Skyweb plc is a large company specialising in software research. Its board consists of ten directors, six of whom hold executive office, with each director requiring re-appointment every four years. The company’s shares have had a premium listing on the London Stock Exchange for the last two years. The company decides to expand its board by appointing two new directors, one of whom will be a non-executive director. The board’s nomination committee, which consists of three non-executives and two executives (one of whom is the company’s Chairman), nominate several candidates to be put to the general meeting. Unfortunately, one member of the nomination committee did not contribute to the committee’s work, as he was recently appointed for the first time to the office of director and had not yet received any training on his roles and responsibilities. The company has made a handsome profit. Accordingly, the executives believe that all the directors of the board should receive a 25 per cent pay rise. The pay increase is agreed upon at a meeting of the entire board. The remuneration of all the directors consists solely of a base salary and the directors’ service contracts are two years in length. Several large institutional investors have expressed concern over the competence of the company’s auditor. Accordingly, it is decided that Skyweb will appoint a new auditor. John, the CEO and Chairman, has a friend of his who has a reputation for being a very competent and thorough auditor. Accordingly, John convinces the board that his friend should be nominated. The appointment is confirmed by the company at the AGM. The newly-appointed auditor also provides additional non-audit services to the company as and when required. Adam is considering purchasing a substantial number of shares in MultiTech. However, he is concerned about the company’s commitment to good corporate governance practices and, based on the above events, he asks for your advice regarding any examples of poor corporate governance practices that the company might have engaged in.

Introduction

• This question requires you to advise a potential shareholder, who has concerns about the company he may invest in. There are a few basic details that you may wish to mention early on, as they will be relevant throughout your answer (e.g. the company has a premium listing and so is subject to the UK Corporate Governance Code). Note that, at the time of writing, the 2018 Code is the relevant Code in force.
• You may choose to set out Skyweb’s responsibilities regarding the Code (i.e. to provide a statement setting out how it has applied the Code’s Principles, and how it complies or explains against the Code’s Provisions).
• You will then want to identify the ways that Skyweb’s practices differ from those stated in the Code. Skyweb has deviated from the Code’s Principles/Provisions in numerous ways.

Composition of the board

• At the start of the question, Skyweb has ten directors, only four of whom are non-executive directors. The company then expands its board by two, so that it has seven executive directors and five non-executive directors.
• Provision 11 of the Code provides that at least half the board, excluding the chair, should consist of non-executive directors whom the board considers to be independent. The company has three executives and two non-executives (one of whom is the chair), so the company will need to explain why it has not complied with Provision 11.

Re-appointment

• The opening paragraph informs you that the directors require re-appointment every four years. Provision 18 of the Code provides that all directors should be subject to annual re-election. The company will need to explain why it has not complied with Provision 18.

Nomination committee

• You are told that the board’s nomination committee consists of three non-executives and two executives (one of whom is the Chairman). Provision 17 of the Code provides that the board should establish a nomination committee to lead the process for board appointments. The company does have a nomination committee, but Provision 17 goes on to say that a majority of the nomination committee members should be independent NEDs. This clearly has not been complied with, and so the company will need to explain why not.
• You are told that one member of the nomination committee has not contributed to the committee’s work as he has recently become a director and has yet to receive the relevant training. Principle B.4of the 2016 UK Corporate Governance Code provided that [a]ll directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge’, but this is not repeated in the 2018 Code, Instead it can be found in the accompanying Guidance on Board Effectiveness.

Remuneration

• The board has agreed to award all directors a 25 per cent pay increase. This provides a good example of a situation where the provisions of the Code are more important than the provisions of the CA 2006 or the model articles.
• The model articles provide that the directors can determine their own remuneration. Provision 32 of the Code however, states that the executives’ remuneration should be determined by a remuneration committee consisting of at least three independent non-executive directors (two in the case of a smaller company). Clearly, Skyweb has not complied with this recommendation.
• Principle R states that when authorising remuneration, directors should take into account ‘individual and company performance.’ As the directors of Skyweb receive a base salary only, Principle R not arguably been complied with. As a premium-listed company, Skyweb must explain how it has applied the Code’s Principles.
• Finally, the directors have service contracts of two years in length. Provision 39 of the Code provides that ‘[n]otice or contract periods should be set at one year or less’ and so the company will need to explain why it has not complied with Provision 39.

Auditor

• A new auditor is appointed at the AGM. This auditor is a friend of Skyweb’s Chairman, although the question does not imply anything untoward about this – in fact, the Chairman knows the auditor to be thorough. However, Provision 24 of the Code states that the board should establish an audit committee of at least three independent non-executive directors (two in the case of a smaller company). This committee should make recommendations to the board regarding the appointment, re-appointment and removal of the company’s auditor. Clearly, Provision 24 has not been complied with, and so the company will need to explain why not.
• The new auditor also provides the company with additional non-audit services. Auditors can earn substantial amounts through such services, which can create a conflict of interest. If the auditor causes the company trouble, they may refuse to engage him for such additional work. Accordingly, it has been argued that an auditor’s independence may be affected if he also provides the company with non-audit work.
• To combat this, Provision 26 of the Code states that the company should, in its annual report, explain how the auditors’ objectivity and independence is to be safeguarded if he also provides the company with additional non-audit services.

Comply or explain

• The above would seem to indicate that Skyweb has scant regard for good corporate governance practice. However, the Code acknowledges that its recommendations may not be suitable for all companies and listed companies that do not comply with the Code must state why. You may want to mention that, even though Skyweb has failed to implement many of the Code’s recommendations, it may have good reasons for not doing so. These should be stated in the company’s annual report and Adam would be well-advised to obtain a copy of the company’s annual report to see if this is the case.