I OVERVIEW OF GOVERNANCE REGIME
The United Kingdom (UK) system of corporate governance is generally seen as an effective model that has influenced many other jurisdictions in Europe and Asia. This helps to attract international companies wishing to gain access to a wide pool of investors, who are reassured by the governance obligations placed on issuers regardless of where their key business operations are located. In this chapter we focus on UK-incorporated companies with a premium listing on the Main Market of the London Stock Exchange. Requirements are relaxed, to a degree, for companies that are only able (or only choose) to obtain a standard listing, that are unlisted or that are not UK-incorporated companies.
The UK corporate governance system comprises laws, codes of practice and market guidance. Mandatory and default (i.e., opt-in or opt-out) rules and legal standards derive from common law, from statute (notably the Companies Act 2006 (Companies Act)) and from regulation (notably the Listing Rules and the Disclosure Guidance and Transparency Rules (DTRs) published by the Financial Conduct Authority (FCA), which is a statutory body). Some of these laws and regulations derive from EU law, but some are specific to the UK. The City Code on Takeovers and Mergers (Takeover Code) also has an important role to play in control-seeking transactions, and has statutory force. Each company's constitution, which will also impose governance requirements, has legal effect as a statutory contract between the company and its members.
The most important code of practice is the UK Corporate Governance Code (the Code), which is published and updated periodically by the Financial Reporting Council (FRC), which is also a statutory body. The current edition of the Code was published in 2018 and, as of 1 January 2019, applies to all accounting periods. In parallel, the UK Stewardship Code (Stewardship Code) seeks to drive best practice in enhancing the quality of engagement between investors and companies, and applies to the institutional investor community and not to companies directly. It was recently revised by the FRC, with the revised version taking effect from 1 January 2020. Finally, guidelines from the institutional investor community supplement these laws, regulations and codes of practice.
Despite not being of relevance to the companies we are considering here, it is worth noting that a new set of corporate governance principles for large private companies was published in December 2018. The Wates Principles are designed to assist large private companies to comply with the new statutory requirement for all companies of a significant size, which were not previously required to provide a corporate governance statement, to disclose their corporate governance arrangements. The Wates Principles introduce a more flexible approach to good corporate governance than the Code.
The bedrock of best practice corporate governance in the UK is a unitary board collectively responsible for the long-term success of that company. Core provisions include:
- a separate chair and CEO;
- a balance of executive and independent non-executive directors;
- strong, independent audit, nomination and remuneration committees;
- transparency on appointments and remuneration; and
- effective rights for shareholders (including a binding say on pay and without-cause removal rights), who are encouraged to engage with the companies in which they invest.
One defining feature of the Code is the comply or explain approach: rules for companies with a stock exchange listing (Listing Rules) require all companies either to comply with the Code or to explain why they do not. The Code is issued with an acknowledgement of flexibility; this is in recognition of the principle that no single governance regime would be appropriate, in its entirety, for all companies. This approach does, however, rely on shareholder engagement to challenge non-compliance where appropriate. Nevertheless, the FRC noted that 95 per cent of all FTSE 350 companies (the 350 largest UK-listed companies by market capitalisation) reported full compliance with the previous edition of the Code, or full compliance with all but one or two provisions, and there are encouraging steps being taken toward compliance with the latest edition of the Code. In many cases, non-compliance is due to circumstances rather than deliberate choice. This confirms that the provisions of the Code are widely adopted by companies despite the comply or explain philosophy.
The Code states that an explanation for non-compliance should set out the background, provide a clear rationale for the action being taken and explain the impact that action has had. Where non-compliance is intended to be limited in time, companies are required to indicate when they expect to conform to the relevant provision of the Code.
For the past few years, the UK system of corporate governance has, much like other systems around the world, been the subject of political and media scrutiny. Much focus has been on the responsibilities of business to a wider set of stakeholders in the context of some high-profile scandals, business failures and a shifting paradigm on corporate purpose. The revised Code reflects some of this debate; it envisages more companies becoming subject to its standards, removes certain exemptions for public companies outside the FTSE 350 and extends certain governance principles to large private companies. However, there remains, in many respects, a gulf between the baseline legal duties of companies and directors, and recent commentary around corporate purpose and governance.
