Corporate governance in the UK is fundamental because itimproves companies’ handling of affairs. In the world of business today, theincrease in pay inequality and disengagement of executives with stakeholdershas caused the need for change. This essay will analyse and discuss the strengthsand weaknesses of the proposals put in place to reform corporate governance inthe UK. To conclude that the releasing pay ratios; increasing the transparencyof large companies and increasing the size of remuneration committees were thebest options due to their ability to tackle their problems efficiently andeffectively. The ease inflexibility and high standards make corporategovernance in the UK one of the leading structures in the world (The Departmentfor Business, Energy and Industrial Strategy, 2017). The government looked tobuild on this in 2016 by continuing to make the UK an appealing place forinvestors and corporations. Policymakers focused on three main aspects ofcorporate governance: executive pay, strengthening the voice of the stakeholderand corporate governance in large privately-held businesses (The Department forBusiness, Energy and Industrial Strategy, 2017). Within these three aspects,they consulted and sought the views of different experts in their correspondingfields for the nine proposals they looked to take forward.
Although thegovernment chose these proposals, not all of them were deemed to be effective. Pay ratios One of the proposals suggested is that companies shouldrelease their pay ratios publicly. This is beneficial as it increases thetransparency of the board of executives within a firm and increases stakeholderand shareholders awareness, whilst tackling the agency problem. A stakeholderis someone that has an interest in a business’ performance whilst a shareholderis one that owns a part of the company. The government proposed that companiesshould disclose the ratio, which compares the CEO’s pay to the average pay oftheir UK workforce (The Department for Business, Energy and IndustrialStrategy, 2017).
The need for transparency in pay ratios is vital, as theexecutives focus on their own interests (e.g. boosting their own compensation).This is an example of the agency problem. Jensen (2011) states that CFO bonusplans are counterproductive, as they focus on increasing their bonus insteadincreasing the profits of the shareholders. For example, bonus plans encouragethe executives to manipulate their annual financial reports to boost perceivedperformance (Murphy and Jensen, 2011).
Furthermore, recently there has been anincrease in shareholder revolt against the executive’s remuneration policy andthe amount in which executives receive. The topic of executive pay is generallyoverlooked in annual shareholder meetings, as stated by the Institute ofdirectors, even though on average 30% of investors reject the executives’remuneration report (The Guardian,2017). Hence the need for an increase intransparency as it exposes the executives’ intentions. The release of pay ratios will increase the transparency ofthe executives and expose those that exploit their power. There have beenseveral instances which display the rise in inequality.
For example, the CEO ofMcDonald’s now earns up to 74 times more than the average worker, showing theextent of the gap in earning and the importance of the exposure (Dixon, 2017).The new proposal will allow stakeholders to view the spread of wealth withinthe firm thus increasing their awareness of the inequality in pay. As theincrease in the concerns of the stakeholders will build the pressure on theexecutives to improve the equality in pay, tackling the agency problem. On the other hand, the use of pay ratios may misleadstakeholders. When comparing different companies and their ratios, thestakeholders could adopt a mind-set that every firm should have a similarspread of wealth.
This is not the case as the way in which wealth is spreadwithin a firm is down to the executive’s view of the success of the firm andthe skill-set of the workers. Simon Osborne, Chief Executive of the Institute ofChartered Secretaries and Administrators (ICSA), stated: “A comparisonbetween CEO and average worker pay is meaningless without a good understandingof the demography of a company” (ICSA, 2017). For example, a large retailstore is more likely to have a higher pay ratio than a small accounting firmdue to the higher number of unskilled staff. This misinterpretation could be corrected by the inclusionof a narrative by the company. When companies release their pay ratios theyshould include an explanation of the reasons for the distribution. This wouldgive the stakeholder a better understanding of how the company came to aconclusion when deciding the differences in pay. The firm would also be able tovalidate the reasons for differences in comparison to their competitors. Thisstrategy has been successful at Buffer, a software application company.
Thefirm releases a formula on how the employees’ salaries are formulated, whichincludes different factors such as seniority and experience (Richman, 2016). Thesefactors have given the employees a better understanding of the differences inpay and thus shows the advantages in these types of narrative. Therefore,although user understanding may be a problem when issuing pay ratios, the useof them has many advantages. These advantages allow the companies to tackle theissues of pay inequality effectively through increasing pressure on board.
