European Funds Comment: Workforce Engagement in Portfolio Companies

22 November 2019

Across Europe, the decisions made by large companies – both public and private – are under increasing scrutiny. It is not just that outsiders are asking more questions – they are asking about a wider range of issues. For example, companies are expected to articulate a clear strategic response to the longer-term challenges of climate change; they are expected to explain how they are making a positive contribution to the fight against forced and child labour; and they should be able to say that they have effective policies to avoid inadvertent complicity in corruption or money laundering.

And it is not only the decisions themselves that are being scrutinised. Policy-makers and stakeholders also want to understand – and, to some extent, dictate – the process by which decisions are made.

In the past, corporate governance reporting and corporate governance codes were largely the preserve of publicly listed companies, supposedly protecting distant shareholders from wayward managers. Not any more. In the UK, “very large” private companies – broadly, those with more than 2,000 employees, or both turnover and assets that exceed £200m and £2bn respectively – will need to start describing their corporate governance arrangements in some detail when they produce their next annual report. They are being encouraged to sign up to the Wates Corporate Governance Principles, written specifically for private companies. If they do, they will have to explain how they comply with those Principles. And a much larger group of UK companies – any that do not qualify as Small or Medium Sized (SMEs), or which have more than 250 employees – will need to describe how they have made sure that stakeholder and/or employee issues have been taken into account in decision-making.

These are big changes, and they are expected to have an impact on behaviour in the UK. Private equity-appointed non-executive directors sitting on portfolio company boards should take careful note. (For more detail, read our comprehensive note.)

Perhaps one of the more difficult aspects of these new requirements, and one that will be heavily scrutinised when firms start to report next year, is the way in which companies engage with the workforce (a term that is deliberately broader than “employees”). Those that sign up to the Wates Principles will be expected to “develop a range of formal and informal channels that enable them to engage in meaningful two-way dialogue, enabling the workforce to share ideas and concerns with senior management.” In their annual report, the directors will have to demonstrate how meaningful dialogue has been facilitated and how any insights were considered in decision-making. And, as mentioned above, many other companies will be legally required to describe their engagement practices, even if not signed up to Wates.

That means that a recent survey of emerging practices among UK public companies is instructive for large private companies. The survey asked the 100 largest UK companies how they were proposing to implement the workforce engagement requirement that is now included in the revised UK Corporate Governance Code. Three methods of engagement are suggested in that Code (repeated in the regulator’s Guidance on the Strategic Report, which applies more broadly): a director appointed to the board from the workforce; establishment of a formal workplace advisory panel; or a designated non-executive director who is tasked with representing employee interests. The Code (and the Guidance) allow other engagement methods to be used, or a combination of the above, but these have to be described.

Only 36 UK companies responded to the questionnaire, perhaps indicating that a number of companies are still formulating their plan as regards workforce engagement. Of those companies that did respond, over one-third were not planning to use any of the three suggested methods, but had bespoke mechanisms in mind, including: employee surveys, “town hall meetings”, site visits, analysis of whistleblowing reports, works councils and employee forums. Not surprisingly, given the UK’s legal and cultural preference for a unitary board structure, no companies say they are planning to co-opt an employee representative to the board, but a significant number are going to identify a designated non-executive director (NED) with specific responsibility for employee concerns. A smaller number will use a “workforce advisory panel”, although often in conjunction with a designated NED.

As large UK portfolio companies of private equity firms adapt to these new reporting requirements, the lessons from larger companies are certainly helpful. Given that there will probably be significant scrutiny of the reports when they emerge next year, this may be a good topic for portfolio company boards to include in the agenda for their final board meeting of the year. Nominated directors may want to ask questions if management is not yet focused on it.