II CORPORATE LEADERSHIP
i Board structure and practices
The UK system features a unitary board. There is no two-tier structure: executive directors and independent, non-executive directors instead act together as one board. The company's powers are exercised by its board acting collectively, with a small number of decisions requiring shareholder approval. In practice, substantial managerial authority is delegated by the board to the company's executives; the board appoints the executives and exercises an oversight function by approving decisions that do not require shareholder approval and that have not been fully delegated. Standing committees of the board typically include at least a nomination committee, audit committee and remuneration committee, but the creation of other standing committees, or ad hoc committees to exercise delegated powers, is permitted.
There is currently no co-determination principle in the UK requiring seats on the board to be reserved for employee representatives. However, as its most significant new proposal, the Code seeks to amplify the voice of workers in the boardroom. Companies can choose from three options to achieve this: a director appointed from the workforce, a formal workforce advisory panel or a designated non-executive director with specific responsibility for ensuring that the views of the workforce are represented to the board. Around 60 per cent of companies have taken the designated non-executive director approach, with the next most popular approach a combination of two or more of the above or alternative appropriate arrangements, such as employee forums.
The Code recommends that the board and its committees should have an appropriate balance of skills, experience, independence and knowledge of the company to enable them to discharge their respective duties and responsibilities effectively. At least half of the board, excluding the chairperson, is required to comprise individuals determined by the board to be independent. This way, no individual or small group of individuals can dominate the board's decision-making. It is the CEO, however, who is responsible for delivering the agreed strategy and for the day-to-day running of the company's business.
The criteria for determining whether a director may be regarded as independent are set out in the Code. A director will not be regarded as independent if that director:
- has been an employee of the company or its group within the past five years;
- has, or has had within the past three years, a material business relationship with the company;
- has received or receives additional remuneration from the company apart from a director's fee, participates in the company's share option or a performance-related pay scheme, or is a member of the company's pension scheme;
- has close family ties with any of the company's advisers, directors or senior employees;
- holds cross-directorships or has significant links with other directors through involvement in other companies or bodies;
- represents a significant shareholder; or
- has served on the board for more than nine years from the date of their first election.
The Code requires that the board constitutes a nomination committee, an audit committee and a remuneration committee. The strength and independence of these committees – whose particular duties are addressed in the Code and in recommended terms of reference published by ICSA – is a key factor in ensuring effective corporate governance, although ultimate responsibility for areas addressed by these committees remains with the board collectively. Some boards also constitute a risk committee that is separate from the audit committee, and has responsibility for overseeing risk exposure and future risk strategy.
The Code recommends that the audit committee should comprise at least three directors, all of whom are independent and one of whom should have recent and relevant financial experience. The chairperson of the board should not be a member of the audit committee. FTSE 350 companies are required to put their audit engagement out to competitive tender at least every 10 years, and the audit committee oversees this process.
The nomination committee should comprise a majority of independent directors. The chairperson of the board can be a member of (and chair) the nomination committee, but should not chair the committee when dealing with the appointment of their successor. The remuneration committee should comprise at least three independent directors. The chairperson of the board may sit on (but not chair) the remuneration committee, provided they were independent on appointment. Before appointment as chair of the remuneration committee, the appointee should have served on a remuneration committee for at least 12 months.
The separation of chairperson and CEO is one of the key checks and balances of the UK system. It has been recognised for some time that combining the roles increases the likelihood of one individual having unfettered decision-making powers. The Code recommends splitting the role of chairperson and CEO, and that the division of responsibilities between the two positions should be clearly established. If the roles of chairperson and CEO are combined (or if the CEO succeeds as chairperson), this must be publicly justified in accordance with the comply or explain principle, and the company should consult with major shareholders ahead of appointment, from whom it should expect close questioning.
