Ellason lens on… the FRC Annual Review of Corporate Governance 2021

Wed 01, December

The Financial Reporting Council has recently published its second review of companies’ reporting against the 2018 UK Corporate Governance Code. This year’s report highlights a general improvement in the level of reporting; noting that better governance practices can improve company decision making processes, and improved disclosure increases the accountability of a company to its shareholders and stakeholders.

The report, however, notes some areas which require further attention to improve the standard of reporting, including on the Code’s remuneration principles. Notably:

The report reiterates one of the major concerns raised by the FRC last year of the need to improve the level of ‘comply or explain’ reporting. Companies should be explicit when they have not complied with the Code and provide the explanation why. These disclosures can be improved by providing the context and background for non-compliance, the rationale for the approach being taken (including any mitigation actions) and set out by when the company intends to comply. The report also noted that the Provision with the highest level of non-compliance was on alignment of executive pensions to the workforce average.

Ellason commentary: Avoiding boilerplate language and providing supporting information can pre-emptively address shareholder concerns before they are reflected in votes at the AGM. For example, providing detailed explanation as to why executive pensions are not yet fully aligned with the workforce; and how the company intends to address this can assuage shareholder concerns and ensure adherence with the Code provision of ‘comply or explain’.

Companies should demonstrate how executive remuneration aligns with the company purpose, values and strategy. Whilst all the companies reviewed by the FRC stated that their remuneration structures supported the strategy, less than half explained in any detail how they did this. The choice of performance metrics is crucial, and it should be clearly explained in the remuneration report how the chosen metrics align with the company’s purpose and support its strategy.

Ellason commentary: Improved explanation on how remuneration is aligned with purpose and strategy assures both stakeholders and shareholders that the remuneration policy encourages behaviours that will lead to sustainable, long-term value creation. Companies should be delivering a consistent message throughout the annual report, with a clear narrative on how purpose, values, strategy and pay are connected.

Companies should provide greater detail on the engagement with employees on executive remuneration matters; explaining the methods undertaken, the issues discussed, and the feedback received.

Ellason commentary: Whilst approaches to employee engagement continue to evolve, with many direct engagement approaches being impacted by the pandemic, companies are still expected to report in detail on the nature of the engagement undertaken with the workforce on executive remuneration and the feedback received to increase confidence in the process. We anticipate many more companies will be reporting in their 2021 annual reports on how the remuneration committee has engaged with the workforce, based on our discussions with clients and other corporates.

Companies should also report on the impact and outcome of engagement with shareholders. The report highlights examples of good practice in this area as covering the remuneration issues discussed, the feedback received and the impact this had, if any, on remuneration policy and outcomes.

Ellason commentary: The report notes that almost three-quarters of companies surveyed reported seeking input from a range of investors – beyond the largest holders – which was encouraging. However, few provided specific commentary on how the views sought informed Board decisions. The FRC is looking for companies to demonstrate the effectiveness of this process in their public reporting.

Companies should explain whether the committee has used its discretionary powers to override remuneration outcomes.

Ellason commentary: Shareholders welcomed the enhanced reporting companies provided last year to position the remuneration outcomes against this wider context and there is a desire for this to continue. The FRC’s report notes that the best disclosures included not only those where discretion was used to moderate for the impact of the pandemic but also those where the pay outcome was justified in the context of the stakeholder experience and the committee explained why it did not see it as necessary to use its discretionary powers.

Please do not hesitate to contact any of the Ellason team should you wish to discuss this issue further.