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Executive pay and binding shareholder votes: what does this mean for HR and remuneration policy?

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The Government has completed a period of consultation on enhanced shareholder voting rights on executive pay. Included among the proposals are fundamental changes to the framework for directors' remuneration for listed companies incorporated in the UK.

At the moment, listed companies produce a single directors' remuneration report, on which shareholders have an 'advisory' vote at the AGM. No part of a director's remuneration is conditional on the shareholder vote being passed, nor must any be repaid if the report is voted down.

The proposals on which the Government has been consulting would mark a significant increase in the ability of shareholders to influence executive pay.

Annual binding vote on future remuneration policy

One of the most important of the Government's proposals is that there should be an annual binding vote on future remuneration policy. The threshold for the vote in favour of the remuneration policy has not yet been set, but the Government's suggestion is that it should be somewhere between 50% and 75%.

The principal intended benefit of a binding vote is to give shareholders a more effective sanction in relation to the remuneration process than they currently have – providing a more powerful incentive to boards and remuneration committees to design proportionate and fair remuneration policies. A secondary benefit would be to give shareholders a targeted way of expressing their criticism of remuneration structure without having to resort to vetoing the reappointment of directors or, in a more extreme form, removing directors from the board.

On the downside, to be truly informed, a binding vote on future remuneration policy would require much-enhanced levels of engagement and participation by shareholders. The reality is that shareholder engagement varies hugely, as large companies have many different types of shareholders, ranging from those with a long-term to those with a short-term perspective – which raises a question as to how practical this proposal is.

Another risk is that an annual vote could serve to create a ratchet effect, with pressure to increase remuneration across the board. It also leaves open the question of how a remuneration committee will exercise its discretion under the policy.

If a binding vote is implemented, there will be a challenge for companies to set a remuneration policy that allows sufficient competitiveness and flexibility to recruit and retain high-calibre directors, while also being acceptable to shareholders. This will require careful judgement and balance, and an effective on-going dialogue with shareholders.

Binding vote on exit payments over a year's base salary

As part of its continuing campaign against 'payments for failure', another significant proposal on which the Government has consulted is to give shareholders a binding vote (50%) on exit payments to directors, to the extent that they exceed one year's base salary. As the concept of an exit payment is broadly defined, the majority of termination payments currently made to directors would exceed the one year's salary threshold and would need to be put to a shareholder vote if the proposed regime were already in force.

There are a number of problems with this proposal, which ideally should be addressed before it proceeds. For example, if the proposal goes ahead: -

it is likely that companies will introduce higher base salaries so as to increase the threshold amount for a termination payment. This could in turn have a multiplier effect on options and benefits where those are determined by reference to the salary.

Directors will also seek to achieve higher compensation during employment, in the knowledge that termination payments will be curtailed.

Remuneration committees are likely to be reluctant to exercise discretion favourably in Long Term Incentive Plans on termination, which may affect 'good' as well as 'bad' leavers.

Where a company wishes to seek permission from shareholders to pay a particular individual above the limit of one year's salary, there will be a delay before such a payment can be made, which is likely to lead to more litigation, adding to the cost of settlement.

The proposals also risk placing UK-incorporated companies at a competitive disadvantage in relation to foreign-incorporated companies, which will have more freedom to negotiate termination packages.

The Government is expected to confirm the precise measures it intends to implement later this summer and directors and shareholders alike are awaiting the final form of these proposals with interest.

Whatever the content of the final legislation, however, the acid test for the success of the Government's proposals will depend on the extent to which, in the long term, shareholders seize and use their new powers.

Jonathan Exten-Wright (pictured) is an employment partner at global law firm, DLA Piper