The Code states that executive remuneration should be aligned to the company's purpose and values. A significant proportion of executive directors' remuneration should be structured to link rewards to the successful delivery of the company's long-term strategy (but pay for non-executive directors should not include performance-related elements).
Levels of executive remuneration have been heavily criticised by the public and in the media in recent years. In October 2019, following the collapse of Thomas Cook, directors were widely criticised in the media for their large remuneration packages during the company's final years. Standard Chartered also recently experienced 40 per cent of its shareholders voting against its new remuneration policy owing to a change in the methodology used to calculate executive pension allowances. The protest vote was the largest at a UK bank for five years.
Long-term incentive plans (LTIPs) have been the source of much scrutiny, and the Code now contains enhanced governance requirements for such plans. Among other things, there is a requirement for a five-year combined holding period between award and the participant receiving any economic benefit, and a requirement for companies to have clawback powers. The Code also requires additional disclosures to be made by the remuneration committee, for example, as to why the remuneration package is appropriate, how factors such as risk (behavioural and reputational) have been considered, and whether any discretion has been applied to the remuneration outcomes. The remuneration committee is also required to engage with shareholders and the workforce in setting executive remuneration, and to report on this engagement and its outcomes.
Shareholders of UK-incorporated, listed companies have a binding vote on companies' directors' remuneration policy. In broad terms, shareholders are required to approve, at least every three years, a policy setting limits and conditions for directors' remuneration. If payments and awards made by the company to its directors are not consistent with the shareholder-approved policy, they are recoverable from the director in question, and the directors responsible for approving the unauthorised payment or award are liable to compensate the company. Shareholders have, in addition, an annual advisory (i.e., non-binding) vote on the implementation of the approved policy during the previous year. Companies are also obliged to publish a report on directors' remuneration in their annual report, including the remuneration policy in the years it is being put forward for approval. This regime does not apply to employees or consultants who are not directors.
On 10 June 2019, the amended EU Shareholder Rights Directive was implemented in the UK. Key changes include a new requirement to keep remuneration reports available on a company's website for a period of 10 years and to disclose the annual change in each director's remuneration to the annual change in average pay of the company's employees over a five-year rolling period. Previously, the requirement was to keep remuneration reports available for one year, and only the CEO's remuneration was compared to the average employee's remuneration (although this requirement was, in itself, novel and relatively untested in the UK).
Where a company has 250 or more employees, it is also required to publish statutory calculations each year showing the size of the pay gap between male and female employees.
The role of the independent director is seen as essential in providing a balance on the boards of listed companies, and the Code and related guidance emphasise the need for independent directors to be suitably experienced, committed and prepared to challenge the executive directors. The Code emphasises the need for the board to promote the long-term sustainable success of the company, generating value for shareholders and contributing to wider society. It is the board's responsibility to establish the company's purpose, values and strategy, aligning each with the culture of the company. The concept of purpose is a novel and much-discussed requirement of the Code and there is little in the way of guidance as to how a company should establish, articulate, monitor and report against a statement of purpose (to the extent it does not do those things already). Statements of purpose are necessarily unique to each company, but each should focus on the stakeholder considerations necessary to ensure the long-term sustainable success of that company (i.e., the derivative generation of economic value for shareholders). The FRC's recent corporate governance review suggests that only 50 per cent of companies surveyed are currently articulating a purpose beyond generating a profit. The FRC expects investors to undertake closer analysis of the narrative used in company statements to assess a company's approach to its workforce and stakeholders, including to determine whether there is evidence of a clear sense of corporate purpose, culture and values, and how these align with the company's strategy.
The primary function of independent directors, according to the Code, is to scrutinise the performance of management and monitor the reporting of performance. The board should appoint an independent director to be the senior independent director to provide a sounding board for the chairperson and to serve as an intermediary for the other directors and shareholders when necessary. The senior independent director should be available to shareholders if they have concerns that contact through the normal channels of chairperson, CEO or other executive directors has failed to resolve, or for which such contact is inappropriate. The FRC's Guidance on Board Effectiveness (2018) further emphasises the critical role of the senior independent director to help resolve significant issues when the board is under periods of stress. Independent directors should hold meetings without the executives being present both with the chairperson and, at least annually, without the chairperson (led by the senior independent director) to evaluate the chairperson's performance.
