Corporate Industrial Strategy, 2017). Within these three aspects,

Corporate governance in the UK is fundamental because it
improves companies’ handling of affairs. In the world of business today, the
increase in pay inequality and disengagement of executives with stakeholders
has caused the need for change. This essay will analyse and discuss the strengths
and weaknesses of the proposals put in place to reform corporate governance in
the UK. To conclude that the releasing pay ratios; increasing the transparency
of large companies and increasing the size of remuneration committees were the
best options due to their ability to tackle their problems efficiently and
effectively.

 

The ease inflexibility and high standards make corporate
governance in the UK one of the leading structures in the world (The Department
for Business, Energy and Industrial Strategy, 2017). The government looked to
build on this in 2016 by continuing to make the UK an appealing place for
investors and corporations. Policymakers focused on three main aspects of
corporate governance: executive pay, strengthening the voice of the stakeholder
and corporate governance in large privately-held businesses (The Department for
Business, Energy and Industrial Strategy, 2017). Within these three aspects,
they consulted and sought the views of different experts in their corresponding
fields for the nine proposals they looked to take forward. Although the
government chose these proposals, not all of them were deemed to be effective.

 

Pay ratios

 

One of the proposals suggested is that companies should
release their pay ratios publicly. This is beneficial as it increases the
transparency of the board of executives within a firm and increases stakeholder
and shareholders awareness, whilst tackling the agency problem. A stakeholder
is someone that has an interest in a business’ performance whilst a shareholder
is one that owns a part of the company. The government proposed that companies
should disclose the ratio, which compares the CEO’s pay to the average pay of
their UK workforce (The Department for Business, Energy and Industrial
Strategy, 2017). The need for transparency in pay ratios is vital, as the
executives focus on their own interests (e.g. boosting their own compensation).
This is an example of the agency problem. Jensen (2011) states that CFO bonus
plans are counterproductive, as they focus on increasing their bonus instead
increasing the profits of the shareholders. For example, bonus plans encourage
the executives to manipulate their annual financial reports to boost perceived
performance (Murphy and Jensen, 2011). Furthermore, recently there has been an
increase in shareholder revolt against the executive’s remuneration policy and
the amount in which executives receive. The topic of executive pay is generally
overlooked in annual shareholder meetings, as stated by the Institute of
directors, even though on average 30% of investors reject the executives’
remuneration report (The Guardian,2017). Hence the need for an increase in
transparency as it exposes the executives’ intentions.

 

The release of pay ratios will increase the transparency of
the executives and expose those that exploit their power. There have been
several instances which display the rise in inequality. For example, the CEO of
McDonald’s now earns up to 74 times more than the average worker, showing the
extent 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 within
the firm thus increasing their awareness of the inequality in pay. As the
increase in the concerns of the stakeholders will build the pressure on the
executives to improve the equality in pay, tackling the agency problem.

 

On the other hand, the use of pay ratios may mislead
stakeholders. When comparing different companies and their ratios, the
stakeholders could adopt a mind-set that every firm should have a similar
spread of wealth. This is not the case as the way in which wealth is spread
within a firm is down to the executive’s view of the success of the firm and
the skill-set of the workers. Simon Osborne, Chief Executive of the Institute of
Chartered Secretaries and Administrators (ICSA), stated: “A comparison
between CEO and average worker pay is meaningless without a good understanding
of the demography of a company” (ICSA, 2017). For example, a large retail
store is more likely to have a higher pay ratio than a small accounting firm
due to the higher number of unskilled staff.  

 

This misinterpretation could be corrected by the inclusion
of a narrative by the company. When companies release their pay ratios they
should include an explanation of the reasons for the distribution. This would
give the stakeholder a better understanding of how the company came to a
conclusion when deciding the differences in pay. The firm would also be able to
validate the reasons for differences in comparison to their competitors. This
strategy has been successful at Buffer, a software application company. The
firm releases a formula on how the employees’ salaries are formulated, which
includes different factors such as seniority and experience (Richman, 2016). These
factors have given the employees a better understanding of the differences in
pay and thus shows the advantages in these types of narrative. Therefore,
although user understanding may be a problem when issuing pay ratios, the use
of them has many advantages. These advantages allow the companies to tackle the
issues of pay inequality effectively through increasing pressure on board.

