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Boardroom pay continues to be a subject that provokes much excitement in the media and with politicians, as well as among shareholders who ultimately bear the cost. In September 2011 the Department for Business Innovation and Skills (BIS) produced a discussion paper on executive remuneration,1 with a follow-up in January 2012 summarising the responses received.2 Also in January, Vince Cable, Business Secretary of State, announced the measures he is now planning to put in place.3
IDENTIFYING THE PROBLEM
For many years, the response from the Government to over-generous pay packages for directors has been to require more disclosure. Providing information in the annual report and accounts on boardroom remuneration would give shareholders the detail they need to rein in excessive rewards. And yet, as reports have got longer and more complex in response to the wish for more disclosure – in 2010, the Barclays remuneration report ran to 17 pages, with 24 separate tables of information – the perception has been that senior pay levels have continued to rocket. One statistic much quoted by Cable shows median total remuneration of FTSE 100 CEOs rise from £1m in 1998 to £4.2m in 2010, greatly outstripping the growth in investors’ total returns over the same period.
The introduction in 2002 of the shareholder advisory vote on the directors’ remuneration report was also intended to encourage greater shareholder engagement on the issue.4 Losing a vote has no legal effect and, at worst, will only do reputational harm to a board and sour relations with investors. Nonetheless, shareholder activism has increased and in 2009 around one in five FTSE 100 companies saw more than 20 percent of shareholder votes fail to support their remuneration report.
Government continues to decline to intervene directly to set pay rates, but the idea that requiring more and better disclosure is the solution has been superseded. The emphasis now is on bringing about a change in culture and using a range of measures to achieve that end.
While it is recognised that remuneration reports are too complex, with Cable criticising “too much data and too little information,” there is as yet no indication from BIS that the disclosure requirements are to be reduced in any way. Indeed, more information will need to be provided in a number of areas, but in an attempt to improve the presentation of that information, it is proposed that there will in future be two remuneration reports: one detailing how pay policy has been implemented in the year under review; and one looking forward and setting out future policy for executive pay.
In addition, BIS’ proposals for improvements in narrative reporting suggest a split between a brief strategic report, which will include a high level review of remuneration and an annual directors’ statement containing more detailed information in a prescribed lay out with standard headings.5
The benchmarks used in setting future pay policy will need to be explained, as will the extent to which employee earnings throughout the company and resulting differentials in pay have been taken into account. Companies will need to explain how proposed pay structures match and support their strategy, how performance will be assessed and what rewards will result for executives in different scenarios – for example, when certain objectives are hit, exceeded or missed. That will require more openness on performance criteria, an area where companies are often reluctant to provide detail for fear they disclose commercially sensitive information of interest to competitors.
Similarly, when reporting on pay in the past year, it will be necessary to explain how awards relate to performance for that and previous years. A “distribution statement” will also be required, comparing the amount spent on executive pay with that expended under other headings such as dividends, investment, tax and general staffing costs. A single, aggregate figure for each director’s total pay will now become a requirement, although as yet there is no information on how this figure will be calculated. In practice, many companies already provide a cumulative total for each board member in a table of directors’ pay.
Cable has said that the pay ratio between a CEO and an average employee is a “genuinely useful metric” but as yet it is not clear if this is to become a requirement. He has, however, made clear that companies will need to explain how they have consulted employees on issues of director pay and the extent to which their views have been taken into account. Indeed, he has pointed out that some little used regulations dating from 20046 already give employees the right to require the establishment of arrangements whereby they can be informed and consulted on work issues of importance to them, including executive pay. Greater use of these existing rights is seen as preferable to the imposition of worker representatives on boards or remuneration committees.
Although BIS has emphasised the need for clarity in remuneration reports, it seems unlikely that they are about to get shorter with these additional requirements for new disclosures.
SAY ON PAY
What are shareholders to do with all this added information? The AGM’s advisory vote on the remuneration report is seen as having been of value, but Cable believes that it is now time to introduce binding votes. It is, however, recognised that there are problems with such a proposal in respect of awards that have already been paid or agreed, where the difficulties of unpicking existing commitments are seen as too great.