In practice, independent directors generally meet with the other directors for board meetings at least eight times per year in addition to attending committee meetings. They should (and often do) have direct access to all staff below board level and all advisers and operations, and receive information at an early stage (before executive directors have made key decisions). The Code provides that, as part of their role as members of a unitary board, independent directors should constructively challenge and help develop proposals on strategy. On the other hand, a conscientious and independent standard of judgement, free of involvement in the daily affairs of the company, is seen as an independent director's key contribution to the boardroom. In this regard, the board is required to determine annually whether a director is independent in character and judgement and whether there are relationships or circumstances that are likely to affect the director's judgement.
Independent directors should also monitor the performance of management in meeting agreed performance objectives. They should satisfy themselves on the integrity of financial information and that financial controls and systems of risk management are robust and defensible. They are responsible for determining appropriate levels of remuneration of executive directors, and have a prime role in appointing and, where necessary, removing, executive directors, and in succession planning.
All directors, both executive and non-executive, owe the same fiduciary duties and a duty of care and skill to the company. These duties are derived from common law but have now been largely codified under the Companies Act. These statutory duties are:
- to act within their powers (i.e., in accordance with the company's constitution);
- to exercise their powers in good faith in the manner they consider most likely to promote the success of the company for the benefit of its shareholders;
- to exercise independent judgement;
- to exercise reasonable care, skill and diligence;
- to avoid conflicts of interest;
- not to accept benefits from third parties; and
- to declare any interest in a proposed transaction or arrangement with the company.
These statutory duties must still, however, be interpreted and applied in accordance with the pre-existing common law duties. Indeed, in respect of some directors' duties that have not been codified under the Companies Act, the common law rules remain the only relevant law. These include the duties not to fetter their discretion, not to make unauthorised profits by reason of their office and to keep the affairs of the company confidential.
UK law has adopted the enlightened shareholder approach to the orientation of its directors' duties. The Companies Act requires directors, when deciding how to exercise the powers of the company, to have regard to:
the likely consequences of any decision in the long term, the interests of the company's employees, the need to foster the company's business relationships with suppliers, customers and others, the impact of the company's operations on the community and the environment, the desirability of the company maintaining a reputation for high standards of business conduct, and the need to act fairly as between members of the company.
Much recent discussion of corporate governance reform has centred on the duties companies owe to stakeholders. The Code now seeks to ensure that companies are more open and accountable to their stakeholders, and particularly their workforce. Recent legislation also requires large companies to report on how directors have discharged their duty to consider the above-mentioned stakeholders. None of these developments will authorise directors to prefer the interests of other stakeholders to those of the shareholders; nor will it give other stakeholders any ability to hold directors legally accountable for their decisions. However, the recent trajectory of enhanced disclosures opens companies up to a new regime of public censure on such matters.
UK law takes a relatively strict approach to the enforcement of directors' duties. For example, unauthorised self-dealing is not reviewed ex post against an entire fairness standard, as it might be in Delaware; rather, the transaction is in principle voidable at the instigation of the company without any inquiry into its fairness. Breach of duty is, in principle, actionable only by the company to which the duty is owed, and not by its shareholders or creditors. While a shareholder may bring a derivative action on behalf of the company in relation to actual or threatened breaches of duty, the UK legal system is not well suited to private enforcement of directors' duties outside formal insolvency proceedings, so litigation by shareholders of a listed company alleging breach of duty by its directors is extremely rare.
In relation to control-seeking transactions (i.e., any proposed acquisition of 30 per cent or more of the voting rights), the Takeover Code requires shareholder approval for any proposed action by the directors that may result in any offer (or expected offer) for the company being frustrated, or in shareholders being denied the opportunity to accept or reject the offer on its merits. Shareholders are protected by the substantive and procedural rules regulating control transactions.
