IIRC response to UK government on corporate governance reform

On 17 February 2017 the International Integrated Reporting Council submitted a response to the UK government’s consultation on corporate governance reform. The IIRC’s responses to questions posed by the government can be found below.

Is there a need to improve public trust in large UK companies? If so, what actions do you think government and business can take?

Public trust in business is low – the Edelman Trust Barometer is just one of several annual surveys that demonstrate the decline in trust in all established institutions, and business is key among them. This fall in trust has real consequences; it makes capital harder to source and more expensive; it impacts market efficiency; and it reduces the productivity of capital, making it more difficult to fund long-term investment. Encouraging patient capital is an objective of the Government’s Industrial Strategy and we believe the principles of the UK’s corporate governance system should be aligned to meet that objective.

In taking action to redress the balance and restore trust in business, we must be clear that this is not a UK-only phenomenon, but is international in scope. The UK has always demonstrated leadership in corporate governance, and our submission is made in that context, drawing on the IIRC’s experience of working in multiple jurisdictions globally.

We believe that transparency is the key. The flow of information between the management of a business and its principal stakeholders needs to be less moderated. The evidence shows that investors use corporate reporting as a proxy for corporate governance, the quality of management and, therefore, for capital allocation decisions. Improving the quality of corporate reporting must therefore be a key element in improving public trust in large UK businesses.

We believe above all that the UK should adopt a more inclusive corporate governance model. Most stakeholders have expectations of businesses over multiple time horizons and will wish to understand how value is being conserved and enhanced in its multiple dimensions – from protecting shareholder interests to securing the skills and intellectual capital to grow. This reasoning led to the development of the International Integrated Reporting Framework, which has been adopted by a large number of businesses in the UK and internationally, a key benefit of which has been to build trust and understanding with stakeholders. We would encourage the UK Government to study, in particular, the benefits of adopting a multi-capital approach and take action to embed this principle within mainstream corporate governance.

Evidence from the adoption of Integrated Reporting in over thirty markets worldwide demonstrates that this will orient the business towards the long-term and ensure the wider purpose of business is adequately expressed, taking into account the needs of primary stakeholders.

Is there a need to further reform the executive pay framework? If so, what do you think needs to be done?

We believe that the current statutory framework is robust but could be strengthened by the inclusion of more visible linkages in the Strategic Report between a company’s strategy, key performance indicators and performance (based on multi-capital thinking). We believe this greater insight would underpin the Strategic Reporting requirements to encourage an improvement in the quality of dialogue between boards and shareholders to focus less on the quantum of remuneration and more on the strategy underpinning it.

Is there a need to strengthen the voice of employees and other stakeholders at board-room level in UK companies? If so, how do you think this would best be done?

This review was prompted, in part, by isolated, but well-publicised, corporate reporting failures that has undermined public confidence. The root cause of those failings, in many cases, was a failure of management fully to reflect the legitimate needs, interests and expectations of its primary stakeholders within core governance and management of decision-making. Isolated disclosure requirements lead to silo-based management and decision-making. Therefore, while the Strategic Report is a very welcome development, and its requirements are consistent with the principles of Integrated Reporting, there remains a gap in terms of requiring the full integration of information to provide a clearer and more consistent understanding about how the needs of stakeholders are being taken into account in the implementation of strategy. One corporate governance innovation that we would highlight from international experience is the creation of a Corporate Stakeholder Relationship Officer (CSRO), an executive board position, a core element of whose role would be to bring to the attention of the board the evolving needs, interests and expectations of the company’s primary stakeholders, enabling the business to stay responsive and relevant. As such wider stakeholder needs become a core and permanent board agenda item.

Is there a need to extend elements of the UK’s corporate governance and reporting framework to some privately-held businesses? If so, which elements and to which companies?

Integrated Reporting has been developed as an inclusive framework, focused on a set of fundamental concepts and guiding principles that are universal in scope and application. We believe this approach is the best, and simplest, guarantor of the integrity of corporate governance and reporting in a modern business environment, with complex and diverse ownership models. We would therefore welcome greater alignment around a set of common principles that are easily identifiable and accepted by listed and privately-held businesses. For example, the introduction of a multi-capitals model for identifying and managing the varied resources and relationships used by business to create value would help to orient all businesses – private and public – towards longer-term decision-making, helping to attract more dedicated capital which will help to grow and sustain productive enterprises. We believe this should be helpful in the context of the Government’s Patient Capital Review, announced in the Chancellor’s Autumn Statement, and a key part of the Industrial Strategy.

Is the current corporate governance framework in the UK providing the right combination of high standards and low burdens? Apart from the issues addressed specifically in this green paper can you suggest any other improvements to the framework?

We feel it would be beneficial to have an international level playing field for corporate governance and reporting. Therefore the Government should use its voice at the G20 and in other international fora to put issues of corporate governance on the agenda to develop a broad consensus. As the UK develops new trading relationships in the aftermath of its withdrawal from the European Union, corporate governance and disclosure should become a major tool of soft power to enable the flow of productive and high quality investment. The signposting of developments such as Integrated Reporting, a global framework which strongly aligns to the UK’s legislative and regulatory regime, will only serve to amplify the UK’s influence and reputation for promoting high quality corporate governance and reporting to foster the conditions for investment.

Integrated Reporting is part of the trend towards removing burden for business, not adding to it, by creating efficiencies through having a holistic view of how your business will create value now and in the future.

The International Integrated Reporting Council’s four key recommendations are as follows:

1. Ask companies to demonstrate their adherence to Section 172: Section 172 of the Companies Act sets out the duty of directors to promote the success of the company, with various matters listed for the director to consider. However, companies are not required to report on their adherence to Section 172 or explain how they are fulfilling all of these duties. The language in Section 172 is very similar to that of the International <IR> Framework and we believe that the <IR> Framework would act as a useful tool to enable companies to demonstrate they are thinking about these issues.
2. Advance the benefits of multi capitals: This review was prompted by a series of well publicised failings in public companies, as well as a well reported disconnect between the public and business caused by a growing lack of trust. When a company thinks, acts and reports through the prism of the six capitals the issues that create this lack of trust are better managed and understood. For example, issues of human capital and stakeholder relationships are better articulated and considered.
3. Encourage corporate reporting integration to reduce silo thinking and decision-making: Companies are required to prepare a range of corporate reports – (strategic, financial, governance etc). However, there is no requirement to make these reports a holistic, consistent communication that tells the companies value creation story. We ask that the government calls on companies to prepare the various suite of reports they produce on an integrated basis. This will ensure better understanding by investors and all other stakeholders of how this company operates and its viability for the short, medium and long term.
4. Advocate for an internationally recognised approach: The Green Paper articulates that overseas investors now hold 54% of the value of the UK stock market. Integrated Reporting is now being implemented in over 30 countries – it is an internationally developed and internationally relevant framework that creates a common language for corporate reporting. By signposting UK companies to use the <IR> Framework, policymakers will be putting UK business on the same playing field as other businesses and investors internationally.