Saturday, August 18, 2012

UK Government Proposes Binding Shareholder Vote on Executive Pay as Part of Broad Reform of Executive Compensation Reporting

The UK Government proposes to give shareholders a binding vote on executive compensation   as part of a package of measures to address failings in the corporate governance framework for executive remuneration. The draft regulations also specify that the directors’ remuneration report is to contain two distinct parts. First, a policy report setting out all elements of a company’s remuneration policy and key factors that were taken into account in setting the policy. This part of the report will only be required when there is a shareholder vote on the policy. Second, a report on how the policy was implemented in the past financial year, setting out actual payments and details on the link between company performance and pay. The directors’ remuneration report will remain a legally required standalone report. The Government said that this does not preclude companies from including information about remuneration anywhere else in annual reports.

While executive compensation is primarily an issue for companies and their shareholders, the Government feels that it has a role to provide an effective corporate governance framework for executive pay; particularly where shareholders lack the information and power they need to hold companies to account. According to Vince Cable, the Secretary of State for Business, there is compelling evidence of a disconnect between pay and performance in large public companies and the call for action has been loud and clear. Business leaders and investors now recognize that the link between pay and performance has grown weak; noted the Minister, and the constant, ratcheting up of executive pay is unsustainable.

The Minister said that the overall goals of the proposed reforms are to restore a stronger, clearer link between pay and performance; reduce rewards for failure; promote better engagement between companies and shareholders; and empower shareholders to hold companies to account through binding votes. Currently, in both the UK and US, pursuant to the Dodd-Frank Act, shareholders have an advisory, non-binding vote on executive pay.

Since 2002, UK Company law has required quoted companies to produce a Directors’ Remuneration Report. The Government proposes to require that this report be comprised of two distinct parts: a policy report and an implementation report

Policy Report

The first part is a policy report setting out a forward looking policy on remuneration, including exit payments, and disclosure of material factors taken into account when setting pay policy. This part of the report will be subject to a binding shareholder vote and it will only be legally required when there is a shareholder vote, which at a minimum will happen every three years.

The policy report would have to include a table setting out the key elements of pay and supporting information, including how each element supports the achievement of the company’s strategy, the potential value and performance metrics. The policy report must also include information on service contracts and scenarios for what directors will get paid for performance that is above, on and below target. It must also contain information on the percentage change in profit, dividends and the overall spend on pay and the principles on which exit payments will be made. Importantly the policy report must list the material factors that have been taken into account when setting the pay policy.

The idea for a requiring a pay policy table in the remuneration report was driven by the Government’s perception that companies do not consistently disclose information in an easily navigable format on how their pay policy supports company strategy and performance. For each element of pay, the table would include information on how the pay supports the company’s short and long-term objectives and a summary of the performance metrics and their relative weighting, as well as the period of time over which they are measured. There would also be a summary of how each element of pay operates, including the possibility for claw backs and for the withholding of deferred pay when performance is not sustained.

In order to put all these disclosures in context, the Government proposes that the table be accompanied by a narrative explanation of whether the remuneration policy for directors differs from the remuneration policy for other employees and, if so, an explanation of why. For variable elements of pay, the report will also include an explanation of why performance metrics were chosen or, if no performance metrics have been applied,
why that is the case. However, the Government does not expect companies to be forced to disclose performance metrics where doing so would harm shareholder interests.

The Government also assured that it would not mandate the exact format of the pay table, leaving to each company the flexibility to design a table that fits with their business model.

Implementation Report

The second part of the Remuneration Report is a report on how the policy has been implemented in the reporting year, including actual payments made to directors set out as a single figure, exit payments made and disclosure of the link between company  performance and pay. It will be required on an annual basis and will be subject to a shareholder advisory vote. The implementation report must also contain performance details against metrics for long term incentives, total pension entitlements for defined benefit schemes, and a chart comparing company performance and CEO pay. It must also contain information about who has advised the remuneration committee.

Statement by Chair of Remuneration Committee

In n order to further improve transparency and make it easier for shareholders to quickly find the key information on pay within a report, the Government proposes that the remuneration report should be prefaced by a statement to the shareholders from the Chairman of the Remuneration Committee summarizing the key messages on executive pay and the context in which decisions have been taken. In recognition of the
fact that the relevant information will vary between companies and from year to year, the Government does not propose to prescribe what this letter should cover. The Government noted that it is already good practice in many companies for the remuneration committee chairman to write a letter as a preface to the report. As a result, the Government does not envisage this additional requirement will place significant additional burdens on companies.