 

Remuneration
committee

 

Another proposal with an aim to reduce the inequality in pay
is the proposal to broaden the responsibility of the remuneration committee.
This would give the shareholders an understanding of what reasonable earnings
should be for the executives. The government proposed that the committee should
have more responsibility across the company, suggesting they should explain how
executive pay links to the pay policy of the whole firm (Jay, Reid and Tierney,
2017). They also suggested that remuneration committee members should have a
minimum 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 the
handling of the remuneration policy. The skills which they possess would be
mature and experienced, giving them a better insight and understanding when
making remuneration policy decisions. However, there may be an issue that it is
hard to find staff with 12 months experience and therefore difficult to
implement this proposal. Second, the wider range of responsibility would
increase the contact between the remuneration committee and the shareholders.
This contact would, therefore, give the shareholders more information about
what 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 and
increase management expertise.  

 

 

Stakeholder
engagement guidance 

 

Another area the government looked at ways to strengthen the
voice of stakeholders within a corporation. Corporate governance in the United
Kingdom mainly focuses on the needs of the shareholders. The executive’s
performance is normally measured on the basis of the company’s financial
performance within the market and therefore most decisions which made are in
order to improve the firm and shareholders on a financial basis (Garcia-Castro
et al, 2008). Employees opinions and needs are regularly ignored as a result of
this. However, it is important to increase the voice of the stakeholders and
for businesses to deliver an enlightened shareholder value (Jay, Reid and
Tierney, 2017). The enlightened share value (ESV) is a business model where the
directors strive to increase the shareholder’s wealth long term while being
attentive to the wide range of stakeholder’s requirements (Million, 2010). The
voice of stakeholders is essential as they are able to improve a business’s
performance. One of the best ways to achieve this is through having the ICSA
and the investment association provide guidance on ways the directors could
engage with their stakeholders.

 

While the proposal exposes businesses to new ways of
interacting with their employees and stakeholders, the suggestion raises some
issues. The new guidance which would be given to companies can easily be
overlooked, as firms could decide that none of the engagement techniques are
worth using. Furthermore, stakeholders could be manipulated by the director’s
use of these methods. The board may adopt new practices in order to look like
change is occurring when in reality things will stay the same. This would be in
order to make the business look good public, so they do not receive any
backlash from their stakeholders. These weaknesses in this proposal leave it
lacking effectiveness and does not solve corporate issues when compared to
other proposals.

 

Stakeholder representatives

 

Another policy to strengthen the
voice of the stakeholders was through the use of stakeholder representatives.
The government suggested that premium companies have to adopt one of the
following three methods in order to increase stakeholder representation: a
stakeholder advisory council, a non-executive director in charge of voicing
stakeholder’s views or hiring a director from the employees. However, the use
of a two-tier board would be more effective than these proposals when improving
stakeholder representation.

Firstly, the use of a
non-executive director or an employee director limits the amount of
representation the stakeholders receive at board level. This may lead to them
being isolated by the board members. Their views could be overlooked, as if it
does not match the majority of the director’s views then their proposal would
be voted against. Furthermore, it would be difficult for the director to
represent the views of all the stakeholders, as it is quite demanding for one
person to liaise with the many different stakeholders that the firm has in
order to find out their concerns. However, with a team of employee and
stakeholder representatives, just like the ones in the two-tier supervisory
board, each individual would be assigned to a certain area, therefore, making
it easier to collect the concerns and opinions of the many different
stakeholders.

Second, the stakeholder advisory
committee could be useful when partnered with a non-executive director.
Although the committee would be a good hub for collecting the several different
stakeholder views, they may struggle to get their view to board level alone. This
is unlike the supervisory committee in the two-tier model where the stakeholder
representatives are part of the board already. However, the advisory committee
could be effective if they were partnered with a non-executive director, as
this would allow their concerns to reach the board level where they can be
discussed. This also defeats the workload problem the non-executive director would
face when collecting the different stakeholder perspectives alone.

Second, the stakeholder advisory
committee could be useful when partnered with a non-executive director.
Although the committee would be a good hub for collecting the several different
stakeholder views, they may struggle to get their view to board level alone.
This is unlike the supervisory committee in the two-tier model where the
stakeholder representatives are part of the board already. However, the advisory
committee could be effective if they were partnered with a non-executive
director, as this would allow their concerns to reach the board level where
they can be discussed. This also defeats the workload problem the non-executive
director would face when collecting the different stakeholder perspectives
alone.

