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ICLGThe International Comparative Legal Guide to:
A practical cross-border insight into corporate governance
Published by Global Legal Group, with contributions from:
12th Edition
Corporate Governance 2019
Arthur Cox Ashurst Hong Kong BAHR Barun Law LLC Bowmans Cektir Law Firm Cleary Gottlieb Steen & Hamilton LLP Cravath, Swaine & Moore LLP Cyril Amarchand Mangaldas Davies Ward Phillips & Vineberg LLP Davis Polk & Wardwell LLP Elias Neocleous & Co. LLC Ferraiuoli LLC Glatzová & Co., s.r.o. Hannes Snellman Attorneys Ltd
Herbert Smith Freehills LLP Houthoff Lenz & Staehelin Luther S.A. Macfarlanes LLP Mannheimer Swartling Advokatbyrå Miyetti Law Nielsen Nørager Law Firm LLP Nishimura & Asahi Novotny Advogados NUNZIANTE MAGRONE Olivera Abogados / IEEM Business School Payet, Rey, Cauvi, Pérez Abogados Pinsent Masons LLP Schoenherr
Stibbe SZA Schilling, Zutt & Anschütz Rechtsanwaltsgesellschaft mbH Tian Yuan Law Firm Travers Smith LLP Uría Menéndez Villey Girard Grolleaud Wachtell, Lipton, Rosen & Katz Walalangi & Partners (in association with Nishimura & Asahi)
WWW.ICLG.COM
The International Comparative Legal Guide to: Corporate Governance 2019
General Chapters:
Country Question and Answer Chapters:
1 Corporate Governance, Investor Stewardship and Engagement – Sabastian V. Niles,
Wachtell, Lipton, Rosen & Katz 1
2 Directors’ Duties in the UK – The Rise of the Stakeholder? – Gareth Sykes, Herbert Smith Freehills LLP 7
3 Human Capital Management: Issues, Developments and Principles – Sandra L. Flow &
Mary E. Alcock, Cleary Gottlieb Steen & Hamilton LLP 11
4 Dual-Class Share Structures in the United States – George F. Schoen & Keith Hallam,
Cravath, Swaine & Moore LLP 16
5 ESG in the US: Current State of Play and Key Considerations for Issuers – Joseph A. Hall &
Betty M. Huber, Davis Polk & Wardwell LLP 23
6 Governance and Business Ethics: Balancing Best Practice Against Potential Legal Risk –
Doug Bryden, Travers Smith LLP 32
7 Corporate Governance for Subsidiaries and Within Groups – Martin Webster, Pinsent Masons LLP 36
8 Australia Herbert Smith Freehills: Quentin Digby & Philip Podzebenko 40
9 Austria Schoenherr: Christian Herbst & Florian Kusznier 47
10 Belgium Stibbe: Jan Peeters & Maarten Raes 53
11 Brazil Novotny Advogados: Paulo Eduardo Penna 64
12 Canada Davies Ward Phillips & Vineberg LLP: Franziska Ruf & Olivier Désilets 73
13 China Tian Yuan Law Firm: Raymond Shi (石磊) 79
14 Cyprus Elias Neocleous & Co. LLC: Demetris Roti & Yiota Georgiou 87
15 Czech Republic Glatzová & Co., s.r.o.: Jindřich Král & Andrea Vašková 94
16 Denmark Nielsen Nørager Law Firm LLP: Peter Lyck & Thomas Melchior Fischer 101
17 Finland Hannes Snellman Attorneys Ltd: Klaus Ilmonen & Lauri Marjamäki 109
18 France Villey Girard Grolleaud: Pascale Girard & Léopold Cahen 117
19 Germany SZA Schilling, Zutt & Anschütz Rechtsanwaltsgesellschaft mbH:
Dr. Christoph Nolden & Dr. Michaela Balke 124
20 Hong Kong Ashurst Hong Kong: Joshua Cole 131
21 India Cyril Amarchand Mangaldas: Cyril Shroff & Amita Gupta Katragadda 136
22 Indonesia Walalangi & Partners (in association with Nishimura & Asahi):
Sinta Dwi Cestakarani & R. Wisnu Renansyah Jenie 144
23 Ireland Arthur Cox: Brian O’Gorman & Michael Coyle 150
24 Italy NUNZIANTE MAGRONE: Fiorella F. Alvino & Fabio Liguori 157
25 Japan Nishimura & Asahi: Nobuya Matsunami & Kaoru Tatsumi 163
26 Korea Barun Law LLC: Thomas P. Pinansky & JooHyoung Jang 170
27 Luxembourg Luther S.A.: Selim Souissi & Bob Scharfe 175
28 Netherlands Houthoff: Alexander J. Kaarls & Duco Poppema 182
29 Nigeria Miyetti Law: Dr. Jennifer Douglas-Abubakar & Omeiza Ibrahim 189
30 Norway BAHR: Svein Gerhard Simonnæs & Asle Aarbakke 197
31 Peru Payet, Rey, Cauvi, Pérez Abogados: José Antonio Payet Puccio &
Joe Navarrete Pérez 202
32 Puerto Rico Ferraiuoli LLC: Fernando J. Rovira-Rullán & Andrés Ferriol-Alonso 208
33 South Africa Bowmans: Ezra Davids & David Yuill 215
34 Spain Uría Menéndez: Eduardo Geli & Ona Cañellas 222
35 Sweden Mannheimer Swartling Advokatbyrå: Patrik Marcelius & Isabel Frick 231
36 Switzerland Lenz & Staehelin: Patrick Schleiffer & Andreas von Planta 236
Contributing Editors
Sabastian V. Niles &
Adam O. Emmerich,
Wachtell, Lipton, Rosen &
Katz
Publisher
Rory Smith
Sales Director
Florjan Osmani
Account Director
Oliver Smith
Senior Editors
Caroline Collingwood
Rachel Williams
Group Consulting Editor
Alan Falach
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Continued Overleaf
Country Question and Answer Chapters:
EDITORIAL
Welcome to the twelfth edition of The International Comparative Legal
Guide to: Corporate Governance.
This guide provides corporate counsel and international practitioners with
a comprehensive worldwide legal analysis of the laws and regulations of
corporate governance.
It is divided into two main sections:
Seven general chapters. These are designed to provide an overview of key
issues affecting corporate governance law, particularly from a multi-
jurisdictional perspective.
The guide is divided into country question and answer chapters. These
provide a broad overview of common issues in corporate governance laws
and regulations in 33 jurisdictions.
All chapters are written by leading corporate governance lawyers and
industry specialists, and we are extremely grateful for their excellent
contributions.
Special thanks are reserved for the contributing editors Sabastian V. Niles
& Adam O. Emmerich of Wachtell, Lipton, Rosen & Katz for their
invaluable assistance.
The International Comparative Legal Guide series is also available online
at www.iclg.com.
Alan Falach LL.M.