It would be extremely difficult for the board of a UK company unilaterally to adopt anything equivalent to a shareholder rights plan, or to issue shares to a white-knight bidder to block a hostile takeover. For better or worse, takeover regulation in the UK strongly favours the short-term interests of shareholders by depriving the board of anything other than the power to persuade shareholders to reject an unwanted offer. Changes to the Takeover Code from early 2018 do, however, give the board additional time for such persuasion, and require bidders to provide additional disclosures regarding their intentions for the target business (against which they can be held accountable after the takeover).
Other legislation imposes criminal and civil liability on directors, including health and workplace safety laws, environmental laws and competition and securities laws.
Appointment, nomination, term of office and succession
The Code provides that there should be a formal, rigorous and transparent procedure for the appointment of new directors to the board. The search for candidates should be conducted, and appointments made, on merit, against objective criteria and within that context should promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths. A nomination committee should lead the process for board appointments and make recommendations to the board. Independent directors should be appointed for specified terms subject to annual re-election. The Code prohibits the chairperson from remaining in post beyond nine years from the date of their first joining the board; however, this can be extended for a limited time, where necessary and with explanation, to facilitate effective succession and the development of a diverse board.
The Code states that all directors should be re-elected annually by shareholders. Each director's election is voted on separately, with statute requiring majority rather than plurality voting (i.e., an ordinary majority of shareholders can vote against – and hence block – a director's election). In theory, an ordinary majority of shareholders also has a statutory right to remove a director at any time and without cause, but annual re-election renders this right largely irrelevant in practice. Consequently, there is no concept of a staggered board under UK law.
The board should satisfy itself that plans are in place for the orderly succession of appointments to the board and to senior management with a suitably diverse pipeline, so as to maintain an appropriate balance of skills and experience within the company and on the board and to ensure progressive refreshing of the board.
The Hampton-Alexander Review (most recently published in 2019) and the Parker Review (most recently published in 2020) have both made a series of recommendations for companies to further gender and ethnic diversity, respectively, at board level.
The Parker Review recommended that all FTSE 100 boards should have at least one non-white director by 2021, and the same for FTSE 250 boards by 2024. The 2016 Hampton-Alexander Review set a target of 33 per cent women on FTSE 350 boards and 33 per cent women in FTSE 100 executive leadership teams by 2020. Both also make a number of recommendations to facilitate attainment of those targets.
Recent additions to the Code seek to reflect these recommendations in asking boards to intensify their efforts. Nomination committees will be required to ensure a diverse pipeline for succession, and annual reports will be required to explain actions taken to increase diversity and inclusion, as well as their outcomes. The Code also recognises a wider concept of diversity, which covers gender, social and ethnic backgrounds, cognitive and personal strengths diversity. The Listing Rules already require that companies' annual reports include a description of their diversity policy and its objectives, how it is being implemented and the results.
As of November 2019, the number of women on FTSE 100 boards exceeded 32 per cent (up from 12.5 per cent in 2011), but within the FTSE 350 there were still two all-male boards and 42 companies with only one woman on their board, with women still underrepresented in chair and CEO roles. Despite the seemingly modest target, representation of ethnic minorities on FTSE 100 boards actually fell from 9 per cent of boards in 2018 to 7.4 per cent in 2019, and the latest figures in the Parker Review show that 37 per cent of FTSE 100 companies and 69 per cent of FTSE 250 companies do not meet the Parker Review's targets for ethnic diversity. Improved reporting on board and ethnic diversity was, however, praised by the most recent Parker Review.
Listed companies are subject to a wide range of periodic, ad hoc and event-driven disclosure obligations, many of which derive from, or have been harmonised under, EU law, and relate to the following key areas:
- financial and operating results of the company, together with certain elements of narrative reporting;
- share capital and voting rights;
- members of the board and key executives;
- directors' remuneration;
- price-sensitive information (inside information);
- share dealing by insiders and significant shareholders;
- governance structure and policies (comply or explain);
- significant transactions; and
- transactions with related parties.
