Industry experts welcome Government reforms to directors' remuneration
David Woods, June 21, 2012
The business secretary, Vince Cable has unveiled what he says is the “ comprehensive reforms of the framework for directors’ remuneration in a decade.”
The package of measures will address failures in corporate governance by empowering shareholders to engage effectively with companies on pay. It will give shareholders binding votes on pay policy and exit payments, so they can hold companies to account and prevent rewards for failure; boost transparency so that what people are paid is easily understood and the link between pay and performance is clearly drawn; and ensure that reform has a lasting impact by empowering business and investors to maintain recent activism.
Cable said: "At a time when the global economy remains fragile, it is neither sustainable nor justifiable to see directors' pay rising at 10% a year, while the performance of listed companies lags behind and many employees are having their pay cut or frozen.
"In January we kicked off a national debate aimed at encouraging shareholders to become more actively engaged as company owners in better aligning directors' pay with performance. I have been greatly encouraged by the 'shareholder spring' and I want to see that momentum sustained. That is why I am bringing forward legislation to strengthen the powers of shareholders through a binding vote on pay."
The Government's reforms will provide shareholders with new powers to hold companies to account, while making it easier to understand what directors are earning and how it links to company performance. A binding vote on pay policy, requiring the support of a majority of shareholders voting to pass. The policy should clearly set out how pay supports the strategic objectives of the company and include better information on how directors' pay compares to the wider workforce. The binding vote will be held annually unless companies choose to leave their remuneration policy unchanged, in which case it will be compulsory at least every three years. For the first time, once a policy is approved companies will not be able to make payments outside its scope.
If a company chooses to change its pay policy, it will have to put it before shareholders for re-approval. Importantly, this will encourage companies to devise long-term policies and put a brake on annual pay ratcheting. As part of their pay policy, companies will have to clearly explain their approach to exit payments, which will also be subject to the binding vote. When a director leaves, the company will have to promptly publish a statement of payments the director has received. Companies will not be able to pay exiting directors more than shareholders have agreed. Alongside the binding vote on policy, shareholders will continue to have an annual advisory vote on how pay policy was implemented in the previous year, including actual sums paid to directors.
If a company fails the advisory vote it will be required to put its overall pay policy back to shareholders in a binding vote the following year. In addition, the Financial Reporting Council will consult on updating the Corporate Governance Code so that companies should make a statement when a significant minority of shareholders vote against a pay resolution.
Companies will have to report a single figure for the total pay directors received for the year. This figure will cover all rewards received by directors, including bonuses and long-term incentives. Companies will also have to report details of whether they met performance measures and a comparison between company performance and Chief Executives' pay.
Mercer has welcomed the Government's policy in response to institutional investor feedback.
Christopher Johnson, UK head of Mercer's human capital business, said: "We support the Government's move to encourage greater dialogue on executive remuneration between companies and their shareholders.
"By making the binding vote on the remuneration policy effective for three years, some of the difficulties we foresaw will be mitigated - in particular returning to shareholders with amended proposals in the event of a negative vote.
"Current levels and approaches to executive pay reflect a market failure. We understand the government's focus on investor responsibilities but we believe that board effectiveness is equally important and would like to see the Government and companies put a greater focus on this area.
"We are concerned that the new requirements may restrict companies' ability to adapt their reward offerings to reflect changing business environments and markets for talent. However, a triennial binding vote should encourage companies to adopt a longer term and transparent approach to their executives' pay."
Sean O'Hare, remuneration partner at PwC, added: "The good news for business is that the Government has listened to their main concerns by setting the binding vote threshold at 50% and including termination payments within future policy rather than as a separate vote. This is a much more workable solution and should help reduce the burden on companies. It is encouraging that the proposals help support UK businesses by allowing them to operate in agreed guidelines, rather than being overly prescriptive.
"Reducing the vote to every three years, or annually if changes to the remuneration policy are made, is a sensible move. It may cause remuneration committees to benchmark less frequently which could reduce the inflationary effect of pay comparisons.
"It is questionable whether the proposals will lead to a wholesale reduction in executive pay. As recent events have shown, investors already have the tools to hold companies to account on pay and the new proposals don't add that much.
"There's a risk that expectations have been raised that won't be met. Many UK companies operate in a global market and can't just ignore that. But if pay doesn't fall, the Government may come under pressure to have another go in a year or two.
"We are still awaiting the detailed legislation to go through parliament, so as always the devil will be in the detail."
To introduce these reforms, the Government will shortly bring forward amendments to the Enterprise and Regulatory Reform Bill, which is currently before Parliament.
Revised, simplified regulations setting out how companies must report directors' pay will be published at the same time. This will include measures to make pay reports clearer and more transparent for investors.
In line with good policy making, we will give people the chance to comment on these regulations before they become law. The Government intends all these reforms to be enacted by October 2013.