Group Consulting Editor
Global Legal Group
Alan.Falach@glgroup.co.uk
37 Turkey Cektir Law Firm: Av. Berk Cektir & Av. Uğur Karacabey 244
38 United Kingdom Macfarlanes LLP: Robert Boyle & Tom Rose 251
39 Uruguay Olivera Abogados / IEEM Business School: Juan Martin Olivera 258
40 USA Wachtell, Lipton, Rosen & Katz: Sabastian V. Niles 264
The International Comparative Legal Guide to: Corporate Governance 2019
1
chapter 1
wachtell, lipton, rosen & Katz Sabastian v. niles
corporate governance, investor Stewardship and engagement
The New Paradigm of Corporate Governance is an implicit and
voluntary corporate governance and stewardship partnership among
corporations, shareholders and other stakeholders working together
to achieve long-term value and resist the short-termism that impedes
long-term economic prosperity. At the request of the World
Economic Forum, members of Wachtell, Lipton, Rosen & Katz
prepared a paper titled, The New Paradigm: A Roadmap for an Implicit Corporate Governance Partnership Between Corporations and Investors to Achieve Sustainable Long-Term Investment and Growth, which was issued in September 2016 and have subsequently updated and refined these principles to take into
account feedback from key stakeholders, including major
corporations, institutional investors, and third-party initiatives.
The below is an updated outline of synthesised principles intended
to promote the common goal of facilitating sustainable long-term
value creation through the governance roles of the board of directors
and senior management, the role of investors in impacting corporate
strategy and governance decisions within a framework of
stewardship, and engagement between companies and investors to
forge relationships built on transparency, trust and credibility.
Companies and investors would tailor the application of these
principles to their specific facts and circumstances. With respect to
stakeholder governance, boards of directors and senior management
have a pivotal role in harmonising the interests of shareholders and
other stakeholders, and it is worth recognising that shareholders and
other stakeholders have more shared objectives than differences –
namely, they have the same basic interest in facilitating sustainable,
long-term value creation.
Guiding Principles
Governance:
1. Purpose and Strategy. The board of directors and senior management should jointly articulate the company’s purpose
and oversee its long-term strategy, ensuring that the company
pursues sustainable long-term value creation.
2. Management and Oversight. The board of directors is responsible for monitoring company performance and for
senior management succession.
3. Quality and Composition of Board of Directors. Directors should have integrity, competence and collegiality, devote the
significant time and attention necessary to fulfil their duties,
and represent the interests of all shareholders and other
stakeholders. The board of directors as a whole should
feature backgrounds, experiences and expertise that are
relevant to the company’s needs.
4. Compensation. Executive and director compensation should be designed to align with the long-term strategy of the
company and incentivise the generation of long-term value,
while dis-incentivising the pursuit of short-term results at the
expense of long-term results.
5. Corporate Citizenship. Consideration should be given to the company’s purpose and its stakeholders, including
shareholders as well as employees, customers, suppliers,
creditors, and the community in which the company does
business, in a manner that contributes to long-term
sustainability and value creation.
Stewardship:
1. Beneficial Owners. Institutional investors are accountable to the ultimate beneficial owners whose money they invest.
They should use their power as shareholders to foster
sustainable, long-term value creation for their investors and
for the companies in which they invest.
2. Voting. Investors should actively vote on an informed basis consistent with the interests of their clients, which aligns with
the long-term success of the companies in which they invest.
3. Investor Citizenship. Investors should consider value-relevant sustainability, citizenship and ESG factors when
developing investment strategies.
Engagement:
1. By the Company. The board of directors and senior management should engage with major investors on issues
and concerns that affect the company’s long-term value and
be responsive to those issues and concerns.
2. By Investors. Investors should be proactive in engaging in dialogue with a company as part of a long-term relationship
and should communicate their preferences and expectations.
3. Shareholder Proposals and Votes. Boards of directors should consider shareholder proposals and key shareholder concerns
but investors should seek to engage privately before
submitting a shareholder proposal.
4. Interaction and Access. Companies and investors should each provide the access necessary to cultivate engagement
and long-term relationships.
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Governance
Purpose and Strategy. The board of directors and senior
management should jointly articulate the company’s purpose
and oversee its long-term strategy, ensuring that the company
pursues sustainable long-term value creation.
■ The board of directors should oversee the company’s
business strategies to achieve long-term value creation,
including by having meaningful input over the company’s
capital allocation process and strategy.
■ The board of directors should help the company articulate its
purpose and the ways in which it aims to make a positive
contribution to society, recognising that there are various
stakeholders, including employees, customers, communities
and the economy and society as a whole.
■ The board of directors should go beyond a “review and
concur” role to ensure that it understands the strategic
assumptions, uncertainties, judgments and alternatives that
underpin the company’s long-term strategy.
Management and Oversight. The board of directors is
responsible for overseeing the management of the company,
monitoring company performance and preparing for senior
management succession.
■ The board of directors sets the “tone at the top” to cultivate an
ethical culture and demonstrate the company’s commitment
to integrity and legal compliance. In setting the right tone,
transparency, consistency and communication are key – the
board’s vision for the company should be communicated
effectively throughout the organisation and to the investing
public. Companies should have in place mechanisms for
employees to seek guidance and alert management and the
board of directors about potential or actual misconduct
without fear of retribution.
■ The board of directors should periodically review the
company’s bylaws, governance guidelines and committee
charters and tailor them to promote effective board functioning.
The board of directors should be aware of the governance
expectations of its shareholders who hold a meaningful stake in
the company and take those expectations into account in
periodic reviews of the company’s governance principles, being
mindful of the stage of the company’s development and all
other relevant factors. The board of directors has two key roles
with respect to management: oversight of management and
partnership with management. The board of directors should
work to foster open, ongoing dialogue between members of the
board and management. This dialogue requires directors to
have access to senior management outside of board meetings.
Management has an obligation to provide information to
directors, and directors should seek clarification and
amplification where necessary. The board of directors and CEO
should together determine the information the board should
receive and periodically reassess the board’s information needs.
The key is to provide useful and timely information without
overloading the board. Deep understanding of a company’s
business cannot be gained or maintained solely in regularly
scheduled board meetings. At the core, every director should
understand how the company makes a profit and fulfils its
purpose, and the threats and opportunities it faces.
■ The board of directors and senior management should jointly
determine the company’s reasonable risk appetite, oversee
implementation of standards for managing risk and foster a
culture of risk-aware decision-making. In fulfilling its risk
management function, the board’s role is one of informed
oversight rather than direct management of risk. The board
of directors should consider significant risks to the company,
including technological disruption, cybersecurity and
reputational risks. The board should not be reflexively risk
averse; the board should seek appropriate calibration of risk
to benefit the long-term interests of the company.
■ Even with effective risk management, crises will emerge and
test the board of directors, with potential situations ranging
from the unexpected departure of the CEO to risk
management failures and major disasters. Each crisis is
different, but in most instances when a crisis arises, directors
are best advised to manage through it as a collegial body
working in unison with the CEO and senior management team
(unless the crisis relates directly to the CEO and/or
management team). Once a crisis starts to unfold, the board of
directors needs to be proactive and provide careful guidance
and leadership in steering the company through the crisis. If
there is credible evidence of a violation of law or corporate
policy, the allegation should be investigated and appropriate
responsive actions should be taken. The board of directors,
however, should be mindful not to overreact, including by
reflexively displacing management or ceding control to
outside lawyers, accountants and other outside consultants.
■ The board of directors should maintain a close, truly collegial
relationship with the CEO and senior management that
facilitates frank and vigorous discussion and enhances the
board’s role as strategic partner and evaluator. The board of
directors should monitor the performance of the CEO and
senior management.
■ The board of directors and senior management should maintain
a succession plan for the CEO and other key members of
management and oversee the cultivation and development of
talent. The board of directors should prioritise succession
planning by addressing it on a regular rather than reactive
basis, including having an emergency plan in the event of an
unexpected CEO departure or disability. Direct exposure to
employees is critical to the evaluation of the company’s senior
management. This is especially important in the current
environment in which it is typical for the CEO to be the only
management person with a seat at the board table.
