Executive Pay Back in the Firing Line, Contributed by Alasdair Steele, Nabarro LLP
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 levels: a number of respondents commented on the difficulty in establishing exactly what remuneration an executive receives due to the range of benefits and bonus structures that may be used. There is a growing desire to see a single total figure reported that would include all the different elements of remuneration, such as pension contributions, bonuses, long term incentive plans, and share options.
- Use of remuneration consultants: there is a perception that the use of remuneration consultants has contributed to the growth in executive pay as executives are bench-marked against a peer group and companies seek to reward their executives in the median quartile (thereby automatically driving the quartile itself higher). Increased disclosure around the use of remuneration consultants (particularly the extent to which the firms providing remuneration consultancy provide other services to the company) and the advice given by them was seen as being useful.
- Simplification of structures: the link between performance and pay is frequently difficult to understand, given the often complex remuneration structures that are used. Simplifying the remuneration structures is seen as being beneficial so that shareholders can clearly see the link between the performance and pay received. The Association of British Insurers (ABI) encourages the publication of the performance measures by which bonus entitlements are calculated.2 A reduction in the frequency with which long-term incentive plans and other remuneration elements are reviewed is also something to be encouraged, though there is recognition that companies need the flexibility to be able to respond to changes in circumstances and strategy.
— 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:
- Companies will be required to publish “clearer and more relevant information”3 on executive remuneration, particularly in respect of future pay policy and the implementation of past policies.
- A single figure for the total pay of each director will need to be provided, together with an explanation of how the pay relates to the performance of the company, and a distribution statement showing how executive pay compares with other outgoings, such as general staffing costs, taxation, dividends, and business investment.
- There will be a further consultation on changing current voting arrangements to give shareholders a binding vote on future pay policy and on notice periods longer than one year and exit payments greater than one year’s salary. The future pay policy would need to include real numbers on potential payouts that could be received. The consultation will also consider whether votes on pay proposals should require a 75 percent majority to be passed, rather than the current simple majority.
- The Financial Reporting Council will be asked to amend the UK Corporate Governance Code to prevent serving executives from sitting on the remuneration committees of other large companies.
- There will requirements for greater transparency on the role of remuneration consultants, their fees, and who they advise.
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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