However, the large representation
of stakeholders at board level could have unfavourable effects on the company.
Milton Friedman states that the goal of a company is to increase the
shareholder’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 the
shareholders do not need to be considered as their role is to primarily
increase the shareholder’s wealth (Solomon, 2010) Furthermore, Gorton and
Schmid (2004) also disagree with the large number of stakeholder
representatives. They find that the goals of the firm are altered by the
employee representatives, with evidence showing that firms with a higher
employee representation at board level perform worse than firms which have
fewer representatives (Gorton and Schmid, 2004). On the other hand, the
presence of employee and other stakeholder representatives on the supervisory
board is effective for improving the operations of the business. The employee’s
knowledge of the operating process will allow them address areas which can be
improved. This, therefore, improves the firm’s efficiency and thus increases
profits (Fauver and Fuerst, 2004).

For strengthening the voice of
stakeholders, the government should look to other policies to improve this area
of corporate governance. Though the current proposals could possibly be more
effective if they were partnered with another method, on their own they are not
likely to be effective. The use of two-tier boards may reduce the focus of
increasing shareholders wealth for increasing stakeholder representation.
However, in comparison to the government’s proposals of stakeholder
representation, having stakeholder representatives at board level increases
their voice and also improves the firm as a whole.

Transparency
and governance of large companies

Another proposal suggested was that all large companies
(with over 2000 employees) must disclose their arrangements for corporate
governance (The Department for Business, Energy and Industrial Strategy, 2017).
Increasing the transparency of larger firms is key as it exposes those which
have not adopted good practice. This is especially important in large firms
where bad practices can be hidden, this allows them to highlight areas of
improvement. Furthermore, when a firm is transparent with their proceedings,
the loyalty of the firm’s stakeholders increases as they feel valued. For
example, Patagonia, an American clothing brand, displays each step of their
supply chain process. On the Patagonia website, they have released videos
showing and explaining each stage of their manufacturing process and
highlighting where they can improve (Richman, 2016). Customers are also able to
add where they believe improvements can be, showing that the firm values their
customers’ opinions. The transparency of large companies is therefore improved,
developing trust and satisfaction but also making their operations more
efficient.

 

Not all the
proposals for improving corporate governance of large privately held businesses
are effective. For instance, the government developed a set of governance
principles for large companies in order improve governance of large companies.
These ideas may be beneficial as they provide a guideline on ways to handle
cooperate governance in the firm. The firm manager may use these proposed
methods help managers when finding an efficient method as some tend to struggle
to find efficient ways to improve governance. On the other hand, as the
proposals are voluntary it is easy for them to be overlooked by the large
firms. The methods proposed could be deemed as ineffective for them or firms
may already have procedures which they prefer. Furthermore, there would also be
problems if these methods were compulsory, as many companies would struggle to meet
the inflexible rules. This would deter from the UK’s original success in
corporate governance, which is due to their flexibility. This highlights the
ineffectiveness of the proposal, whether it is compulsory or voluntary.

 

Conclusion and
discussion

 

Overall, the proposals listed here each have their benefits
and limitations, however this study provides some conclusions. Firstly, releasing
pay ratios, increasing the transparency of large companies and increasing the
size of remuneration committees would all tackle their problems efficiently therefore
improving corporate governance practice. Second, the implementation of an
employee advisory committee would need to be partnered with a non-executive
director to be fully effective in order to have the stakeholders view
represented at board level. Third, there were some proposals which were not
featured in the reform report which would have been effective, such as the use
of two tier boards. The two-tier board would have tackled two key problems
which are stakeholder representation at board level and supporting the load
when working with different stakeholders.  Finally, there were some proposals which were
seen as ineffective, such as the creation of corporate governance guidelines
for large companies with voluntary use and the use of non-executive and
employee directors to increase stakeholder representation.

 

In conclusion, corporate governance helps improve
stakeholder-firm relationships, boosting effectiveness and performance. The
reform educates businesses on areas that need to be improved so that they can
reflect and improve their own policies. In the future, the research in
governance should focus on enforcing ways that lead to businesses complying
with the proposals, as in the past businesses have failed to meet the
governance requirements. These improvements in governance would, therefore,
attract more businesses to the UK thus benefitting the economy.

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