■ Companies should frame required quarterly reporting in the
broader context of their long-term strategy and use interim
results and reporting to address progress toward long-term
plans. Companies should not feel obligated to provide
earnings guidance.
■ The board of directors should carefully consider extraordinary
transactions and receive the information and take the time
necessary to make an informed and reasoned decision. The
board of directors should take centre stage in a transaction that
creates a real or perceived conflict of interest between
shareholders and management, including activist situations. It
may be desirable for the board of directors to retain
experienced outside advisors to assist with major transactions,
particularly where there are important or complicated
financial, legal, integration, culture or other issues or where it
is useful for the board of directors to obtain independent
objective outside guidance. However, the board should be
careful not to create unnecessary divisions through the use of
special committees with their own separate advisors when
there is no legal requirement for a special committee.
Quality and Composition of Board of Directors. Directors should
have integrity, competence and collegiality, devote the significant
time and attention necessary to fulfil their duties and represent the
interests of all shareholders and other stakeholders. The board of
directors as a whole should include diverse backgrounds,
experiences and expertise tailored to the company’s needs.
■ Every director should have integrity, strong character, sound
judgment, an objective mind, collegiality, competence and
the ability to represent the interests of all shareholders and
other stakeholders. After competency and integrity, the next
most important (yet often underemphasised) consideration is
collegiality as part of an effective board culture.
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wachtell lipton corporate governance, investor Stewardship and engagement
■ When filling vacancies, directors should take a long-term
strategic view focused not merely on filling immediate
vacancies on an ad hoc basis, but on constructing a well-rounded board that works well together and is bonded
together by mutual trust and respect. The quality of team
dynamics may have a significantly greater impact on firm
performance than the sum of individual director
contributions.
■ The composition of a board should reflect a complementary
diversity of thought, background, skills, experiences, and
tenures. The board of directors should develop a system for
identifying diverse candidates, including women and
minority candidates, and for effectively integrating new
members into the board dynamic.
■ A substantial majority of the board of directors should be
independent. The board of directors should consider all
relevant facts and circumstances when evaluating
independence. Long-standing board service should not, by
itself, disqualify a director from being considered
independent.
■ The board of directors should decide, based on the
circumstances, whether to have separate or combined chair
and CEO roles alongside an independent board leader. The
board of directors should explain its decision to shareholders,
and, if the roles are combined, should appoint a strong lead
independent director. The lead independent director should
serve as a liaison between the chairman of the board and the
independent directors, preside over executive sessions, call
meetings of the independent directors when necessary, guide
the board’s self-assessment or evaluation process, and guide
consideration of CEO and senior management compensation
and succession within the context of relevant board
committees.
■ The size of the board of directors will depend on the nature,
size and complexity of the company and its state of
development. In general, the board of directors should be
large enough to include a diversity of perspectives and as
small as practicable to promote open dialogue.
■ Companies should consider limitations on the number of
other boards of directors on which a director sits to ensure a
director’s ability to dedicate sufficient time to the
increasingly complex and time-consuming matters that the
board of directors and committees are expected to oversee.
■ The composition of a board of directors should reflect a range
of tenures. The board of directors should consider whether
policies such a mandatory retirement age or term limits are
appropriate, but board refreshment should be tempered with
the understanding that age and experience can bring wisdom,
judgment and knowledge. Substantive director evaluation
and re-nomination decisions will serve better than arbitrary
policies.
■ Directors should spend the time needed and meet as
frequently as necessary to discharge their responsibilities and
should endeavour to attend all board and committee
meetings, as well as the annual meeting of shareholders. The
full board of directors should have input into the board
agenda.
■ Time for an executive session without the CEO or other
members of management should be on the agenda for each
regular board meeting.
■ Confidentiality is essential for an effective board process and
for the protection of the company, and director confidentiality
is not inconsistent with engagement pursuant to The New
Paradigm. Directors should respect the confidentiality of all
discussions that take place in the boardroom. Moreover,
directors generally owe a broad legal duty of confidentiality
to the company with respect to information they learn about
the company in the course of their duties.
■ The board of directors should have a well-developed
committee structure with clearly understood responsibilities.
Decisions about committee membership should be made by
the full board based on recommendations from the
nominating and governance committee, and committees
should meet all applicable independence and other
requirements. Committees should keep the full board of
directors and management apprised of significant actions.
■ Companies should conduct a robust orientation for new
directors and all directors should be continually educated on
the company and its industry. New board members should
receive extensive education about the company’s business,
purpose and strategy. That process should include sessions
with the CEO, other directors, members of senior
management and, in appropriate cases, major shareholders.
■ Companies may find it useful to have an annual two- to three-
day board retreat with senior executives to conduct a full
review of strategy and long-range plans. Companies should
also provide directors with regular tutorials and site visits as
part of expanded director education, and external experts,
such as expert counsel or other consultants, in appropriate
circumstances to assure that, in overseeing complicated,
multi-industry and new-technology businesses and strategies,
the directors have the information and expertise they need.
Companies and boards may also find it useful for directors to
have access to the workforce.
■ The board of directors should evaluate the performance of
individual directors, the full board of directors, and board
committees on a continuing basis. Evaluations should be
substantive exercises. Evaluations should be led by the non-
executive chair, lead independent director, or appropriate
committee chair, and externally facilitated evaluations may
be appropriate from time to time.
Compensation. Executive and director compensation should be
designed to align with the long-term strategy of the company
and incentivise the generation of long-term value, while dis-
incentivising the pursuit of short-term results at the expense of
long-term results.
■ The board of directors should develop management
compensation structures that are aligned with the long-term
strategy and risk compliance policies of the company. The
board of directors should carefully consider whether
management compensation structures promote risk-taking
that is not consistent with the company’s overall risk appetite.
A change in the company’s long-term strategy or risk
compliance policies should trigger a re-evaluation of
management compensation structures.
■ Executive compensation should have a current component
and a long-term component. A substantial portion should be
in the form of stock or other equity, with a vesting schedule
designed to ensure economic alignment with investors. In
general, executives should be required to hold a meaningful
amount of company stock during their tenure and beyond.
■ The board of directors or its compensation committee should
understand the costs of compensation packages and the
maximum amount payable in different scenarios. In setting
executive compensation, the compensation committee should
take into account the position of the company relative to other
companies, but use such comparison with caution, in view of
the risk of an upward ratchet in compensation with no
corresponding improvement in performance.
■ In considering executive compensation, companies should be
sensitive to the pay and employment conditions elsewhere in
the company and take into account the pay ratios within the
company. The board of directors should also consider the
views of shareholders, including as expressed in “say-on-
pay” votes, but should not abdicate its role in deciding what
is best for the company.
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wachtell lipton corporate governance, investor Stewardship and engagement
■ Companies should monitor, restrict or prohibit executives’
ability to hedge the company’s stock and oversee the
adoption of policies to mitigate risks, such as compensation
recoupment or clawbacks.
■ Directors should receive compensation that fairly reflects the
time commitment and exposure to public scrutiny and potential
liability of public company board service, with appropriate
benchmarking against peer companies. Independent directors
should be equally compensated, although lead independent
directors and committee chairs may receive additional
compensation and committee fees may vary.
■ If directors receive additional compensation not related to
service as a director, such compensation should be disclosed
and explained to shareholders.
