The time for change has arrived again; after significant consultation over the past year or so, the latest version of the UK Corporate Governance Code (the “Code”) is now effective for all accounting periods commencing on or after October 1, 2014.
The Financial Reporting Council (“FRC”) generally seeks to update the Code every two years, in an attempt to ensure its contents remain on the pulse of developments and relevant to listed companies. The latest round of revisions seeks to extend the outlook of risk management strategies for a greater period, while also placing more emphasis on aligning remuneration policies with the long-term success of companies.
In an effort to improve the standard of information provided to shareholders, issuers will now be required to include a viability statement in their annual reports. More specifically, this should include a declaration on whether it was considered appropriate to adopt the going concern basis of accounting. Moreover, whereas traditionally going concern statements generally related to the coming 12 month period, it appears the FRC is attempting to encourage issuers to state whether they believe they will be able to continue in operation and meet their liabilities over a “significantly longer” period than 12 months. Indeed, Mr. Stephen Haddrill, CEO of the FRC, stated that “Recognising the different circumstances for business, companies are allowed to choose the period over which they look forward but we are clear this should be more than a year and reflect the nature of the business.” These viability statements should provide investors with a broader assessment of long-term solvency and liquidity, providing greater transparency to current and prospective shareholders.
In keeping with an increased focus on the long-term, the section relating to executive remuneration in the Code has been altered. A notable change has been made to underlying pay principles, representing a move away from the idea that the retention of talent is sufficient justification for large pay packages. Previously, the Code stated that “levels of remuneration should be sufficient to attract, retain and motivate directors of the quality required to run the company successfully…” which, some argue, has led to the constant escalation of compensation in the name of stealing talent away from other companies. However this may no longer be the case; as Mr. Haddrill explains, “the changes to the Code are designed to strengthen the focus of companies and investors on the longer term and the sustainability of value creation”. The revised wording of section D of the Code provides that: “Executive directors’ remuneration should be designed to promote the long-term success of the company.”
Another notable change included in the revised terms of the Code relates to the potential for recovery of remuneration awarded to executives. Ever since the financial crisis, the desire to enact mechanisms to recover compensation that had been granted based on misleading financials, or Company performance, has been gathering momentum, and the revised Code reflects this. The latest version of the Code recommends that, when designing performance-related remuneration for executives, “Schemes should include provisions that would enable the company to recover sums paid or withhold the payment of any sum, and specify the circumstances in which it would be appropriate to do so.” As such, for the first time, companies will be required to include clawback or malus provisions, or explain why they have not, in keeping with recent legislation in the UK which requires companies to disclose whether recovery provisions were part of a company’s remuneration policy.
It appears the FRC is seeking to encourage companies to look further into the future when assessing risk management and designing their remuneration structures, aims which appear to be in line with most investors’ sentiments. Moreover, the permeation of recovery provisions into the best practice recommendations continues, and most will likely see this as a step in the right direction in what many investors perceive as a battle against the ‘payment for failure.’