Remunerationcommittee Another proposal with an aim to reduce the inequality in payis the proposal to broaden the responsibility of the remuneration committee.This would give the shareholders an understanding of what reasonable earningsshould be for the executives. The government proposed that the committee shouldhave more responsibility across the company, suggesting they should explain howexecutive pay links to the pay policy of the whole firm (Jay, Reid and Tierney,2017). They also suggested that remuneration committee members should have aminimum of 12-month experience on a remuneration board. The two aspects of the proposal tackle the problem well.First, the 12-months previous experience required for each member improves thehandling of the remuneration policy. The skills which they possess would bemature and experienced, giving them a better insight and understanding whenmaking remuneration policy decisions. However, there may be an issue that it ishard to find staff with 12 months experience and therefore difficult toimplement this proposal.
Second, the wider range of responsibility wouldincrease the contact between the remuneration committee and the shareholders.This contact would, therefore, give the shareholders more information aboutwhat compensation should look like for executives and help make improvements.Even though the rise in communication would be time-consuming for the committee,their actions would be very beneficial as they would reduce inequality andincrease management expertise. Stakeholderengagement guidance Another area the government looked at ways to strengthen thevoice of stakeholders within a corporation. Corporate governance in the UnitedKingdom mainly focuses on the needs of the shareholders.
The executive’sperformance is normally measured on the basis of the company’s financialperformance within the market and therefore most decisions which made are inorder to improve the firm and shareholders on a financial basis (Garcia-Castroet al, 2008). Employees opinions and needs are regularly ignored as a result ofthis. However, it is important to increase the voice of the stakeholders andfor businesses to deliver an enlightened shareholder value (Jay, Reid andTierney, 2017). The enlightened share value (ESV) is a business model where thedirectors strive to increase the shareholder’s wealth long term while beingattentive to the wide range of stakeholder’s requirements (Million, 2010). Thevoice of stakeholders is essential as they are able to improve a business’sperformance. One of the best ways to achieve this is through having the ICSAand the investment association provide guidance on ways the directors couldengage with their stakeholders.
While the proposal exposes businesses to new ways ofinteracting with their employees and stakeholders, the suggestion raises someissues. The new guidance which would be given to companies can easily beoverlooked, as firms could decide that none of the engagement techniques areworth using. Furthermore, stakeholders could be manipulated by the director’suse of these methods.
The board may adopt new practices in order to look likechange is occurring when in reality things will stay the same. This would be inorder to make the business look good public, so they do not receive anybacklash from their stakeholders. These weaknesses in this proposal leave itlacking effectiveness and does not solve corporate issues when compared toother proposals. Stakeholder representatives Another policy to strengthen thevoice of the stakeholders was through the use of stakeholder representatives.The government suggested that premium companies have to adopt one of thefollowing three methods in order to increase stakeholder representation: astakeholder advisory council, a non-executive director in charge of voicingstakeholder’s views or hiring a director from the employees. However, the useof a two-tier board would be more effective than these proposals when improvingstakeholder representation.Firstly, the use of anon-executive director or an employee director limits the amount ofrepresentation the stakeholders receive at board level. This may lead to thembeing isolated by the board members.
Their views could be overlooked, as if itdoes not match the majority of the director’s views then their proposal wouldbe voted against. Furthermore, it would be difficult for the director torepresent the views of all the stakeholders, as it is quite demanding for oneperson to liaise with the many different stakeholders that the firm has inorder to find out their concerns. However, with a team of employee andstakeholder representatives, just like the ones in the two-tier supervisoryboard, each individual would be assigned to a certain area, therefore, makingit easier to collect the concerns and opinions of the many differentstakeholders. Second, the stakeholder advisorycommittee could be useful when partnered with a non-executive director.Although the committee would be a good hub for collecting the several differentstakeholder views, they may struggle to get their view to board level alone. Thisis unlike the supervisory committee in the two-tier model where the stakeholderrepresentatives are part of the board already. However, the advisory committeecould be effective if they were partnered with a non-executive director, asthis would allow their concerns to reach the board level where they can bediscussed.
This also defeats the workload problem the non-executive director wouldface when collecting the different stakeholder perspectives alone.Second, the stakeholder advisorycommittee could be useful when partnered with a non-executive director.Although the committee would be a good hub for collecting the several differentstakeholder views, they may struggle to get their view to board level alone.This is unlike the supervisory committee in the two-tier model where thestakeholder representatives are part of the board already. However, the advisorycommittee could be effective if they were partnered with a non-executivedirector, as this would allow their concerns to reach the board level wherethey can be discussed.
