The timing of the revisions to the UK Corporate Governance Code to reflect the changing economic and social climate have stood companies in good stead in recent months.
The current economic downturn caused by the pandemic has both highlighted inequalities and raised expectations placed on businesses, while the Black Lives Matter movement has brought race to the fore.
The code – updated in 2018 to emphasise the importance of diversity and culture, among other changes – provides UK-listed companies with a platform to respond through meaningful reporting, demonstrating good corporate citizenship.
Not all have embraced this, however, with noticeable shortfalls around diversity. In its Review of Corporate Governance Reporting, published last November, the Financial Reporting Council (FRC) found many inconsistencies. Despite examples of good practice, companies continue to engage in box-ticking.
The FRC highlights superficial reporting on diversity: ‘Many companies stated the importance of diversity and diverse boards but offered little explanation in the way of evidence to support their assertions.’ This failure to demonstrate action and outcomes questions directors’ commitment to transparency and their focus on forging strong relationships with stakeholders.
The limited response of directors reflects a compliance mindset. The greatest disclosures are around gender and ethnicity – the two areas where targets have been set
Is target-setting the answer?
Target-setting reflects both the strengths and weaknesses of the UK’s approach to diversity:
- Overall, by setting targets rather than laws, the UK has tried to avoid tokenism – individuals are more likely to be appointed on merit rather than to meet a quota.
- Voluntary targets have boosted gender diversity on UK boards. There are notable successes: the Davies Review led to females on FTSE 100 boards rising from 12.5% in 2011 to 26% by 2016; the target set by the Hampton-Alexander Review – women to comprise 33% of FTSE 350 boards by December 2020 – looks likely to be met. Yet this increase is largely in non-executive director positions – EY and Cranfield Management School’s Female FTSE Board Report 2020 notes that more women are needed in influential roles, with only five female CEOs and 13.2% female executives in the FTSE 100.
- The FRC reported in 2020 that the approach of most listed companies to board ethnic diversity is unsatisfactory. How are the Parker Review recommendations (each FTSE 100 board to have at least one director of colour by 2021 and by 2024 for the FTSE 250) to be met when most companies fail to mention ethnicity in their board diversity policy or set measurable ethnicity targets? The Parker update in 2020 pointed to insufficient progress – 150 out of 256 listed companies surveyed still had no directors of colour.
The code sets out best practices on diversity. Principle J states that: ‘Board appointments and succession plans should be based on merit and objective criteria and, within this context, should promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths.’
The role of the nominations committee is expanded, with the annual report disclosing:
- the process used in relation to appointments and succession planning and how both support developing a diverse pipeline
- the policy on diversity and inclusion, its objectives and linkage to company strategy, how it has been implemented and progress on achieving the objectives
- the gender balance of those in the senior management and their direct reports.
The limited response of directors reflects a compliance mindset. For example, diversity has many components, but the greatest disclosure in corporate reports is around gender, followed by ethnicity – the two areas where targets have been set. Only a small number of companies disclose characteristics such as sexual orientation.
The FRC is critical of the reporting of diversity targets. Only 26% of companies disclose targets for both the board and executive pipeline. Few have board targets beyond gender (many are solely in line with the Hampton-Alexander Review), while those that have ethnicity targets are focused primarily on the Parker Review. These are minimum targets, but most boards are not looking to go beyond them.
A step-change is required. Rather than thinking of diversity as a standalone issue, directors should consider inclusion as the key enabling factor. Creating inclusive environments where employees are treated with respect and have equal access to opportunities and resources leads to greater diversity at the top.
This should have a positive effect on business performance; different backgrounds and perspectives in the boardroom promote cognitive diversity, which is likely to offer rigorous debate, reduce group-think and enable better decision-making.
Directors need to act quickly or risk alienating key stakeholders:
- Shareholders are increasingly taking notice. In October 2020, Legal and General warned investee companies that it will vote against those still with all-white boards by 2022.
- Employees are becoming frustrated at the slow progress. I observe this often – from discussions with young digital executives possessing valuable skills but little likelihood of a board appointment, to women in governance workshops now calling for the UK to introduce legislative gender quotas, despite concerns about tokenism.
- Customers are alerted to unfairness through the reporting of pay gaps, increasing reputational risk. Examples are the BBC pay gap for women journalists and, more recently, Lloyds Bank, where its voluntary ethnicity pay gap report showed that black staff are paid 20% less than colleagues because they ‘are disproportionately under-represented at senior levels’.
Increasing boardroom diversity is not easy. However, organisations looking to improve relationships with stakeholders, attract talented young people and develop their boards as high-performing teams need to respond. Better succession planning, broader recruiting from diverse talent pools and careful mentoring of newly appointed directors will all be required.