s172 Reporting And The Purpose Of The Company

As we enter into the New Year, we know that directors and management teams for companies with December year ends will have begun to turn their attention to the drafting of the Annual Report.  One relatively new obligation upon large UK companies has been the introduction of a “Section 172 Report” within the Annual Report, which sets out how directors have had regard to their duties under s172 of the Companies Act 2006 over the course of the reporting year. 

Introduced for financial years beginning on or after 1 January 2019, it is only now that good practice s172 reporting is beginning to emerge. This article reviews the FRC’s feedback on s172 reporting to date and the questions those involved in the drafting of the s172 report should be asking themselves. It also and looks at growing pressure to revise directors’ duties in an era where the impact of business on wider stakeholder groups and the environment is coming increasingly to the forefront.

s172 of the Companies Act 2006  

s172 of the Companies Act sets out the duty of directors to promote the success of the company. The legislation states that:

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. 

There is a common misconception that directors are expected to weigh the company’s interests against all the other stakeholder interests and balance them out somehow, but we do not consider that to be the correct approach.  Stakeholder impacts can of course materially affect the outcome of a decision and the director’s role is therefore to weigh up all the relevant factors and then decide what’s best for the company in the long term. In terms of success, directors should generally be looking to long-term value creation rather than a short-term profit goals. Given the potentially ruinous impact of (for example) poor ethics, short termism, and bad employment practices upon a company’s brand and business, this also creates a better vantage point from which to approach broader stakeholder engagement.  

s172 reporting 

The Companies (Miscellaneous Reporting) Regulations 2018, alongside the revised UK Corporate Governance Code 2018 introduced a requirement for large companies to include a s172 statement in their annual report for financial years beginning on or after 1 January 2019.

S172 statements require companies to explain how the directors have considered the interests of stakeholders when discharging their duty to promote the success of the company. The statements were introduced in part to improve corporate governance standards through disclosure, requiring directors to be transparent and mindful in their decision making, encouraging full consideration of the impact of key decisions beyond the financial, and engagement with a broader range of potentially impacted stakeholders. In theory this should lead to better information through the “feedback loop” and accordingly better decision making. 

FRC Review

In its 2020 year-end letter[1], the FRC appeared underwhelmed with the first year of s172 statements, finding that although companies were reporting on the methods and frequency of engagement that they have with stakeholders, they were not reporting sufficiently on the feedback received, and actions being taken as a result of the engagement, and how such engagement was impacting upon decision making.  The FRC also reported a perception amongst investors of only receiving the good news with companies failing to highlight the many challenges and difficult decisions they face on a regular basis, particularly in the Covid environment.

FRC Lab recommendations 

In October 2020, the FRC Lab published its tips for s172 reports[2],  followed in July 2021 by a more detailed report[3]from the FRC Lab noting investors’ preferences regarding the disclosures, reporting that readers want to understand how a company is progressing towards fulfilling its purpose and achieving long-term success. It also noted that the Covid-19 pandemic had highlighted the importance of the need for companies to actively engage with stakeholders and the need to improve reporting in this area.

The report poses a series of questions for companies and provides practical examples by various companies of corporate reporting considered by investors to represent better practice. 

ONE suggestions

We would encourage all those involved in the preparation and review of s172 statements for their forthcoming annual reports to consider whether the following tests are met: 

  • Is the statement boilerplate or lacking in precision?  The statement should clearly set out both the decision-making process and how stakeholders are factored into that process and should include details of key decisions made over the year to help to illustrate that process in action.

  • Does the s172 statement set out those stakeholders that the Board has identified as key, and the reasons for this judgement, taking into account the company’s long-term strategy?

  • Does the statement set out an assessment of how effective stakeholder engagement has been over the year and the outcomes of such engagement, including the impact that such engagement has had upon decision-making?

  • Does the statement set out the oversight that boards have over delegated engagement?

  • Does the statement set out where engagement has been less successful and how the board is looking to improve engagement with certain stakeholders in future years?

  • Does the statement also consider where difficult decisions have had to be made, rather than just focusing on positive engagement?