Corporate Citizenship. Consideration should be given to the
company’s purpose and its stakeholders, including shareholders
as well as employees, customers, suppliers, creditors, and the
community in which the company does business, in a manner
that contributes to long-term sustainability and value creation.
■ Companies should be good citizens of the communities in
which they do business and produce value and solutions for
stakeholders, with consideration of relevant sustainability and
societal issues in operating their businesses. Good stakeholder
relationships are good business and are good for business.
■ Companies should identify and articulate their purposes –
i.e., their objectives and contributions to societal and public
interests. Profits are not the raison d’être of a company, but rather are a product of its pursuit of its corporate purposes.
■ The board of directors and senior management should
integrate relevant ESG matters into strategic and operational
planning, budgeting, resource allocation and compensation
structures. The company should communicate its policies on
these subjects to shareholders.
■ Companies have an important perspective to contribute to
public policy dialogue on issues related to the company’s
business or purpose. If a company engages in political
activities, the board of directors should oversee such
activities and consider whether to adopt a policy of disclosure
of the activities.
Stewardship
Beneficial Owners. Asset managers are accountable to their
client investors – the beneficial owners whose money they invest
and those clients are accountable to the ultimate beneficiaries of
the invested assets. Investors should use their power as
shareholders to foster sustainable, long-term value creation for
their investors and for the companies in which they invest.
■ Investors should provide steadfast support for the pursuit of
reasonable strategies for long-term growth and speak out
against conflicting short-term demands. An asset manager’s
support should be expressed through constructive engagement,
public expressions of support, and voting in favour of
company-sponsored proposals. The support of institutional
investors, and the vocal endorsement from respected and
influential asset managers to act as a “champion” for a
company, can be decisive in curbing short-termist pressure.
■ Asset managers and investors who have policies supporting
ESG and sustainable long-term investment strategies should
not invest in activist hedge funds whose tactics promote
short-termism.
■ Investors should establish a firm-wide culture of long-term
thinking and patient capital that persists through cycles of
short-term turbulence, including through the design of
employee compensation structures that discourage the
sacrifice of long-term value for short-term gains.
■ Investors should adopt and disclose guidelines and practices
that help them oversee the corporate governance practices of
investee companies. Disclosure should include investors’
long-term investment policies, evaluation metrics, governance
procedures, views on quarterly reports and earnings guidance,
and guidelines for relations with and policies towards short-
term activists. Investors should also disclose whether they use
consultants to evaluate strategy, performance and transactions
and how a company can engage with those consultants.
■ Investors should evaluate the performance of boards of
directors, including director knowledge of governance and
other key investor concerns, as well as the board of directors’
understanding of the company’s long-term strategic plan.
That evaluation may be shared with the board of directors
and/or senior management through the lead independent
director or independent chair or CEO, with candid feedback
expected in return.
Voting. Investors should actively vote on an informed basis
consistent with the interests of their clients, which aligns with
the long-term success of the companies in which they invest.
■ Investors should devote sufficient time and resources to the
evaluation of matters for shareholder voting in the context of
long-term value creation. Investors should consider
increasing their in-house staffing and capabilities to the
extent appropriate to dedicate sufficient time and attention to
understanding a company’s business plan and long-term
strategy, getting to know its management and engaging
effectively with the companies in which they invest.
■ Investor votes should not abdicate decision-making to proxy
advisory firms; rather, votes should be based on the
independent application of internal policies and guidelines,
and the assessment of individual companies and their boards
and management. Investors may rely on a variety of
information sources to support their evaluation. Third-party
analyses and recommendations, including those of proxy
advisory firms, should assist but not be a substitute for
individualised decision-making that considers the facts and
circumstances of each company.
■ Investors should disclose their proxy voting and engagement
guidelines and report periodically on stewardship and voting
activities.
■ Asset managers and investors who have announced their
adoption of, and adherence to The New Paradigm or who have
policies supporting ESG and sustainable long-term investment
strategies should explain any vote in favour of a proposal by an
activist hedge fund that is opposed by the company.
■ Investors should have clear procedures that help identify and
manage potential conflicts of interest in their proxy voting
and engagement and disclose such procedures.
Investor Citizenship. Investors should consider value-relevant
sustainability, citizenship and ESG factors when developing
investment strategies.
■ Investors should consider the ways in which ESG factors are
relevant to sustainable growth and integrate material ESG
factors into their investment analysis and investment decisions.
■ Investors should disclose their positions on societal purpose,
social and other ESG matters.
Engagement
By the Company. The board of directors and senior
management should engage with major investors on issues and
concerns that affect the company’s long-term value and be
responsive to those issues and concerns.
■ Companies should disclose their adoption of and adherence
to The New Paradigm.
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wachtell lipton corporate governance, investor Stewardship and engagement
■ The board of directors and senior management should
establish communication channels with investors and be open
to dialogue. Boards should be responsive to shareholders and
be proactive in order to understand their perspectives.
■ Companies should clearly articulate for investors the
company’s vision, purpose and strategy, including key
drivers of performance, risk and evolution of business model.
The company should explicitly describe how the board of
directors in particular has actively reviewed long-term plans
and that it is committed to doing so regularly.
■ Companies should explain and make the financial case for
long-term investments, including capital projects,
investments in equipment and technology, employee
education, workforce training, out-of-the-ordinary increases
in wages and benefits, research and development, innovation
and other significant initiatives.
■ Companies should make adequate disclosures on a variety of
topics, including: how compensation practices encourage and
reward long-term growth; the director recruitment and
refreshment process; succession planning; consideration of
relevant sustainability, citizenship, and ESG matters; climate
risks; political risks; corporate governance and board practices;
anti-takeover measures; material mergers and acquisitions; and
major capital commitments and capital allocation priorities.
Companies should explain the bases for their recommendations
on the matters that are submitted to a shareholder vote.
■ Companies should disclose their approach to human capital
management, including employee development, diversity
and a commitment to equal employment opportunity and
advancement opportunity, health and safety, labour relations,
and supply chain labour standards.
By Investors. Investors should be proactive in engaging in
dialogue with a company as part of a long-term relationship and
should communicate their preferences and expectations.
■ Investors should disclose their adoption of, and adherence to,
The New Paradigm.
■ Investors should actively listen to companies, participate in
meetings or other bilateral communications and
communicate their preferences, expectations and policies
with respect to engaging with and evaluating companies.
Investors should accept their responsibility to understand the
purpose and strategy of companies in which they invest, and
to eschew ideological positions not tailored to each
company’s position and needs. Investors should clearly state
their expectations for a company and provide candid and
constructive feedback.
■ Investors should address and attempt to resolve differences
with companies promptly, by first engaging in a constructive
and pragmatic manner that is intended to build trust and a
common understanding, and should give due consideration to
the company’s rationale.
■ Investors should acknowledge their role in supporting the long-
term interest of the company and its stakeholders as a whole,
provide companies with candid and direct feedback and give
companies prompt notice of any concerns. To the extent that an
asset manager’s or investor’s expectations for any given
company evolve over time, the asset manager or investor
should proactively communicate those changes to the company.
■ Investors should invite companies to privately engage and
should work collaboratively with boards of directors and
management teams to correct subpar strategies and
operations, but this does not mean that investors need to
abandon its support for companies in resisting the short-
termism advocated by activists. Asset managers and
institutional investors should make it clear that activists do not
speak for them. Investors should provide an opportunity for a
company to engage privately on an issue or concern before
publicly disclosing a negative opinion about the company.
