UK Government to Introduce Binding Shareholder Votes on Directors' Remuneration
Sarah Jane Leake | Bloomberg Law
Concerns over executive pay in the corporate sphere resurfaced in the wake of the financial crisis, as statistical evidence has increasingly indicated that there is in reality little link between pay and performance. Statistics show that, over the last decade, the average bonus for a FTSE 350 director has increased by almost 200 percent. The average year-end share price, however, has fallen by 71 percent.1 “The legitimacy of UK business in the eyes of wider society,” argues Simon Walker, Director General of the Institute of Directors, “is significantly damaged by pay packages that are not clearly linked to company performance.”2
Faced with diminished returns, while witnessing executive remuneration ratcheting upwards, do shareholders, as the ultimate owners of companies, have the right mechanisms and sufficient information to control those appointed to run companies on their behalf? In the current climate, it seems not.
In part to dampen public disquiet, Vince Cable, Secretary of State for the Department of Business, Innovation and Skills (BIS), in January, outlined a package of measures designed to address failings in the corporate governance framework for executive remuneration.3 Shareholders, who are central to the UK’s corporate governance system, are at the heart of these reforms.
To this end, on 15 March, the Government launched a consultation seeking views on proposals to give shareholders greater influence over executive remuneration through enhanced voting rights. The proposals, which, for the moment, are confined to the remuneration of directors of UK incorporated quoted companies,4 seek to give shareholders the necessary tools to better promote a stronger and clearer link between pay and performance. This should, in consequence, prevent those who have failed to perform well, or those are considered merely mediocre, from reaping unjustified rewards.
Although the advisory vote, which came into effect some nine years ago,5 has given shareholders some power to influence directors’ pay, it must be remembered that this vote is purely advisory; companies are not obliged to take any particular course of action based on the vote, and no aspect of a director’s pay package is contingent on this vote. Moreover, anecdotal evidence suggests that, while, in some cases, companies are prompted to re-think policy, not all companies respond adequately to shareholder concerns in this area.
While it may be difficult to implement,6 the Government proposes giving shareholders a binding vote on a company’s remuneration policy. Under current proposals, companies will need to set out, at the start of the year, a proposed pay policy for the year ahead, detailing potential payouts and performance measures to be employed, which will be put to an annual shareholder vote. Any proposed changes for the forthcoming year will therefore be contingent on the resolution being carried.
Where a company fails to secure the requisite number of votes, the Government proposes that the company should maintain its existing policy or, alternatively, return to shareholders with modified proposals within 90 days. In practice, however, few companies will find themselves in this situation as they are likely to have mitigated against this eventuality by engaging with shareholders in advance.
Increasing Shareholder Support
BIS cautions that, in all likelihood, there are significantly higher levels of dissent than reported. For example, many shareholders are known to abstain, to signal their discontent, without even voting against management. For example, at its 2011 AGM, one FTSE 250 company received 97 percent support for its remuneration report. On closer inspection, however, a substantial number of shareholders (representing some 96 million votes) abstained.7 Moreover, given the increasingly diverse and fragmented nature of the UK’s equity markets, the chances of seeing 50 percent or more votes cast against any resolution remains slim.
Having questioned the level of support that should be required to pass a resolution on remuneration policy, and, as a corollary, the appropriate level of dissent required before the company has to act, the Government is now considering increasing the threshold, beyond a simple majority, to pass a vote on remuneration policy. While a threshold of between 50 and 75 percent is currently being considered, the Government acknowledges that such a rise would necessitate complex legislative change.
Advisory Vote on Implementation
Under the proposals, shareholders will not be able to vote on payments already made and vested. They will, however, be able to cast an advisory vote on how the previously approved policy has been implemented. This is particularly important where, from the shareholder perspective, the money paid to directors is unjustified by the performance of the company over the previous year. While no director’s payout would be contingent on the outcome of this vote, this advisory vote would nonetheless give shareholders the opportunity to express their satisfaction, or indeed dissatisfaction, with how the company has worked within the parameters of the agreed policy.
To inform the advisory vote, companies will need to detail how the policy has been implemented in the previous year, including the level of actual awards made. Moreover, they will have to clearly quantify and justify all awards made to directors. In the Government’s view, this will give shareholders sufficient information to determine whether the agreed policy has been implemented in an appropriate fashion.
Should a company fail to secure support from 75 percent or more of all votes cast, it would, under current proposals, be required, within 30 days, to issue a statement to the market (e.g., via a regulatory news service) detailing: (1) the number and proportion of shareholders voting for, against, and abstained; (2) the main issues shareholders have raised; and (3) how the company plans to work with shareholders to resolve these issues. Where shareholders are consistently dissatisfied with how the remuneration policy has worked in practice, they would of course still have the opportunity to vote against the re-election of directors, as they do today.
Widespread criticism has been levelled at directors who have left companies with substantial exit packages, even where the company they directed has shown mediocre or sub-standard performance. As shareholders have no direct role in negotiating or agreeing directors’ service contracts, which typically set out provisions regarding termination packages, they have limited input on the scale of such payments.
While law reform has gone some way to address this issue (e.g., compensation for loss of office is now is now subject to shareholder approval8), the Government argues that shareholders need further empowerment in this area. This is particularly important given that compensation arrangements on termination can include any bonus that would have been earned over the year, as well as long-term incentives within the performance cycle in question. The existing legislation, opines the Government, “does little to limit payment for failure.”9
The Government therefore proposes introducing a binding vote on any exit payments that exceed the equivalent of one year’s salary, where a director’s contract has been terminated early and without due notice, by the company or by the director. Should a proposal fail to win the majority of votes cast, the company would, in effect, be unable to pay the director in question any award above the basic limit. This voting system would, contends the Government, “give shareholders a real say over payments for failure.”10
Subject to approval and Parliamentary processes, new legislation on shareholder voting rights and on directors’ pay is likely to come into force during the spring of 2013. The Government proposes that the new rules should take effect for companies whose reporting year ends on or after 1 October 2013 and for directors whose contracts are terminated after that date.
Once the proposals are approved, existing service contracts will need to be reviewed and potentially amended to ensure that the provisions relating to variable remuneration do not conflict with shareholders’ ability to approve remuneration on an annual basis. Moreover, companies should avoid entering into new arrangements with regard to remuneration that could give an individual director legal entitlements that may subsequently come into conflict with the remuneration policy.
Once the proposed legislation does come into force, all contracts and other arrangements entered into should not provide for any contractual entitlement to exit payments above one year’s base salary, and should explicitly state that any exit payment in excess of this will be subject to shareholder approval. While companies may end up buying directors out of their existing contractual rights in order to renew their contracts in line with the new legislation, the Government stresses that such payments must be clearly disclosed in the remuneration report when reporting on payments made in the previous year.
Feedback on these proposals is welcome until 27 April, and the Government anticipates being in a position to confirm the detailed measures it plans to take forward in primary legislation during the summer months. Concurrently, it will publish draft regulations for comment, which will determine the content of directors’ remuneration reports, so that the proposals, in their legislative form, can be reviewed as a whole.
The Government also confirms that it will work closely with the UK Listing Authority over the next few months, to consider how the Listing Rules (LR) may need to be reviewed into order to ensure that companies are not subject to conflicting legal requirements.
It is hoped that, ultimately, the introduction of the binding vote on remuneration policy will encourage better quality engagement between companies and shareholders at an early stage in the process of devising remuneration policy and will, therefore, avoid dissent and dissatisfaction later on.
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