CG19 04-07 Layout 1 · 2020. 9. 3. · The International Comparative Legal Guide to: Corporate...

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)

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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

[email protected]

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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■ 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.



■ 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.

iclg to: corporate governance 2019 5www.iclg.com



■ 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.



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


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.



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.

Herbert Smith Freehills llp the rise of the Stakeholder?


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.

iclg to: corporate governance 2019 9www.iclg.com



Gareth Sykes

Herbert Smith Freehills LLP Exchange House, Primrose Street London EC2A 2EG United Kingdom Tel: +44 20 7466 7631


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.



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.



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

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