■ Investors should disclose to the companies in which they
invest their preferred procedures and contacts for
engagement and establish (and disclose) clear guidelines
regarding what further actions they may take in the event they
are dissatisfied with the outcome of their engagement efforts.
Those procedures and policies may differ on a company-by-
company basis depending on the relative stakes involved and
the shareholders’ views about the value of differing levels of
engagement with particular companies.
Shareholder Proposals and Votes. Boards of directors should
consider shareholder proposals and key shareholder concerns
but investors should seek to engage privately before submitting
a shareholder proposal.
■ Boards of directors should respond to shareholder proposals
that receive significant support by implementing the
proposed change if the board of directors believes it will
improve governance, or by engaging with shareholders and
providing an explanation as to why the change is not in the
best long-term interest of the company if the board of
directors believes it will not be constructive.
■ Investors should raise critical issues to companies as early as
possible in a constructive and proactive way, and seek to
engage in a dialogue before submitting a shareholder
proposal. Public battles and proxy contests have real costs
and should be viewed as a last resort where constructive
engagement has failed.
■ Long-term investors should recommend potential directors to
the companies in which they invest if they know the
individuals well, believe they would be additive to the board
and are prepared to discuss with the company the range of
skillsets the investor believes should be included in the board.
■ Shareholders have the right to elect representatives and
receive information material to investment and voting
decisions. Indeed, it is an essential element of correcting
shareholder-corporate relationships that key shareholders be
informed on a company-specific basis and accept the
responsibility that comes with their role in The New
Paradigm. It is reasonable for shareholders to oppose re-
election of directors who have persistently failed to respond
to their feedback after efforts to engage constructively.
■ Boards of directors should communicate drivers of
management incentive awards and demonstrate the link to
long-term strategy and sustainable economic value creation.
If the company clearly explains its rationale regarding
compensation plans, shareholders should give the company
latitude in connection with individual compensation
decisions. The board of directors should nevertheless take
into account “say-on-pay” votes.
Interaction and Access. Companies, investors and other key
stakeholders should provide each other with the access
necessary to cultivate engagement and long-term relationships.
■ Engagement through disclosure is often the most practical
means of engagement, though in other cases, in-person
meetings or interactive communications may be more
effective. Opportunities to engage with shareholders include
periodic letters – both from management to articulate
management’s vision and plans for the future, and from the
board of directors to convey board-level priorities and
involvement – as well as investor days, proxy statements,
annual reports, other filings and the company’s online
presence.
■ Independent directors should be available to engage in
dialogue with major investors in appropriate circumstances,
recognising that such engagement can be achieved without
undermining the effectiveness of management to speak for
and on behalf of the company.
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■ The ultimate decision-makers of a company’s key
stakeholders should have access to the company and the
appropriate representatives and likewise the company should
have access to stakeholders’ ultimate decision-makers.
■ Boards of directors and senior management should cultivate
relationships with the government, the community and other
stakeholders.
■ Companies and investors should cooperate to develop
appropriate metrics to measure the value of ESG and
sustainable investments, such as those advanced by the
Embankment Project of the Coalition for Inclusive
Capitalism.
wachtell lipton corporate governance, investor Stewardship and engagement
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Sabastian V. Niles
Wachtell, Lipton, Rosen & Katz 51 W 52nd Street NY NY 10019 USA Tel: +1 212 403 1000
Fax: +1 212 403 2000
Email: svniles@wlrk.com
URL: www.wlrk.com
Wachtell, Lipton, Rosen & Katz is one of the most prominent business law firms in the United States. The firm’s preeminence in the fields of mergers and acquisitions, takeovers and takeover defence, shareholder activism, strategic investments, corporate and securities law, and corporate governance means that it regularly handles some of the largest, most complex and demanding transactions in the United States and around the world. It features consistently in the top rank of legal advisers. The firm also focuses on sensitive investigation and litigation matters and corporate restructurings, and in counselling boards of directors and senior management in the most sensitive situations. Its attorneys are also recognised thought leaders, frequently teaching, speaking and writing in their areas of expertise.
Sabastian V. Niles is a Partner at Wachtell, Lipton, Rosen & Katz where he focuses on rapid response shareholder activism, engagement and preparedness, takeover defence and corporate governance; risk oversight, including as to cybersecurity and crisis situations; U.S. and cross-border M&A and strategic partnerships; and other corporate and securities law matters and special situations.
Sabastian advises boards of directors and management teams worldwide and across industries, including technology, financial institutions, media, energy and natural resources, healthcare and pharmaceuticals, construction and manufacturing, real estate/REITs and consumer goods and retail.
In addition to serving as Consulting Editor for the New York Stock Exchange’s Corporate Governance Guide, Sabastian writes frequently on corporate law matters and has been a featured speaker at corporate strategy and investor forums. His speaking engagements have addressed topics such as Shareholder Activism; The New Paradigm of Corporate Governance; Hostile Takeovers; Strategic Transactions and Governance; M&A Trends; Board-Shareholder Engagement; Confidentiality Agreements in M&A Transactions; Negotiating Strategic Alliances with U.S. Companies; Current Issues in Technology M&A; Corporate Governance: Ethics, Transparency and Accountability; and Developments in Cross-Border Deals.
Sabastian received his juris doctorate from Harvard Law School, where he co-founded the Harvard Association of Law and Business (and continues to serve on the Advisory Board) and won the U.S. National ABA Negotiation Championship representing the Harvard Program on Negotiation.
7
chapter 2
Herbert Smith Freehills llp gareth Sykes
Directors’ Duties in the UK – the rise of the Stakeholder?
Introduction
There has in recent years been a renewed focus on the role of business
in society in the UK. Factors contributing to this have included the
continuing, and long-standing, concern about the levels of executive
pay and a number of well-publicised corporate failures. The
behaviour and transparency of large businesses in the UK, including
listed companies and privately held businesses, has come under
particular scrutiny, with the debate focussing on how those companies
should take into account the interests of their wider stakeholders
(including the workforce, customers and suppliers), rather than
simply be run in a way that is perceived to favour only shareholders.
It is clear from the “enlightened shareholder value” concept contained
in section 172 of the Companies Act 2006 (the “2006 Act”) that a
director’s core duty is to the company’s members and that directors
are only required to “have regard” to the stakeholder matters.
However, pressure from politicians, society at large and investors
have led to a number of developments which seek to encourage
directors to consider this duty and stakeholder matters more carefully.
The Statutory Duty to Promote the Success
of the Company
Prior to the 2006 Act, directors’ duties in the UK were based on
common law and equitable principles. The 2006 Act codified
directors’ duties with a view to making the law more consistent,
certain, accessible and comprehensive.
The central directors’ duty in the 2006 Act is the duty contained in
section 172 that a director must act in the way he or she considers,
in good faith, would be most likely to promote the success of the
company for the benefit of its members as a whole, having regard to
the list of factors specified in section 172(1). The Government’s
explanatory notes to the 2006 Act make it clear that the list of factors
in section 172(1) is not exhaustive, but highlights areas of particular
importance reflecting wider expectations of responsible business
behaviour.
Companies Act 2006 Section 172(1):
“A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to –
(a) the likely consequences of any decision in the long term,
(b) the interests of the company’s employees,
(c) the need to foster the company’s business relationships with suppliers, customers and others,
(d) the impact of the company’s operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of business conduct, and
(f) the need to act fairly as between members of the company.”
