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.