Corporate governance and private companies

In a recent blog post, I discussed how the recent BHS scandal has ignited the debate surrounding corporate governance and private companies. Recently, the Institute for Chartered Secretaries and Administrators (ICSA) has suggested two reforms that aim to improve governance among private companies. This blog post is focusing on the first (a later post will focus on the second), namely that ‘private companies required under the [CA 2006] to have audited accounts and to produce a directors’ report should be required to disclose in their annual report the extent to which they comply with the UK Corporate Governance Code.’ ICSA has wisely decided not to suggest that all private companies should be required to report against the Code, and by focusing on private companies that require audited accounts, a significant number of private companies would be excluded from the requirement to report (largely via the small company exemption). However, even requiring these companies to report may be problematic for several reasons.

First, the specified private companies would be ‘required’ to report their compliance with the Code. In relation to listed companies, the requirement to comply or explain is found in the Listing Rules (see LR 9.8.6R(5) and (6)), and the requirement to include a corporate governance statement is found in the Disclosure and Transparency Rules. As these rules do not apply to private companies, requiring private companies to report on compliance would require legislation, likely an amendment to the CA 2006 or the subordinate legislation that fleshes out the reporting requirements. This problem this creates is that, currently, only listed companies are required to comply or explain against the Code, meaning that unlisted public companies are not so required. If ICSA’s suggested reform was implemented, it would result in private companies being subject to a stricter requirement than public companies, which runs counter to the ‘think small first’ philosophy found in the CA 2006. If private companies are to be required to report, then surely public companies should be too?

Within ICSA, this view appears to exist. A blog post by Peter Swabey, ICSA’s Policy & Research Director, stated that ‘we advocate that all organisations large enough to require audited accounts, whether listed companies or not, should be required to indicate in their annual report where they have not complied with the UK Corporate Governance Code …’ Clearly, Peter Swabey believes that the requirement to report against the Code should not just be limited to private companies, but to all companies that require audited accounts. It would be useful for ICSA to officially clarify whether it believes that unlisted public companies should be required to report against the Code too.

The second criticism is that ICSA states that private companies should be required to report their compliance with the Code, but it does not expressly state whether they should be required to explain non-compliance (as listed companies are required to do). Again, Peter Swabey’s blog provides more information, stating that ‘we advocate that all organisations large enough to require audited accounts, whether listed companies or not, should be required to indicate in their annual report where they have not complied with the UK Corporate Governance Code and the reasons why they have chosen not to do so‘ (italics added). This indicates that the relevant private companies would be required to comply and explain against the Code. The issue that arises here is that the Code was written with listed companies in mind, and many of the Code’s recommendations will likely be unsuitable for private companies. Indeed, Peter Swabey acknowledges this stating that ‘[p]rivate companies should simply be expected to have more areas where they depart from the existing UK Corporate Governance Code.’ The problem that arises is that private companies would therefore have to spend more time explaining non-compliance than other companies, as they would be departing from more of the Code’s recommendations. For some private companies, this could prove unnecessarily burdensome. Further, given that the quality of explanations for non-compliance offered by listed companies has been criticised, one might wonder at how useful explanations from smaller companies would be.

In my opinion, legislatively requiring private companies to report against the UK Corporate Governance Code would be misguided. If private companies are to be subject to a corporate governance code, then it should be one that is designed for private companies. The CA 2006 recognises that public and private companies must be regulated differently and the same is true as regards corporate governance. I am also of the opinion that, if such a specific code were created, we should, initially at least, encourage private companies to report against it, rather than compelling them. This could be done by amending the model articles to provide that the directors will prepare a report setting out how the company has complied with the code. If the directors or members feel that such reporting is unwarranted, the relevant provision could be removed. If, in time, such reporting became more commonplace, the case for mandatory reporting might be stronger. Whatever solution is implemented, ICSA are absolutely correct to note that governance in private companies is just as important as governance in listed companies, and the time has come to act.

Update (14/02/2017)

Yesterday, the House of Commons Work and Pensions Committee published its response to the government’s Corporate Governance Review. The Committee has recommended that large private companies or those that have over 5,000 defined benefit pension scheme members should be made subject to the UK Corporate Governance Code on a comply or explain basis.

3 thoughts on “Corporate governance and private companies

  1. Pingback: Summary of updates (29 August-4 September 2016) | Company Law and Corporate Governance

  2. Pingback: The Corporate Governance Review | Company Law and Corporate Governance

  3. Pingback: Company Law and the 2017 Manifestos | Company Law and Corporate Governance

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s