  • Does the statement consider the implications of decisions on both long-term success and on stakeholders themselves?

  • Does the statement fit into the narrative of the overall Annual Report? Is there consistency of message and alignment with the company’s purpose and discussion of business model and strategy?

Should the purpose of companies change? 

The introduction of s172 into the Companies Act 2006 marked an attempt to demonstrate that companies exist in a wider ecosphere and that business has wider responsibilities than solely generating profits for shareholders. To some, s172 marked a possible end to shareholder primacy.  Nonetheless, the priority given within s172 to promoting the success of the company for “members as a whole” has held firm as the central tenet of the law, carrying on from the common law position.

It has been fifteen years since the Companies Act was passed into law. The global economic crisis of 2008, continued corporate scandals in the UK and the US, as well as elsewhere, increasing social inequality and, most recently, the COVID-19 pandemic have all caused people to question the purpose of companies and how and whether shareholder primacy (or lack of responsibility for any other parties) created the environment for some of these crises to happen. It has been mooted that s172, as currently articulated, does not adequately impose an appropriate level of social responsibility on corporates and is ripe for a revamp. 

The Better Business Act campaign, supported by a diverse range of stakeholders, aims to encourage companies to review their focus from having a duty to promote the success of the company for shareholder benefit to a duty which aligns the interests of their shareholders with those of wider society. Broadly speaking, the campaign is advocating for:

  • The purpose of the Company to be at the heart of directors’ duties under s172, with directors required to act in a way that “would be most likely to advance the purpose of the Company”.

  • The Company’s purpose remaining to benefit members as a whole, while also taking into account wider society and the environment.  Indeed, the campaign is advocating for s172 to be amended to state that the purpose of a company is to benefit its members as a whole while operating in a manner that also (a) benefits wider society and the environment (commensurate with its size and operations) and (b) reduces the harm the company creates or costs it imposes on wider society or the environment.

  • S172 reporting to focus on how the directors when performing their duties under s172 have advanced the purpose of the Company and taken the relevant factors into account. 

The campaign notes that, in a 2020 poll, 72% of respondents in the UK thought that businesses should have a legal responsibility to people and the planet, alongside maximising profit, which highlights that society in general is ever more interested in the values, environmental and social impacts companies are having. 

This year, the IOD Centre for Corporate Governance has set out its view that it is time for businesses to gain profits with a purpose, which correlates with the concepts from the Better Business Act. The IOD suggests that companies should, whilst continuing to commit to profit generation, lead by example by having a tangibly positive influence on wider society and that investors should also be dedicated to long term sustainable strategies as opposed to temporary financial returns. This only serves to reinforce the increasingly prevalent view of business operating as part of a wider ecosphere. 

In addition to the above, we see investor and proxy voting agency expectations on the behaviours of all listed companies changing, with a greater focus on ESG issues. All these factors are continuing to coalesce around the importance of business taking its wider societal duties more seriously. With that in mind, it will be ever more important for companies to be transparent on the ways in which they are considering long-term strategy and the ways in which stakeholders impact upon, and are impacted by, company strategy. 

Get in contact

Should you wish to discuss any aspect of this article with us, including possible ways in which we can work with your organisation on corporate governance or compliance issues, please contact us at co-sec@oneadvisory.london.   We would be delighted to hear from you. Download this article here.

About ONE Advisory

ONE Advisory is a City-based corporate advisory firm with more than 100 corporate clients, providing Company Secretarial, Corporate Governance and Compliance Services to its London-listed clients. For more information, please visit www.oneadvisory.london.

[1] https://www.frc.org.uk/getattachment/d0448212-fe6c-4752-8abb-aeb414510fec/FRC_Year_End_Letter_Nov_2020_Final.pdf

[2] https://www.frc.org.uk/getattachment/dda7a2e4-fd50-4710-8ed6-860867aebf24/FRC-Lab-Tips-on-s172-Oct-20201.pdf

[3] https://www.frc.org.uk/getattachment/d0470ab4-f134-4584-9f54-a48a8bfdc62d/FRC-LAB-Stakeholders-Report-s172.pdf

 

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