The section 172 duty is based on the common law duty to act in the
best interests of the company. After considerable discussion and
debate throughout the consultation process on the then Companies
Bill, the final-form wording of section 172 reflected a compromise
between two different philosophical positions:
■ the shareholder primacy approach, which would require
directors to make decisions in such a manner as purely to
maximise the interests of shareholders, rather than being
required to take into account the interest of any other
stakeholder group; and
■ the pluralist approach, which would require directors to have
a wider vision beyond profit maximisation for shareholders
and instead oblige them to act in the interests of a wider group
of constituents with a stake or interest in the company and its
business.
This middle way embodied in the 2006 Act is commonly referred to as
“enlightened shareholder value”. This means that a director’s duty is
ultimately still owed solely to the company but in order to promote the
success of the company, directors should also have regard to the
interests of certain stakeholder groups and other principles. The
primary duty is therefore in essence still the same as the common law
duty to act in the best interests of the company and the duty is still
owed to the company itself and not to any shareholder or stakeholders.
No guidance was provided in the 2006 Act as to how directors
should have regard to the factors referred to in section 172(1) and
how they should demonstrate that regard in practice. The
explanatory notes to the 2006 Act provide some assistance. They
state that when having regard to the factors listed, the section 174
duty to exercise reasonable care, skill and diligence will apply and
that it will not be sufficient to pay lip service to the factors.
The guiding principle generally adopted by companies and directors
when the 2006 Act came into force was that they should adopt an
appropriate and proportionate approach when taking key decisions,
in light of the importance of the decision being made and the general
practice within the company for reaching and documenting
decisions of the directors. It is accepted that this will inevitably
involve a weighing exercise, having assessed the interests of various
stakeholders and shareholders.
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Over 11 years on from the commencement of section 172 in the
2006 Act, there is yet to be a reported court judgment which directly
addresses the “enlightened shareholder value” approach and how
directors should have regard to the factors referred to in section
172(1). However, this gap is, to some extent, being filled by the raft
of measures arising from the UK Government’s corporate
governance reform programme.
The Government’s Corporate Governance
Reform Programme
A number of well-publicised corporate failures provided the catalyst
for a renewed focus in the UK on the role of business in society, and
prompted the Government to publish a consultation paper on
corporate governance reform in November 2016. One of the key
issues raised in the consultation paper was how business should take
into account the interests of wider stakeholders, and in particular,
how the employee, customer and wider stakeholder voice in the
board room could be strengthened.
The Government acknowledged that the 2006 Act already required
directors to take into account wider stakeholder interests when
running a company for the benefit of its shareholders, and that many
companies and their directors already recognised the importance of
wider engagement in connection with their business activities.
However, the Government noted that, notwithstanding those
requirements, there had been some examples of poor corporate
conduct where the views and needs of stakeholders, including
employees, suppliers and pension beneficiaries, had not been properly
taken into account by companies and their directors. There was also
an acknowledgment that some stakeholders believe that companies
needed to do more to reassure the public that they are being run with
an understanding and recognition of their responsibilities to
employees, customers, suppliers and wider society.
In light of this, the Government asked what could be done to address
these concerns so as to ensure that UK companies have an appropriate
model of employee, customer and wider stakeholder engagement.
Revisiting Section 172?
Although there was no suggestion in the consultation paper that the
section 172 duty in the 2006 Act should be amended, the consultation
stimulated a debate on the wording of the duty itself. In particular, a
number of civil society organisations and trade unions advocated
amending section 172 so as to ensure directors pay greater heed to
the interests of a company’s stakeholders. Notwithstanding this, the
Government confirmed in its August 2017 response paper that it did
not intend to amend the 2006 Act. This outcome echoed the
conclusion of the Parliamentary Business, Energy and Industrial
Strategy Select Committee which conducted a detailed inquiry into
UK corporate governance. In its April 2017 report, the Committee
stated that “we do not believe that weaknesses in corporate governance arise primarily from the wording of the Companies Act, in particular section 172. We nonetheless recognise that the requirement for directors to ‘have regard to’ other stakeholders and considerations is lacking in clarity and strength and is not realistically enforceable by shareholders in the courts, even if they were minded to take action against their own company directors”.
The Government did conclude that further guidance for companies
of all sizes on how the “enlightened shareholder value” model
enshrined in section 172 should work in practice would be valuable.
It therefore asked the GC100 (the Association of General Counsel
and Companies Secretaries working in FTSE 100 companies) to
produce advice on the duty in section 172.
That GC100 published its guidance in November 2018. It seeks to
provide practical assistance to directors on the performance of their
duty under section 172, with a particular focus on wider stakeholder
considerations. The guidance reiterates that the section 172 duty is
owed to the company, not directly to shareholders or stakeholders.
It explains that, because shareholders are the owners, and the
company is ultimately run for their benefit, section 172 starts with
the benefit of shareholders as a whole as its goal, but the law
recognises and requires that stakeholder factors need to be part of
the assessment. It reminds directors that these stakeholder matters,
and other relevant inputs, should be borne in mind when setting
strategy, in developing policies, in creating a corporate culture and
in guiding and delegating to management and employees.
Critically, it says that the role of the director is not to balance the
interests of the company and stakeholders. Instead, after weighing
up all of the relevant factors, a director should consider which
course of action best leads to the success of the company, having
regard to the long term. This can sometimes mean that certain
stakeholders are adversely affected, but that fact alone does not
make the decision invalid.
Influencing Behaviour Through Reporting
Instead of reforming section 172 itself, the Government’s favoured
approach was to augment the reporting requirements on stakeholder
matters imposed on companies. In doing so, it argued that this
would enhance the operation of section 172 of the 2006 Act, stating
that “a formal reporting requirement will impel directors to think more carefully about how they are taking account of these wider matters. More transparency will also help to reassure investors, creditors and others that companies are being run with a view to their long-term sustainability. In addition, better reporting should improve the visibility of good boardroom practice, allowing it to be replicated and adopted more widely”.
Most UK companies are already required to report on certain
stakeholder matters in their annual report and accounts. For
example, many UK companies are required by section 414C of the
2006 Act to prepare a strategic report as part of their annual report
and accounts. The stated purpose of the strategic report is to help
shareholders to assess how the directors have performed their duty
under section 172; however, this requirement was not fully
appreciated and applied in practice by some companies and their
directors. In light of this, one of the key changes in the revised
edition of the Financial Reporting Council (“FRC”) Guidance on
the Strategic Report (published in August 2018) was to reinforce
that requirement, strengthening the link between the purpose of the
strategic report and the matters directors should have regard to
under section 172 of the 2006 Act.
In addition since 2013, public companies and large private
companies have been required to include certain stakeholder-related
disclosures in their strategic reports (for example, analysis using key
performance indicators relating to environmental and employee
matters where appropriate) and quoted companies have been
required to disclose information about environmental, social,
community and human rights issues. Those quoted company
disclosures were enhanced in 2017 following UK implementation of
the EU Non-Financial Reporting Directive.
The new reporting requirement which has been introduced as part of
the corporate governance reform package is, however, much
broader than these existing requirements. It focuses specifically on
consideration of stakeholder factors in the context of the directors
performing their section 172 duty.
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Companies Act 2006 Section 414CZA
“A strategic report for a financial year of a company must include a statement (a “section 172(1) statement”) which describes how the directors have had regard to the matters set out in section 172(1)(a) to (f) when performing their duty under section 172.”