Companies are required to prepare and publish audited annual financial statements (prepared in accordance with EU-adopted international financial reporting standards) and to make these available to shareholders within four months of the financial year end and in time for the annual general meeting. These form part of the company's annual report, which must include elements of narrative reporting along with the audited financial statements. The annual report must include a strategic report in addition to the directors' report, the purpose of which is 'to inform [shareholders] and help them assess how the directors have performed their duty' to promote the success of the company. In addition to 'a balanced and comprehensive analysis of [both] the development and the performance of the [company's] business during the financial year, and the position of the [company's] business at the end of that year', the strategic report must contain a description of the principal risks and uncertainties affecting the company's business, information about the gender split of its directors, managers and employees, trend information and disclosure about certain environmental matters.
The DTRs require the publication of a half-year report within three months of the end of the relevant six-month period containing a condensed set of (unaudited) financial statements and an interim management report. The interim management report must include details of any important events in the relevant period, the principal risks and uncertainties for the remaining six months and details of related-party transactions.
Companies are required to disclose promptly all dealings in their securities (including non-voting securities) by persons discharging managerial responsibilities (PDMRs) and certain connected persons. Companies are also required to take all reasonable steps to ensure that their PDMRs and persons connected with them comply with the Market Abuse Regulation on dealings in securities. In general, this prohibits all dealings during defined close periods (in the 30 days prior to the publication of certain interim or any annual reports) and at any time when a company is in possession of price-sensitive information, subject to certain exceptions. Even when not absolutely prohibited, dealings by PDMRs and their connected persons above a de minimis threshold must be notified to the company and the FCA.
A person acquiring 3 per cent of the voting rights in a company must notify the company, which is in turn required to make prompt disclosure to the market. Disclosure is also required thereafter whenever that person reaches, exceeds or falls below each additional 1 per cent threshold.
The Listing Rules require significant transactions by a listed company to be disclosed to shareholders. Moreover, Class 1 transactions (i.e., large (measured by reference to profits) assets, gross capital or consideration) require not only disclosure but also shareholder approval by simple majority resolution.
In addition to certain shareholder approval requirements under the Companies Act, the Listing Rules require independent shareholder approval by simple majority resolution for related-party transactions unless they fall within certain exceptions (e.g., small related-party transactions). Related parties include PDMRs and shareholders holding more than 10 per cent of the voting rights, and persons connected with them. The Listing Rules also require a proposal for approval of a related-party transaction to be accompanied by an independent fair and reasonable opinion, typically from an investment bank.
It is worth pausing here to note that the UK is awaiting the implementation of three independent reviews of the audit and financial reporting sector: the Kingman Review of the FRC, the Brydon Review of the quality and effectiveness of audit and the Competition and Markets Authority (CMA) study of the competitiveness and robustness of the statutory audit market. The Kingman Review recommended, among 82 other recommendations, that the FRC be replaced as soon as possible with a new, independent regulator to be called the Audit, Reporting and Governance Authority. This recommendation was accepted by the government, which announced that the new regulator will be accountable to Parliament and have more extensive powers to better prevent corporate failures. Until the new regulator is in place, the government has begun work with the FRC to implement 48 of the other 82 recommendations. The CMA study has resulted in proposed legislation to separate audit from consulting services and, at the date of writing, both Deloitte and PwC have announced plans to reform their audit services. Lastly, the Brydon Review recommended implementing a new auditing standard, splitting the audit and accountancy professions and enhancing the shareholder role in the audit process. At the time of writing, it was not clear which of the Brydon Review's recommendations would be implemented.
IV CORPORATE RESPONSIBILITY
From an internal company perspective, effective corporate responsibility means high standards of risk management, disclosure and transparency, compliance with best practice and effective monitoring. In the UK, a key principle of the Code requires a board to maintain sound systems for managing risk and internal control. It suggests that the board should review these systems at least annually, and consider how much risk the company can (and should) take. The FRC has published its Guidance on Risk Management, Internal Control and Related Financial and Business Reporting, which aims to:
- bring together elements of best practice for risk management;
- prompt boards to consider how to discharge their responsibilities in relation to the existing and emerging principal risks faced by companies;
- reflect sound business practice, whereby risk management and internal controls are embedded in the business process by which a company pursues its objectives; and
- highlight related reporting responsibilities.
