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UK HR E-brief: Government decides on pay ratio reporting and strengthening employee engagement

  • United Kingdom
  • Employment law - HR E-Brief


The Government has announced changes to strengthen corporate governance, further to last year’s green paper consultation. Measures aimed at listed companies and addressing executive pay, including pay ratios, and strengthening employee engagement will be of interest to HR professionals and employment lawyers, given the practical, legal and reputational repercussions. There are also proposals to extend corporate governance reporting to large private companies.

While secondary legislation is proposed as part of the package of reforms, the Government is relying on the Financial Reporting Council to make significant amendments to the Corporate Governance Code to effect many of its changes.

Background: the UK Corporate Governance Code (‘Code’)

The Code sets out standards of good practice for listed companies on board composition and development, remuneration, shareholder relations, accountability and audit. All companies with a premium listing of equity shares in the UK are required under the Listing Rules to report on how they have applied the Code’s principles in their annual report and accounts and to confirm that they have complied with the Code's specific provisions. Where they have not, they should provide an explanation (this is the ‘comply or explain’ approach – the Listing Rules do not require compliance with the Code). The Code is published and monitored by the Financial Reporting Council (FRC).

Executive pay and pay ratios

The Government is seeking to balance the need to attract and retain top talent with growing public and stakeholder dissatisfaction with the levels of executive pay. Recent CIPD research shows that the average FTSE 100 CEO receives an annual pay package of £4.5 million and the pay ratio between CEOs and the average pay of their employees is 129:1.

The Government has resisted calls to give shareholders sweeping new rights to block executive pay, instead opting for a new public ‘naming and shaming’ register, overseen by the Investment Association (the fund managers' trade body), which is expected to include any listed company which faces opposition from at least 20% of shareholders to boardroom pay, along with a record of how those companies are intending to address shareholder concerns.

However, it has decided to move ahead with annual pay ratio reporting which requires listed companies to justify top pay in a narrative when compared to wider workforce pay. The ratio will cover the total remuneration of the chief executive, not just the lower base salary figure, and will be compared to the average total remuneration of the company’s UK workforce. Further details of the methodology with be published later this year.

A large and poorly communicated pay ratio could have negative repercussions on employee engagement, retention and recruitment as well as on corporate reputation. As such, we expect that HR will want to be involved in both internal and external communications on the ratio. This could include, for example, explaining the ratio to employees and their representatives before it is published, deciding how to communicate any anomalies or misleading data, such as where competitors have outsourced their lowest paid jobs, and benchmarking the ratio with comparative employers with a view to understanding key differences and trends over time.

In addition, the Code will be revised to set out more clearly the steps that companies should take when they encounter significant shareholder opposition to executive pay. The Code will give remuneration committees a broader responsibility for overseeing pay and require them to explain the relationship between executive and workforce pay to employees. The recommended minimum holding period for executive share awards will also be extended (to five years).

Employee engagement and reporting on engagement

The Government received strong support for strengthening employee engagement in response to its green paper consultation. As a result, it is inviting the FRC to consult on amending the Code to provide listed companies with the flexibility to decide which of the following mechanisms they use to listen to the employee voice:

  • designate a non-executive director (NED) to represent workforce interests to the board
  • create stakeholder advisory panels which include employees (EAPs)
  • appoint an employee representative, or more than one, to company boards

More broadly, the Government is proposing new legislation to require large private and listed companies to explain how their directors have regard to employee interests in pursuing the success of the company. For example, which of the above mechanisms has been adopted and how employee views influenced boardroom decision-making.

There are a number of practical issues which HR may encounter when responding to the Government’s suggested engagement mechanisms. For example:

  • EAPs - how would employees be appointed or elected in a way that balanced the potentially conflicting interests of a mixed workforce? Training, duties and rights, including time off, would need addressing. Would they feedback to the workforce on matters raised with the board and how would this be facilitated?
  • NEDs – in the absence of an EAP, consideration would need to be given to how, practically, a NED might engage with employees, so that he/she could represent their views and interests to the board. How would the NED reconcile potential conflicts of interest (between a duty to the board and to representing employees)?
  • employee representatives on the board – this option has had limited appeal in the UK due to the unitary board system where all the directors have the same set of duties and collective responsibility applies. In addition, the prospect of a single employee representing the interests of a large workforce could be challenging on many levels (and more than one might be logistically and financially a step too far for some employers)
  • more generally, complex legal group structures, particularly involving multinationals, should consider how best to respond to the Government’s proposals in a way that reflects the operating realities of their business.

Large private companies: new governance proposals

The announcement also contains proposals for increasing governance accountability for large private companies and, possibly, large limited liability partnerships (LLPs), by developing a new voluntary code of corporate governance principles supervised by the FRC. The Government will also require some large private companies to report on their corporate governance arrangements, including whether they follow any formal code. This change will be a significant development for those not currently engaged in any form of corporate reporting.

Next steps

The FRC will move forward with revising the Code this winter and the Government has stated that it intends to bring legislative reforms into effect by June 2018, to apply to reporting years commencing on or after that date. As further details are published by the Government and FRC, the exact scope of the reforms (whether they apply to all or just some listed companies and to which private companies) will also become clear. The Government is promising sector and industry-led guidance, in particular to reflect existing best practice in relation to employee and stakeholder engagement.