It is important to note that the requirement is not simply for the
directors to report that they have discharged their section 172 duty,
nor are directors required to report on how they have discharged that
duty. Instead, directors are obliged to provide a narrative as to how
stakeholder matters have been considered by the directors and the
impact of that consideration. Separate, but complementary,
reporting obligations have also been introduced, requiring
companies to explain how the directors have engaged with
employees, how they have had regard to UK employee interests and
how they have had regard to the need to foster the company’s
business relationships with suppliers, customers and others.
In terms of what companies should disclose as part of a section
172(1) statement, the Government has suggested that information
on some or all of the following could be included:
■ the issues, factors and stakeholders the directors consider
relevant in complying with section 172(1)(a) to (f) of the
2006 Act and how they have formed that opinion;
■ the main methods the directors have used to engage with
stakeholders and understand the issues to which they must
have regard; and
■ information on the effect of that regard on the company’s
decisions and strategies during the year.
The Government has also said that the content of a section 172(1)
statement will depend on the individual circumstances of each
company. It says that companies will need to judge what is
appropriate, but the statement should be meaningful and informative
for shareholders, shed light on matters that are of strategic
importance to the company and be consistent with the size and
complexity of the business. The FRC Guidance on the Strategic
Report contains further guidance as to how companies could
approach this reporting requirement.
Although the vast majority of companies and their directors will
already be considering stakeholder factors, the challenge will be
articulating that consideration succinctly in the strategic report.
Companies will likely need to review their existing processes and
procedures to put greater focus on stakeholder matters to enable
them to fulfil their reporting obligations. For example, whilst many
companies refer to the impact on stakeholders when preparing board
papers in connection with mergers and acquisitions and other
significant matters, references to stakeholders are not necessarily
systematically incorporated when preparing board papers on other
matters.
Rebalancing the UK Corporate Governance
Code
One of the other key pillars to the Government’s corporate
governance reform programme was a fundamental review of the
UK Corporate Governance Code (the “Governance Code”) which
applies to companies with a premium listing of shares in the UK.
The provisions of the Governance Code apply on a “comply or
explain” basis, that is companies may chose not to comply with a
provision, but if they do so, they must provide an explanation as to
the alternative action being taken. In practice, the vast majority of
companies subject to the Governance Code report that they fully
comply with its provisions.
The revised edition of the Governance Code was published in July
2018 and one of its key features is the enhanced focus on
stakeholders and consideration of stakeholder interests. In response
to the Government’s objective to strengthen the voice of employees
and other stakeholders in the board room, a new principle was
introduced in to the Governance Code referring to a company’s
responsibilities to shareholders and stakeholders, stating that the
board should ensure effective engagement with, and encourage
participation from, these parties.
That overarching principle is supported by a provision in the
Governance Code which states that the board should understand the
views of the company’s key stakeholders and describe in the annual
report how their interests, and the matters set out in section 172 of
the 2006 Act have been considered in board discussions and
decision-making. There is clear overlap between this provision and
the section 172(1) statement, but slightly different wording and
emphasis. As a result, companies will need to take care to ensure
that the engagement, behaviour and reporting requirements in the
Governance Code and the section 172(1) statement are dealt with in
an appropriate manner.
In relation to engagement with the workforce, there is also a new
provision stating that companies should adopt a method for
workforce engagement, with suggested methods including a
director appointed from the workforce, a formal workforce advisory
panel or a designated non-executive director. The term “workforce”
is used (instead of employee) in the Governance Code, a deliberate
choice which seeks to encourage companies to consider how their
actions impact on all members of their workforce, not only those
with formal employment contracts.
The introduction to the Governance Code explicitly states that it is
not intended to override or be a reinterpretation of section 172.
However, its enhanced focus on stakeholder matters will influence
directors when they are considering the application of their section
172 duty.
Consideration of stakeholder matters is also key themes in the
recently published Wates Corporate Governance Principles for
Large Private Companies, which is intended to provide a framework
and benchmark for corporate governance best practice for large
privately held UK companies.
The Rise of the Stakeholder?
The directors’ duty contained in section 172 has been in force for
over a decade. The increasing focus on stakeholder interests and
responsible business practices in the UK has, rightly, brought to the
fore questions as to whether directors are discharging their statutory
duties properly, including giving due consideration to the interests
of stakeholders.
However the directors’ core duty in section 172 to promote the
success of the company for the benefit of its members as a whole
remains unchanged. A director’s primary duty is to the company’s
shareholders. The GC100 guidance provides a timely reminder of
this. As the Parliamentary Business, Energy and Industrial Strategy
Select Committee in its corporate governance report “now is not the time to introduce uncertainty to UK markets by seeking to reframe the law”.
Notwithstanding that the wording of section 172 and the duty
remains unchanged, arguably the new reporting requirements and
Governance Code provisions are a more effective mechanism to
push consideration of stakeholder matters higher up the board room
agenda than reframing section 172 itself would have been.
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Gareth Sykes
Herbert Smith Freehills LLP Exchange House, Primrose Street London EC2A 2EG United Kingdom Tel: +44 20 7466 7631
Email: Gareth.Sykes@hsf.com
URL: www.herbertsmithfreehills.com
Gareth helps companies navigate the increasingly challenging corporate law and governance framework in the UK. He is a member of the Herbert Smith Freehills Corporate Governance Advisory Team, advising a range of listed and privately held companies on a variety of governance issues. His expertise includes advising on corporate reporting requirements, the UK Corporate Governance Code, continuing obligations pursuant to the UK listing regime, company meetings and directors’ duties.
A key part of Gareth's role is horizon-scanning, analysing new law and regulation to ensure that the firm's clients anticipate and remain at the forefront of corporate law and regulatory developments and practice. Gareth writes widely on corporate governance matters.
Prior to his current role, Gareth advised a variety of corporates and investment banks on a wide range of transactions including mergers and acquisitions, joint ventures and equity capital markets transactions.
Operating from 27 offices across Asia Pacific, EMEA and North America, Herbert Smith Freehills is at the heart of the new global business landscape providing premium quality, full-service legal advice. The firm provides many of the world’s most important organisations with access to market-leading dispute resolution, projects and transactional legal advice, combined with expertise in a number of global industry sectors, including Banks, Consumer products, Energy, Financial buyers, Infrastructure & Transport, Mining, Pharmaceuticals & Healthcare, Real Estate, TMT and Manufacturing & Industrials.
Enhanced reporting requirements have proved to be effective in
changing behaviour in other areas in the UK. For example, in recent
years, new obligations requiring companies to report on their gender
pay gap and modern slavery and human trafficking in their business
and supply chain have led to increased focus on these areas, not only
by companies themselves but by the media and civil society which
have pushed companies to raise the bar following their disclosures.
For some companies which already consider and address stakeholder
matters appropriately, these new stakeholder requirements should
not be arduous. For other companies which have perhaps not
considered stakeholder issues as fully as they could have, it provides
a timely opportunity for them to review their practices. Though care
should be taken not to demote these requirements to a mere box-
ticking exercise in board papers or board meetings.
These new reporting requirements cannot eliminate poor corporate
practices nor deal will all perceived stakeholder injustices, but they
provide an opportunity for companies to demonstrate their
understanding of wider stakeholder concerns and interests and
should go some way to rebuilding trust in business in the UK and
providing reassurance that companies are not being run solely in the
interests of the board and shareholders.
