Guest post by Damien Knight of MM&K
At last, ‘quoted companies’ (i.e. UK incorporated companies with a listing on a main exchange) are faced with the full reality of the UK Government’s new regime for directors’ remuneration reporting and binding votes on pay policy. One thing is certain – companies are going to have to start their policy reviews and shareholder consultations several months earlier than they are used to doing.
Primary legislation: the remuneration policy vote
At the core of this regime, and in many ways the scarier part for remuneration committees, are changes to the Companies Act 2006 (CA 2006), which were wrapped up in clauses within the Enterprise and Regulatory Reform Act 2013. This act gained Royal Assent on 25th April. The relevant sections (79-82) of the latter act can be found here >>
In short, the legislation requires quoted companies with year ends of 30th September 2013 or later to put their remuneration policy to a 50% majority vote at their upcoming AGM. Thereafter companies can only provide remuneration or loss of office payments that are consistent with the policy unless they obtain shareholder approval at a general meeting to a revised policy or to the specific payments.
Any director who authorizes a payment outside the policy is “jointly and severally liable to indemnify the company that made the payment for any loss resulting from it” (a civil law sanction). The onus is on the director to show a court that he or she has acted honestly and reasonably. There is a question whether directors who delegate decisions to their remuneration committee are also liable. Boards may need to revisit the committee terms of reference.
The company normally has three years from the end of the year in which the first policy vote is held before it is obliged to go back to a general meeting for another binding policy vote. However, if a future AGM advisory vote on policy implementation is lost, a new vote on policy has to be held the following year.
The new reporting regulations
CA 2006, as revised by the new primary legislation, also enables the Government to issue its new Directors’ Remuneration Reporting Regulations, and we saw a draft of these in March. At the end of June the Department for Business, Innovation and Skills (BIS) laid the new regulations before Parliament, and these are now final, with significant changes.
Significant changes in the regulations
1) There are signs that companies will be able to draw their future policies more generally than feared from earlier drafts.
a) Although the maximum for any component has to be stated, this has been changed from “maximum potential value” to “maximum that may be paid…expressed in monetary terms or otherwise”. “Otherwise” could embrace a percentage of salary, a number of shares, or even a percentage of equity.
b) The final regulations have introduced a new Section 21 in which a company is required to state how it intends to implement the approved directors’ remuneration policy in the coming year – e.g. performance measures and targets (but see 2 below) and changes in implementation details from the previous year. This new section does not have to include any items which are explicit in the approved policy; but unlike the policy it is not subject to the binding vote. There is scope, therefore, for pushing the generality of policy drafting to the limit and providing shareholders with the details under Section 21. Indeed a fair degree of wriggle room is essential if the new regime is going to function at all.
c) The regulations do not proscribe the inclusion of discretion in the future policy. In fact, by adding a clause (24(4)) which requires the future policy report to set out the extent of directors’ discretion allowed within the policy, there is an implied acceptance that a degree of discretion will be necessary.
2) The final version of the regulations provides a wider ‘get out’ from having to disclose measures and particularly targets before the event. The previously drafted exception of commercial confidentiality has been moved to a dominant position in the introduction to the regulations (Section 2 (5) & (6)) which requires only an explanation and an indication when the withheld information on measures or targets will be reported. Section 26 which describes the information to be provided in the policy table only mentions performance measures (ie the measurement dimensions) and does not refer to targets at all.
3) There are a number of changes which allow more flexibility in reporting implementation, including the use of estimated figures, averaging share prices where the final vesting price is not known, the allowable break-out of non-executive director figures into simpler tables and the exclusion of de minimus payments to past directors or for loss of office. But always companies are required to report their reasons and limits they are applying.
4) One important relaxation from the draft regulations is reporting the policy for recruitment remuneration. The company is now free to report only the principles, range of reward elements/approach and maximum level of variable remuneration expressed as a monetary sum or otherwise. In the previous draft the ratio of a recruit’s salary to the CEO’s salary would have had to have been capped within the policy.
5) The sections defining pension value have been revised entirely from the rather vague descriptions in the earlier draft. They are now aligned with the relevant sections of the Finance Act 2004 with use of a pension factor of 20 for defined benefit plan valuation calculations.
The Government has promised to publish a set of guidelines for the implementation of the new regulations.
What should remuneration committees be thinking about?
Short of resigning from the board or taking the company back onto AIM, directors have got some serious and urgent thinking to do. Remuneration committees will face their shareholders with their new remuneration policy sometime in the coming year. For the majority, those companies with a December year-end, that means next Spring.
MM&K is advising all its clients to start their remuneration report planning at least three months earlier than usual. 1,300 quoted companies will be competing for the time and attention of institutional shareholders to get informal sign-off on their new policies. There will be a huge bottleneck. Shareholders and their service providers will need to standardise their response to companies’ disclosures if they are to meet their own deadlines.
