At the end of January, just before the start of the bank bonus reporting season, Vince Cable, Secretary of State for the UK Department of Business, Innovation and Skills (BIS), announced the Government's latest proposals to lower what it regards as excessive executive pay. This announcement followed the publication by BIS of the responses received in respect of last year's discussion paper on executive remuneration.1
The BIS Consultation
The Government launched its discussion paper in September 2011 in an effort to examine the perceived disconnect between pay and long-term performance. While, on the one hand, executive pay at the largest companies has continued to grow, falling growth in the economy has had the knock-on effect of slowing wage growth more generally with companies' performances being similarly adversely affected. The consultation was designed to elicit views and explanations on the causes of this situation and on what may be done to address the disconnect.
A total of 164 responses to the discussion paper were received, with respondents ranging from companies and business representative organisations to investors, trade unions, and individuals. The key areas covered are outlined below.
The need for transparency is a recurring theme in corporate governance discussions, from pay, to how investors exercise their rights, to understanding who the actual owner of a share is. In the context of executive pay, three aspects in particular were highlighted as needing greater clarity and transparency:
— Remuneration Committees
Opinion was split on whether changes are needed to the composition of remuneration committees. Some felt that increased diversification of the professional backgrounds of remuneration committee members would be helpful. Having independent advisers to the remuneration committee, however, was not seen as being helpful, as those advisers would not be party to all the information that the remuneration committee members themselves would be privy to by virtue of their also being full board members. Independence of remuneration committee members was also seen as important, with a number of people questioning whether it is appropriate to have executives from other companies sitting on remuneration committees or whether this raises conflicts of interest (in seeing executive pay rise generally). However, half of those who responded did not see a need for stronger guidance to prevent conflicts of interest.
— Employee Involvement
The extent to which remuneration committee members have full knowledge of the strategy of the company was given as one reason for not including employee members on remuneration committees. As the employee member would not be aware of the company's overall strategy, he would not be in the best position to assess what is an appropriate remuneration structure. In addition, given that the remuneration committee is a committee of the board, and the board as a whole is responsible for decision-making, it is not clear how the liability of the directors would be affected by having a non-board member (and therefore someone who has no responsibility for the decisions taken) involved in making decisions (or alternatively, what duties and responsibilities to the company and shareholders the employee representative might have).
The lack of shareholder engagement in companies is seen as one of the causes of many perceived corporate governance failures. Too often, shareholders are believed to agree to board proposals without being seen to properly hold boards to account. Finding ways of encouraging fuller shareholder engagement is another common theme in corporate governance discussions.
Binding Shareholder Votes
At present, the shareholder vote on a company's remuneration report is merely advisory (though there is little doubt that companies do take the vote seriously). Proposals aimed at introducing a binding shareholder vote raise difficult issues over the effect of such a vote, considering that the remuneration report is backward-looking: it reports on what has been done during the previous year and on awards already made. If this proposal is implemented, awards would need to be made subject to approval of the remuneration report, although even then there would still be issues regarding contractual entitlements (for example, pay-outs under contractually agreed, long-term bonus structures). Other matters that could be subject to binding shareholder votes include the approval of executive directors' contracts and termination payments. In both cases, though, there are a number of problems. On new appointments, the new director will usually want to be in a position to sign his new contract before resigning from his existing position. It would be a brave individual who puts himself in the position of publicly saying he wants to leave his existing employment but not having a binding deal on his next. Similarly, with termination payments, to what extent could a subsequent shareholder vote undo previously agreed contractual entitlements?
Including Shareholder Representatives on Nominations Committees
Akin to the concept of having employee representatives on remuneration committees discussed above, the idea suggested is that shareholder representatives should sit on nomination committees to select future directors. As well as objections similar to those raised in the context of employee representative members of remuneration committees, doubts were also expressed over whether or not it would be possible to find shareholder representatives ready to fulfil the role.
Following the responses to the discussion paper, the Government intends to introduce further measures on executive pay:
The extent to which any of these measures succeed in curbing executive pay remains to be seen. Provisions requiring the pre-approval of executive contracts would be likely to dissuade candidates from putting themselves forward for new positions in UK companies. In a world of increasing globalisation, the UK needs to be extremely careful not to introduce rules that drive the best managers and executives to overseas companies – if our overseas competitors are offering higher salaries, surely UK companies will have to at least match that or risk losing our top people. Alasdair Steele is a corporate partner at Nabarro LLP, specialising in UK and cross-border corporate finance, including public and private M&A, strategic investments and primary and secondary equity issues, as well as regularly advising on consortia and corporate joint venture arrangements, particularly in the infrastructure sector. He regularly advises quoted companies and financial intermediaries on the UKLA Listing Rules and Disclosure Rules, the Prospectus Rules, the AIM Rules, the Takeover Code, corporate governance matters and general company law. Telephone: +44 (0) 20 7524 6422; E-mail firstname.lastname@example.org.
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