At the same time, the Code was amended to require an explicit statement in the financial statements about whether the going concern basis of accounting has been adopted, and whether there are any material uncertainties about the company's ability to continue to do so in future. Moreover, companies are also required to include in their annual report a broader statement about the board's reasonable expectation as to the company's viability, based on a robust assessment of the company's principal risks and current position. This information should give investors a clear and broad view of solvency, liquidity, risk management and viability and is expected to be subjected to greater scrutiny by the FRC's successor. The Investment Association advises that directors should consider, for example, the sustainability of dividends and how risks are prioritised. Auditing standards impose obligations on auditors to review and challenge these statements. It is worth noting that the Kingman Review considered the current approach to viability statements insufficiently effective and, if they cannot be made more effective, proposed giving serious consideration to abolishing them.
i Shareholder rights and powers
Under the Companies Act, shareholders have the power to challenge a board in several ways. As few as 100 shareholders or shareholders holding as little as 5 per cent of the voting rights (whichever is less) can requisition a meeting, and add any item to the agenda or add any item to the agenda for the company's AGM; moreover, there is no minimum holding period to qualify. In practice, however, boards are relatively responsive to shareholder concerns, and such requisitions are rare because each director must submit to annual re-election, and because directors are in any event required to obtain shareholder approval for a number of matters, requiring relatively frequent engagement with the company's main shareholders.
Under the Companies Act, shareholders must approve secondary share offerings by simple majority resolution, and in any event, shareholders enjoy statutory pre-emption rights on all secondary share offerings for cash, although they can approve the disapplication of these pre-emption rights by special resolution (i.e., 75 per cent of shares voted). In practice, shareholders typically give directors general authority to issue further shares for cash and on a non-pre-emptive basis within certain guidelines published by institutional investors (e.g., no more than 5 per cent of the company's share capital in any year, and no more than 7.5 per cent on a rolling three-year basis (or an additional 5 per cent in connection with an acquisition or specified capital investment), and then subject to restrictions on the price at which the shares may be issued). Authority to issue further shares is typically renewed at each AGM or sought in relation to a specific transaction where equity funding is required.
Shareholders are also required to approve the terms of share incentive plans and Class 1 transactions such as major acquisitions or disposals (in each case by simple majority), related-party transactions (by simple majority of independent shareholders), as well as any changes to the company's constitution or the rights attaching to their shares (by special resolution). Any proposal to acquire control (defined as 30 per cent or more of the voting rights) of a company subject to the Takeover Code requires an offer to be made to all shareholders on the same terms. Finally, shareholder approval (by way of simple majority) is required under the Companies Act for loans and other credit transactions, and for substantial property transactions, with directors and their connected persons (although in practice the provisions of the Listing Rules cover many more such related-party transactions).
When more than 20 per cent of votes have been cast against any board-recommended resolution or any such resolution has been withdrawn, the Code will require companies to announce what actions it intends to take to consult with shareholders in order to understand the reasons behind the result. There is then a requirement for the company to provide an update on the consultation and any remedial actions within six months of the vote, with a final summary included in the annual report. The Investment Association has also launched its Public Register to aggregate publicly available information regarding meetings of any FTSE all-share company following significant shareholder opposition to a proposed resolution.
A general shareholder equality principle pervades both UK company law and the Listing Rules. There is a one share, one vote norm, and distributions to shareholders (dividends, share repurchases, etc.) are required to be made anonymously on market and on tightly regulated terms unless shareholders waive these requirements. In principle, information must be made available simultaneously to all shareholders, although in practice it is possible to inform key shareholders of significant proposals in order to take soundings on a confidential basis, although this precludes shareholders from dealing in a company's securities until the information has been made public or ceases to be price-sensitive.
ii Shareholders' duties and responsibilities
English law imposes little in the way of active duties or liabilities on shareholders. A majority shareholder does not owe any fiduciary duty to the company or to the other shareholders and is free to exercise its voting rights to advance its own interests, except where it is barred from doing so because of its interest in a proposed transaction or where, in relation to a proposed change to the company's constitution, it is not voting bona fide in the interests of the company.