This also defeats the workload problem the non-executivedirector would face when collecting the different stakeholder perspectivesalone.However, the large representationof stakeholders at board level could have unfavourable effects on the company.Milton Friedman states that the goal of a company is to increase theshareholder’s wealth, the only obligation of a firm is to increase its profits.This is known as the shareholder theory. He argues that the needs of theshareholders do not need to be considered as their role is to primarilyincrease the shareholder’s wealth (Solomon, 2010) Furthermore, Gorton andSchmid (2004) also disagree with the large number of stakeholderrepresentatives. They find that the goals of the firm are altered by theemployee representatives, with evidence showing that firms with a higheremployee representation at board level perform worse than firms which havefewer representatives (Gorton and Schmid, 2004).
On the other hand, thepresence of employee and other stakeholder representatives on the supervisoryboard is effective for improving the operations of the business. The employee’sknowledge of the operating process will allow them address areas which can beimproved. This, therefore, improves the firm’s efficiency and thus increasesprofits (Fauver and Fuerst, 2004). For strengthening the voice ofstakeholders, the government should look to other policies to improve this areaof corporate governance. Though the current proposals could possibly be moreeffective if they were partnered with another method, on their own they are notlikely to be effective. The use of two-tier boards may reduce the focus ofincreasing shareholders wealth for increasing stakeholder representation.
However, in comparison to the government’s proposals of stakeholderrepresentation, having stakeholder representatives at board level increasestheir voice and also improves the firm as a whole.Transparencyand governance of large companiesAnother proposal suggested was that all large companies(with over 2000 employees) must disclose their arrangements for corporategovernance (The Department for Business, Energy and Industrial Strategy, 2017).Increasing the transparency of larger firms is key as it exposes those whichhave not adopted good practice. This is especially important in large firmswhere bad practices can be hidden, this allows them to highlight areas ofimprovement. Furthermore, when a firm is transparent with their proceedings,the loyalty of the firm’s stakeholders increases as they feel valued. Forexample, Patagonia, an American clothing brand, displays each step of theirsupply chain process. On the Patagonia website, they have released videosshowing and explaining each stage of their manufacturing process andhighlighting where they can improve (Richman, 2016). Customers are also able toadd where they believe improvements can be, showing that the firm values theircustomers’ opinions.
The transparency of large companies is therefore improved,developing trust and satisfaction but also making their operations moreefficient. Not all theproposals for improving corporate governance of large privately held businessesare effective. For instance, the government developed a set of governanceprinciples for large companies in order improve governance of large companies.These ideas may be beneficial as they provide a guideline on ways to handlecooperate governance in the firm. The firm manager may use these proposedmethods help managers when finding an efficient method as some tend to struggleto find efficient ways to improve governance.
On the other hand, as theproposals are voluntary it is easy for them to be overlooked by the largefirms. The methods proposed could be deemed as ineffective for them or firmsmay already have procedures which they prefer. Furthermore, there would also beproblems if these methods were compulsory, as many companies would struggle to meetthe inflexible rules. This would deter from the UK’s original success incorporate governance, which is due to their flexibility.
This highlights theineffectiveness of the proposal, whether it is compulsory or voluntary. Conclusion anddiscussion Overall, the proposals listed here each have their benefitsand limitations, however this study provides some conclusions. Firstly, releasingpay ratios, increasing the transparency of large companies and increasing thesize of remuneration committees would all tackle their problems efficiently thereforeimproving corporate governance practice. Second, the implementation of anemployee advisory committee would need to be partnered with a non-executivedirector to be fully effective in order to have the stakeholders viewrepresented at board level. Third, there were some proposals which were notfeatured in the reform report which would have been effective, such as the useof two tier boards.
The two-tier board would have tackled two key problemswhich are stakeholder representation at board level and supporting the loadwhen working with different stakeholders. Finally, there were some proposals which wereseen as ineffective, such as the creation of corporate governance guidelinesfor large companies with voluntary use and the use of non-executive andemployee directors to increase stakeholder representation. In conclusion, corporate governance helps improvestakeholder-firm relationships, boosting effectiveness and performance. Thereform educates businesses on areas that need to be improved so that they canreflect and improve their own policies.
In the future, the research ingovernance should focus on enforcing ways that lead to businesses complyingwith the proposals, as in the past businesses have failed to meet thegovernance requirements. These improvements in governance would, therefore,attract more businesses to the UK thus benefitting the economy.