of large private companies; and
• executive pay.

These latest reforms provide developments in all three of these key areas. A briefing paper has recently been published which outlines the Government’s plans for corporate governance.

In addition…

The new legislation, as well as introducing the pay ratio reporting requirement, will also require large private companies to report on their responsible business arrangements. The directors of all large companies will also be expected to set out how they are acting in the interests of employees and shareholders and the company must report on this.

The Companies Act imposes various duties on company directors, one of these being to consider the interests of different stakeholders when making decisions (particularly financial decisions) relating to the company. The new requirement to provide narrative reporting on the fulfilment of these duties will not be included in the revised corporate governance code and will instead be introduced through legislation.

Pay ratios provide an insight into the culture and internal practices of large companies and this is beneficial to employees and the wider stakeholder base. If the legislation receives Parliamentary approval, the new legislation will come into force from 1 January 2019 (to coincide with the new corporate governance code) and companies will be required to start reporting pay ratios from 2020.