Instead, it seems that the binding vote will be limited to future policy for boardroom pay. The proposals put to shareholders will need to include details of how performance is to be judged and figures for the sums that could be paid if targets are reached. The majority to be achieved on such a vote has not been settled, although it appears that an enhanced threshold of 75 percent of votes cast is being considered.
Cable has also spoken of a binding vote on a company’s implementation of an approved pay policy in the preceding year, including the sums paid out. While admitting the legal difficulties this could lead to, he seems to be keeping this idea under consideration. More details on all these proposals are promised in the near future.
The recent introduction of annual re-election for all directors7 has in any event increased the opportunities for investors to make clear their dissatisfaction with director pay. There have been few if any cases so far of a remuneration committee chair being ejected in an AGM protest vote, but it remains a useful sanction, with potential to ensure that strongly held shareholder views on pay are taken into account.
REWARDS FOR FAILURE
Current legislation requires shareholder approval for any director’s notice period of more than two years.8 That is to be reduced to 12 months, reflecting best practice in the Governance Code.9 A shareholder vote will also be needed to pay compensation to a departing director where it is greater than a year’s basic salary or the minimum sum due under the service agreement, whichever is the lower. “Rewards for failure” have been a regular subject of criticism and the Government now wants to see greater openness surrounding exit payments and the terms on which directors leave.
The clawback of amounts already paid where performance subsequently turns out to have been miscalculated or misstated is now a feature of the financial services sector.10 The Financial Reporting Council is to be asked to amend the Governance Code to require all large listed companies to clawback pay where appropriate. It will also need to update the UK Stewardship Code to take account of the new powers available to investors.
The September 2011 discussion paper raised the possibility of placing employee representatives on remuneration committees, a practice that is common in those European jurisdictions where two tier boards are usual. This suggestion appears to have been rejected, not only because it would go against the UK’s unitary board structure, but also because of the questions that would arise from having non-directors contributing to board decisions. A proposal to have shareholder representatives on nomination committees to ensure greater diversity in board appointments was not taken up for the same reasons. The idea of an employee-wide vote on boardroom pay was also rejected.
Instead, reliance is being placed on boards, heeding the call from Lord Davies for greater diversity among director appointments.11 If non-executives from a variety of backgrounds and experience are appointed, it is argued, remuneration committees will be less prone to the “group think” and received opinions, which are in part blamed for the current high pay culture.
Remuneration consultants are also seen as potentially part of the problem, with an inherent risk of conflicts of interest. A voluntary Remuneration Consultants Code12 has gone some way to regulate their activities, while remuneration reports already have to disclose who has advised the committee, together with details of any other services their adviser might have provided to the company.13 Greater transparency will now be required as to what they do, how they are appointed, to whom they report and whom they advise, and what they are paid.
There has also been criticism of companies where the remuneration committee includes a non-executive director who is a serving executive at another company. Although it is acknowledged this is a rarity, accounting for only 5 percent of remuneration committee members in the FTSE all-share index, the Governance Code may be used to rule against the practice.
LEADING BY EXAMPLE
The Government recognises there is only so much it can do by regulation. Business and shareholders must instead be encouraged to create and follow best practice. It is hoped that such encouragement may come from the High Pay Centre,14 a new think tank established by Deborah Hargreaves who chaired the recent High Pay Commission.
In the meantime, the detail surrounding these proposals is awaited from BIS. Their changes to narrative reporting have recently been put back to April 2013 but there is, as yet, no firm indication whether these reforms on remuneration will be accelerated so they can apply to the 2012/13 reporting season, or if more time is needed to ensure they work as intended.
Martin Webster has practised as a corporate lawyer in the City of London for more than 25 years. He has acted for both quoted companies and growing private businesses and now heads Pinsent Masons’ corporate governance unit, advising companies and their boards on governance, risk management, and general compliance issues. Telephone: +44 0) 20 7418 9598; E-mail: email@example.com.
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