CORPORATE GOVERNANCE REVIEW OF 2004
THE ABI AND THE NEW HIGGS CODE
The new Combined Code is now in force and our monitoring service, the
Institutional Voting Information Service (IVIS), will be basing its guidance on
the new Code for its reports in 2005. Our initial impression is that companies
are making a considerable effort to comply with the new Code, but there are
likely to be a number of areas where formal compliance by all companies will
These may include:
The presence of the chairman on the Remuneration and Audit
Committees, which runs contrary to the provisions of the new Code
Board evaluation, which is new for some companies
The requirement to include a member with recent relevant experience
on the Audit Committee
The ABI supports the code and is keen to see companies comply with it over
time, but we recognise that companies will wish to provide explanations when
they do not comply, especially at this early stage. We are ready to consider
these explanations carefully; the more compelling the explanation, the more
likely it is to receive acceptance.
Where there are differences between companies and investors we believe
these should be addressed by dialogue in the first instance. The normal IVIS
practice is to signal instances where companies are not in compliance, but we
do not place a red or amber top on companies just because they have chosen
to explain rather than comply with the Code. This approach will remain.
There is no policy of targeting chairmen or particular votes. We shall,
however, continue to facilitate dialogue with companies, where our members
feel progress towards compliance is needed or a more specific explanation is
necessary. It is important that companies are willing to enter into such
dialogue where investors seek it.
CHANGES TO OUR REMUNERATION GUIDELINES
The ABI is today publishing an updated version of its guidelines on executive
remuneration. These take account of developments over the past year, as
well as the forthcoming introduction of new International Accounting
The main changes are:
Chairmen and share incentives: A clarification of the view that
chairmen should not receive share incentives geared to performance of
the share price even though they will no longer be formally classified as
independent now the new Combined Code has taken effect. Investor
concern is that this would impair their ability to provide impartial
Bonuses: A call for greater transparency with regard to bonuses.
Advance disclosure of short-term targets may be commercially
sensitive and shareholders recognise their approval cannot be sought
in advance. Once bonuses have been paid, however, it helps to have a
proper understanding of the criteria used in setting the amount. Bonus
levels have been increasing, and it has thus become more critical for
shareholders to satisfy themselves that there is an appropriate link to
Windfall payments on change of control: Measures to discourage
windfall payments on change of control. The new guidelines state that
schemes should pay out only to the amount of the performance period
that has elapsed prior to the change of control, and any payment
should reflect the underlying financial performance of a company.
Companies should make clear when designing schemes how much
they would expect to pay in event of change of control.
Dividends on long-term incentive plans: A recommendation that
companies accrue dividends on long term incentive plans, which would
be paid to the recipients once the shares involved vest. The aim is to
ensure that boards are not encouraged to hold back dividend payments
in order to increase the value of their share incentive schemes.
Approach to new Accounting Standards: A recommendation that
companies publish in advance the approach they will take to adjusting
performance hurdles after the introduction of new accounting
standards, which may make reporting earnings more volatile. Investors
are also seeking greater clarity over pension payments in the light of
recent tax changes. The guidelines reaffirm that we do not expect
companies to compensate individuals for changes to personal taxation.
THE 2004 REPORTING SEASON
During the course of this year IVIS has monitored 677 company annual
reports and issued 68 red tops. A feature of the year has been the increase in
amber tops, which now account for some 30 per cent of meetings covered
and pinpoint complex issues where investor judgement is needed. Most of
these, and most of the red tops, relate to remuneration.
The purpose of an amber top is to highlight difficult cases requiring extra
consideration by investors. In such cases there is often no single right answer,
but a considered judgement is called for. These cases may lead to a diversity
in voting results with high levels of opposition and abstention recorded as well
as support. Companies need to understand that if investors are to avoid box-
ticking and vote on a considered basis, they cannot expect 100 per cent
support for all proposals. Indeed a degree of divergence, which reflects
careful consideration by shareholders is often healthy.
This year has meanwhile seen a further substantial increase in compliance
with the Combined Code. Some 70 per cent of the FTSE 100 and around 58
per cent of the FTSE All-Share comply. In most cases of non-compliance the
explanation has proved satisfactory and has been accepted by investors. Only
10 per cent of IVIS red tops, equivalent to around 1 per cent of all reports,
related to Combined Code issues. The trend towards compliance shows the
effectiveness of the Code in driving evolutionary change.
With regard to remuneration, there has been a marked decrease in the use of
share options, which account for only 19 per cent of new schemes and a
corresponding increase in the use of long term incentive schemes involving
the use of whole shares. These have increased to 54 per cent from 43 per
cent, while there has also been a noticeable increase in the use of deferred
bonus schemes for which recipients may be granted shares in exchange for
deferring part of their bonus.
The ABI has always been neutral in the debate over the relative merits of
options versus long term incentives, but we have been concerned that a
switch towards long term incentive schemes should not lead to an
unwarranted increase in overall remuneration levels as has happened in the
past. There is some sign of this happening as maximum grant levels for long
term incentives have risen over the past year. On the other hand the new
accounting requirements should provide some safeguard against excess as
companies will be obliged to declare the full value of their packages.
On the positive front the incidence of schemes involving re-testing of
performance conditions has reduced sharply while there has been a further
movement towards service contracts of one year or less. Both of these trends
reflect the efforts of the ABI and others in recent years.
SOCIALLY RESPONSIBLE INVESTMENT
Levels of disclosure in accordance with the ABI reporting guidelines on
socially responsible investment have continued to improve with around 80
percent of FTSE 100 companies again providing moderate or full disclosure in
keeping with our guidelines. Within that group around half now provide full
disclosure compared with only a third last year. In the FTSE All-Share, the
number of companies making no disclosure has dropped further to around 15
per cent from around 19 per cent in 2003 and the number of companies
making full disclosure has doubled to 10 per cent from 5 per cent.
We regard this trend as encouraging. The introduction of our guidelines in
2002 has helped companies prepare for the Government’s new Operating and
Financial Review, which also calls on them to report on significant non-
A particularly important development over the last year has been the number
of companies which report that they have integrated their management of
social, environmental and ethical risks into their mainstream risk management
arrangements. Altogether 88 companies have made such a statement. This is
a new trend, and an important indication of the impact of our guidelines.
This year has seen a marked increase in company law and corporate
governance activity at the level of the European Union. The ABI has been
actively involved in this as we believe that the introduction of a comply or
explain approach will help raise standards of governance across the EU while
avoiding the strict rules-based approach adopted in the US. An important
aspect of this, however, is the need to ensure that shareholders have effective
voting rights. We expect this issue to become an important issue for debate in