Certain non-binding expectations are placed on investors by institutional guidelines, the Code and the Stewardship Code. The Stewardship Code recognises the importance of environmental, social and governance factors to investors and the role that asset managers have to play in ensuring market integrity, minimising systematic risks and being stewards of the investments in their portfolios. Signatories must report annually on their stewardship activities and outcomes in a stewardship report. Large investors such as BlackRock and State Street are vocally increasing their engagement with portfolio companies on their environmental, social and governance (ESG) criteria, recognising the growing responsibilities of asset managers to foster long-term value, and the need for companies to develop their purpose and focus on creating stakeholder value. By way of example, TCI, one of the UK's largest long-only hedge funds and activist shareholders, has recently stated that it will sell down its stakes in companies that do not have, and report against, a plan to reduce their carbon emissions. This is in line with a wider trend of expectations of enhanced ESG reporting by companies against often overlapping legal and voluntary reporting criteria.
The Listing Rules contain the concept of a controlling shareholder, who (either alone or together with others acting in concert with it) is able to control 30 per cent or more of the voting rights. Affected companies must enter into a relationship agreement with their controlling shareholder containing certain mandatory terms intended to ensure that the board will remain independent of improper influence by the controlling shareholder. Companies with a controlling shareholder are also subject to additional disclosure requirements, and certain matters require the approval of shareholders independent of the controlling shareholder.
iii Shareholder activism
While institutional investors have traditionally been reluctant to police the corporate governance regime, an increasing number have recently become more vocal. Where institutional investors do have criticisms, they are more likely to engage in private dialogue with the directors. In recent years, however, they have been increasingly involved in activist campaigns, alongside traditional activists such as hedge funds. What distinguishes shareholder activists is that they are prepared to air issues publicly to achieve change. Much activism is still concerned with securing board representation, encouraging M&A activity or building stakes; however, executive remuneration and perceived corporate governance failings are also increasingly focuses. Related-party arrangements, the independence of directors, failures to address shareholder concerns and overly generous bonus or exit remuneration packages have also been addressed by activists in recent years. ESG factors are increasingly a source of shareholder activism too. Partly in response to TCI's letters, companies including Charter Communications, Airbus and Moody's have vowed to improve their environmental disclosures. In the context of stranded assets, this is evidently shareholder activism targeted at preserving long-term shareholder value.
iv Contact with shareholders
A company's relations with its shareholders are also specifically addressed in the Code. Regular engagement with major shareholders in order to understand their views on governance and performance against strategy is encouraged. The Code also requires the chairperson to ensure that the board as a whole has a clear understanding of the views of shareholders. The board should keep in touch with shareholder opinion in whatever ways are most practical and efficient, using the AGM to communicate with investors and encourage their participation alongside more informal consultation throughout the year.
The FRC set quite a chilling context for its most recent corporate governance review: 'a continuing lack of trust in business, high-profile corporate failures, lingering concerns that companies gave little thought to long-term sustainability; and, more generally, the impact of companies on wider society'.
Against this background, businesses in the UK remain under pressure to actively demonstrate their social and environmental licence to operate. Political and media scrutiny remains intense, and the trajectory of enhanced disclosures suggests that these democratic pillars, coupled with enhanced shareholder engagement, will continue to police corporate and executive behaviour. It is no wonder that directors feel under siege as the mismatch between legal duties and social expectations continues.
The world is finally waking up to the threat that catastrophic climate change poses, and the shift in governance and business responses will be decisive. We expect a consolidation in the number of competing ESG reporting regimes to assist with this. Other themes to watch in the year ahead include the replacement of the FRC and any indications of corporate governance changes as the UK prepares for its exit from the EU.
1 Murray Cox is a partner and Hayden Cooke is an associate at Slaughter and May. The authors would like to thank Imogen Green for her help in preparing this edition of the UK chapter.