· 3 min read · Features

Reward for failure

Published:

“Reward for failure” has been in the headlines all too often recently, as George Entwistle, Diamond, Hughes et al all know.

Earlier this year Sir Martin Sorrell, the CEO of WPP, announced he will take a slight cut in his annual salary and benefits in order to appease shareholders. Some 60% of which rejected his reported US$20 million package last year. The irony is that WPP, under Morrell, has been doing rather well.

The point is that for years politicians and pundits have rounded upon "reward for failure" and condemned both the concept and individuals - but has anything changed, or is what an individual is paid when they leave their job still essentially a private matter?

Notice period - employees

As with all employees, you must look at the notice period in the employment contract. If you want the executive to leave immediately (in the absence of gross misconduct), the employer is usually liable to pay the earnings they would have received during the notice period. However, this amount could be reduced due to an employee keen to quickly find another job.

Notice period - directors

A normal notice period for directors is between six and twelve months. It can only be longer than two years if the shareholders formally agree to this at a general meeting. If a notice period does not conform to this, the company is entitled to terminate the director's contract at any time by giving reasonable notice. What is reasonable is determined by factors such as the employee's seniority and the notice period of other employees in similar roles.

There are also Companies Act restrictions on what a company can pay to directors on termination. Shareholder approval is required for any termination payment unless it is being made to comply with a legal obligation, such as a provision in a contract.

Financial services firms subject to the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) code on remuneration

There are extra requirements for employees of banks and other financial institutions. The FCA's and PRA's codes (formerly the FSA code) specify that severance pay must reflect performance and not reward failure. Companies must explain to the relevant regulator the criteria they used to determine severance pay for all employees, but especially in relation to senior employees and those leaving over concerns about effective risk management or compliance.

Quoted companies

Companies with premium (rather than standard) equity share listings are bound by the UK Corporate Governance Code. This also affects executives' terms and states a notice period should be one year at the longest. If it is necessary to offer a longer period to a director recruited from outside the company, this must be reduced to one year after an initial period.

The company's remuneration committee must consider what compensation payments (including pensions) are payable to directors if their employment is terminated early. A director's remuneration package must also be disclosed to shareholders under the Listing Rules. These requirements put pressure on companies to avoid rewarding poor performance - something the media is always interested in.

The Association of British Insurers' recently published guidelines that suggest the link between pay and performance should be demonstrated with even greater transparency for executives. This then allows shareholders to make a more informed decision.

Changes in the pipeline

Under changes being introduced by the Enterprise and Regulatory Reform Act 2013 the government will implement more changes from October 2013 affecting quoted company directors' remuneration in two ways:

Every company must set out their remuneration policy every three years for the shareholders' approval. This will limit director pay-outs (unless the shareholders agree on a new limit through a strict procedure);

an annual report must be produced demonstrating how this was implemented in the past financial year, including details of payments made to directors

This means that any payment, which doesn't comply here, won't be made and, any amount paid can be recovered by the company that paid it. The directors who authorised the payment will also be liable to insure the company for any resulting loss. The new rules apply to payments made from the start of the second financial year beginning on or after 1 October 2013, or any earlier date specified by the Company but only if made under an agreement made after 27 June 2012.

Jessica Corsi is Partner at employment law firm, Doyle Clayton