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11
chapter 3
cleary gottlieb Steen & Hamilton llp
Sandra l. Flow
mary e. alcock
Human capital management: issues, Developments and principles
Human capital management is an increasingly important topic for
investors, employees, customers and other constituencies of a
corporation, and one which presents significant challenges and
opportunities for boards of directors and senior management. Recent
public attention to gender and racial inequality, pay disparities,
employment practices and the #MeToo movement have underscored
the reputational and financial stakes of mismanagement of human
capital management issues. In contrast, sound policies, culture and
compliance implemented by senior management and overseen by
boards can provide a competitive advantage in the battle to attract,
retain and motivate talent and foster a more dynamic workplace.
Given these risks and opportunities and their link to long-term strategic
planning, human capital management has become an issue that
warrants and demands board and senior management attention. The
following is an exploration of key issues, developments and principles
and best practices for boards of directors and senior management to
consider with respect to this evolving and sensitive topic.
Human Capital Management in Focus
Human capital management encompasses an expanding and
interconnected set of issues of interest to numerous constituencies.
Many are issues that companies have grappled with for some time
but which have risen in importance as the U.S. economy shifts from
a focus on industrial production to a focus on information
technology and services largely dependent on skilled employees.
Human capital management involves a number of key issues that are
becoming increasingly more important in discussions of company
culture, namely diversity and inclusion, board nomination and
refreshment, sexual harassment and workplace culture, succession
planning and gender pay equity. Human capital management also
encompasses traditional compensation and employee retention
policies, programmes and practices such as codes of conduct,
whistleblower policies, review and promotion practices, equal
employment opportunity policies, health and safety guidelines and
training and development programmes to encourage employee
engagement and wellness. One challenge in implementing effective
oversight of human capital management is that what is considered a
human capital management issue may vary significantly by industry
and geography and will almost certainly change over time.
Recently, a number of institutional investors – most notably
BlackRock and State Street Global Advisors – have indicated
increasing interest in human capital management issues:
■ BlackRock declared human capital management as one of
five “Investment Stewardship” engagement priorities for
2019; and
■ State Street Global Advisors named corporate culture as a
key area of focus for the firm in 2019.
Given increased investor attention and the significant potential
consequences if these issues are mismanaged, including legal and
financial risk, negative publicity and adverse impacts on employee
recruitment and morale, it is clear that boards of directors and senior
management should be attuned to human capital management issues.
Investors expect that boards of directors will contribute to and
oversee the company’s human capital management as it relates to
long-term strategy and risk management, and from a strategic
perspective, the full board should be focused on these issues.
However, although its issues are often intertwined, human capital
management cannot be approached as a monolith but should be
distilled into individual risk areas with the appropriate board
committee assuming responsibility.
Diversity and Inclusion
Diversity at the board and senior management level sets a tone at the
top that demonstrates a commitment to diversity and inclusion
throughout the company – a commitment that has real value in
attracting, retaining and engaging employees and providing them
with a workplace environment conducive to increased productivity.
Beyond demonstrating a commitment to diversity, a diverse board
and senior management team generates better and more balanced
decision-making. A diverse group of directors and executives is
more likely to engage in discussion and debate and is better able to
react to changes in recognise and respond to the concerns of
customers, investors and employees. Gender and racial and ethnic
diversity are of particular focus at the moment, but other aspects of
diversity are increasingly relevant, including age, religion,
nationality, sexual orientation and background.
Boards of Directors. Board diversity has been an area of intense
focus for investors in recent years, and it continues to gain
importance as institutional investors have started to express
dissatisfaction directly through votes against the chair of or the
entire nominating committee. More recently, state governments
have proposed and enacted legislation to promote more diverse
boardrooms and, in some cases, penalise companies lacking diverse
boards (particularly boards lacking gender diversity).
Going forward, companies without any diverse directors can expect
increased scrutiny from various directions, while companies with a
proportionally small number of diverse directors will likely
experience pressure to continue to make progress. Studies have
often identified at least three directors as a “critical mass” threshold
for seeing the benefits of diversity in the boardroom.
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Senior Management. Diversity at the top of an organisation
informs the commitment to diversity throughout the organisation –
and after the board, senior management is next in line. Many
companies making progress on diversity at the board level continue
to lag in diversity at the executive officer level. Considering that
diversity of senior management is the next logical focus for
investors and other constituencies, companies that begin assessing
and addressing the diversity of their senior leadership will be in a
better position to engage with and preempt criticism from investors.
External Action
■ Proxy advisory firms Institutional Shareholder Services, Inc.
(ISS) and Glass, Lewis & Co. have, as part of their annual
review of proxy voting guidelines, included considerations
regarding board diversity. In 2019, Glass, Lewis & Co.
began recommending voting against nominating committee
chairs of large-cap public companies lacking female directors
and has signaled it may extend the no vote recommendation
to the entire committee. ISS will enforce a similar policy
beginning in 2020, generally voting against nominating
committee chairs of public company boards without women
directors in the absence of limited mitigating factors.
■ Similarly, large institutional shareholders, including
BlackRock, State Street Global Advisors and Vanguard, have
committed to oppose nominating committee chairs or the
entire nominating committee of companies with inadequate
diversity or a lack of disclosure regarding plans to increase
diversity.
■ In 2017, the New York City Comptroller and the New York
City Pension Funds launched the Boardroom Accountability
Project 2.0, a multi-pronged initiative that resulted in letters
being sent to more than 150 companies asking them to
engage with the Comptroller’s office on the topic of board
diversity and to include a board skills matrix in their proxy
statement. Other pension funds, notably the California
Public Employees’ Retirement System (“CalPERS”), have
publicised votes against directors at companies based on a
failure to respond to outreach and efforts on the issue of
diversity.
■ In September 2018, the State of California passed a law
requiring public companies headquartered in the state to have
at least one female director by the end of 2019, increasing to
at least three female directors for companies with six or more
directors by the end of 2021. Companies that do not comply
will face modest fines. The State of New Jersey has since
proposed similar legislation, while Illinois, Massachusetts,
Colorado and Pennsylvania have passed non-binding
resolutions encouraging increased board diversity.
■ In February 2019, the U.S. Securities and Exchange
Commission released new Compliance and Disclosure
Interpretations relating to the diversity-related disclosure
requirements of Regulation S-K under the Securities Act of
1933. Under these interpretations, where a director has self-
identified diversity characteristics, including race, gender,
ethnicity, religion, nationality, disability, sexual orientation
and cultural background, the SEC expects that the company
will include a discussion of these characteristics and how the
nominating committee considered them in the director
background section of its proxy statement.
■ In February 2019, companion bills were introduced in the
U.S. House of Representatives and U.S. Senate that would
require public companies to disclose annually in their proxy
statements data on the racial, ethnic and gender composition
and veteran status of their directors, director nominees and
executive officers based on voluntary self-identification, and
to disclose the adoption of any board policy or strategy to
promote board diversity.
Principles and Best Practices
■ Review Corporate Governance Documents. The nominating and governance committee should review its committee
charter and the corporate governance guidelines to ensure
that the company’s commitment to board diversity is
appropriately reflected.
■ Think Beyond the Full Board. After addressing diversity at the full board level, the board of directors should begin to
think critically about the number of diverse directors on key
board committees and in leadership roles.
■ Engage with Shareholders. The board of directors should review and, if necessary, improve shareholder engagement on
the topic of board diversity and should monitor the
development of shareholder proposals relating to board
diversity.
Board Nomination and Refreshment
Closely tied to diversity and inclusion are a company’s director
nomination and refreshment practices. Diversity of gender, race,
age and other attributes on boards of directors cannot occur without
review and revision of the process by which directors are nominated
and boards are refreshed.
At many companies, lack of board diversity results in part from a
nomination process that relies largely on t