We will repeat our regular advice – start by ensuring that your remuneration policies are fit-for-purpose in supporting the business. If they are, you will be able to defend them with your shareholders and compliance will become a secondary issue.
Key weaknesses of the new regulations
MM&K has participated actively in the consultation process to help ensure the new regulations make a real contribution to improved governance and clarity about directors’ pay. We made direct representations to BIS about a number of concerns we had about the draft regulations issued in March and which we described in our March 2013 issue of Board Walk
We pointed out two weaknesses in particular:
- Scenario Charts: We felt that the omission of share price growth from the policy scenario charts was a mistake and made the scenario forecast incompatible with the historical reporting of the single figure tables.
- Performance Graph: We said the reversion to a relative TSR graph was a retrograde step at a time when the measure has been rightly criticised as a long-term incentive performance measure.
Sadly, our remonstrations have largely been ignored.
From the beginning, we have argued that the Government needed two ‘single figures of total remuneration’, Remuneration Realised, and Remuneration Awarded. Vince Cable was determined to have just one ‘single figure of total remuneration’ and plumped for what we call Total Remuneration Realised (albeit including share options ‘vesting’ in the year rather than those exercised).
Realised vs Awarded – what’s the difference?
Total Remuneration Realised includes the market value of LTIs Realised, ie those which vested in the past year (or in the case of share options, the gains on those which were exercised in the year);
Total Remuneration Awarded includes the expected value of new LTI awards and share options granted in the year.
The former is the better measure for assessing whether total remuneration was justified by company performance; the latter is the better measure for assessing changes in policy.
The Scenario Charts could have been a good substitute for Total Remuneration Awarded if the Regulations had been thought through properly. But, by omitting share price growth in the illustration of policy they ignore one vital reflection of performance. And the treatment of share options has been ducked completely. Under the new regulations as written (Paragraph 34(1)(c)), there is the absurd possibility that a company could pay its directors entirely in market-priced share options and report the remuneration receivable in all performance scenarios as zero (i.e. face value of shares at grant less exercise price)!
Next, the regulations require the single figure to include the value of any deferred element of any bonus with the immediate cash element, even if there is a service condition for eventual payment and it may never be paid. We think some companies might add a nominal long-term performance condition to the deferred bonus plan to make the plan a long-term ‘scheme’ thus postponing the reporting of the deferred element.
Lastly, we noted that the Government has abandoned the clause which required companies to report the value of fees for other professional services collected by the firms advising their remuneration committees. The conflict of interest clearly remains – in the accounting firms, these other fees have been estimated to average 11 times the fees for remuneration committee advice. No wonder accounting firms have been fulsome in their praise for the new regulations.
Overall assessment of the Albatross
The chart below shows our final assessment of how the Government did against its own objectives, defined at the start of its two-year journey leading up to the implementation of the new reporting regime.
NB Vince Cable and his team never explicitly voiced ‘reduce high pay’ as an objective. But, of course, it was their ultimate hope all along.
Regretfully, we think the Government has failed on executive remuneration despite its early promise. The new regulations are fearfully over-engineered and will do nothing to improve clarity of reporting
And we think there is little prospect of them leading to pay restraint. Our hunch is whoever is in Government will have to revisit all of this again after the next election.
Not everyone is going to agree. There are some big winners and big losers in all of this (see panel overleaf).
New Directors’ Remuneration Reporting Regulations – Winners & Losers
| Winners? | Losers? |
| Large Accounting Firms: big time winners. Not only have they fended off the requirement for companies to report the global fees of their remuneration consultants but the gates have been opened to endless compliance and extra audit work | Smaller quoted companies: the new Schedule 8 has 49 sections compared to 20 sections in the existing regulations. The administrative burden offers no value for these companies or their shareholders. |
| Lawyers: the threat of civil action against directors is the hook for lawyers to win the compliance advisory work as well | Retail shareholders: the new report is going to be a tougher read. The opportunity of forcing a meaningful historical performance and pay record has been lost. And they will be deceived by the future policy illustration |
| Institutional shareholder corporate governance staff: they will be in business for years to come | Specialised shareholder and company advisers: economies of scale and low value tick-box approaches by the larger firms will become increasing dominant – if these firms can continue to dodge anti-monopoly moves |
| Fat cats: there is nothing in all of this that is going to bring down supposedly excessive levels of remuneration. The executives still hold the cards | Beneficial shareholders generally: none of this reporting burden is going to add to shareholder returns – show us the hedge fund which uses remuneration reporting compliance as a selection criterion! |
| Financial Reporting Council: the wholesale adoption of the FR Lab’s recommendations in these regulations has reinforced its influence | Remuneration committees: who would want to do the job? |
| Journalists: there will be a lot to get hot under the collar about for a long time yet | General public: the perceived excesses of executive pay will not reduce, although they may increase more slowly under shareholder pressure. Future payouts will frequently exceed the policy illustrations by a large margin, causing more outcry
The Government (in the longer-term): Another policy that will not really deliver |