This follows discussion with business leaders, investors, academics, governance experts and a range of others, who agree there is a problem with rising executive pay, which is not linked to performance.
The consultation sets out a range of measures including an annual binding vote on future remuneration policy; ncreasing the level of support required on votes on future remuneration policy; an annual advisory vote on how pay policy was implemented in the previous year; and a binding vote on exit payments of more than one year's salary
Under these proposals, companies will have to report each year on how they have responded to shareholder concerns and taken previous votes into account. The objective is to promote better engagement between companies and those that invest in them, and create a stronger link between pay and performance.
Business secretary, Vince Cable (pictured) said: "Good corporate governance is vital to creating the right environment for long-term, sustainable growth. Shareholders are at the heart of the UK corporate governance framework, so it's appropriate that we put more information and power in their hands.
"I have no problem with business celebrating success and rewarding talent, but I have heard frustration from all circles that director's pay goes up when times are good, and yet it still goes up when performance is poor.
"I want shareholders to feel empowered to prevent rewards for mediocrity or failure."
These measures will require primary legislation. The purpose of the consultation is to seek evidence on their potential costs and benefits, and the likely impact on business.
Jonathan Exten-Wright, employment partner at DLA Piper LLP, said: "A binding vote on future remuneration policy assumes appropriate shareholder activism within a company. The reality is that shareholder engagement will vary hugely as large companies will have many different types of shareholders ranging from those with a long term to short term perspective.
"An annual vote might only serve to create a ratchet effect with pressure to see increased remuneration across the board." "It still leaves open the question of how a remuneration committee will exercise its discretion under the policy.
"In the event that the binding vote is lost falling back on the previous year's policy could well be inappropriate for the following year. The government's expectation that shareholders could then look to exercising their vote on the re-election of directors to express their dissatisfaction seems impractical.
"A binding vote on exit payments over one year's salary would undoubtedly be a dramatic change. The result of such a vote will inevitably be that employees will look to increase a higher base salary. That may in turn may then have a multiplier effect on options and benefits when those are determined by reference to the salary."
Simon Evans, partner at law firm Freshfields, said: "The proposal for a binding vote on pay-offs is really significant and will make companies more cautious about termination provisions in contracts and the treatment of "good leavers". At the moment, the majority of termination payments would exceed the Government's one year's salary threshold, which captures all elements of a director's package - including discretionary expectations to bonuses and long term incentives as well as contractual rights.
"Typical exit packages would therefore need to be put to a shareholder vote. Companies are likely to respond by paring back termination commitments so that only exceptional cases would be put to shareholders. Possibly, we will see increases to base salary to get within the threshold, but shareholders will be looking out for this."
Sean O'Hare, remuneration partner at PwC, added: "Vince Cable has delivered on his pledge to make radical changes to the way in which remuneration committees interact with shareholders.2
"The proposals announced today represent the most significant shift in the governance of executive pay for a decade since the introduction of the advisory shareholder vote on the directors' remuneration report.
"The proposals announced today will come as a shock to remuneration committees and will leave them facing two shareholder votes on remuneration - one vote on proposed future policy and potential payouts and a separate vote on implementation of that policy and actual payments made.
"It is the vote on the future policy which will be the most difficult for remuneration committees. There are still a lot of loose ends about what needs to be reported on the company's future policy. No additional detail has been provided about what has to be included in the potential level of pay for directors or the methodology to be adopted. Without clear guidance, the risk of mis-reporting and misunderstanding remuneration remains.
"Companies and remuneration committees will need to absorb the detailed information set out in the consultation document and actively engage in responding to the questions posed before the deadline of Friday 27 April."
The proposals are part of a wider package of measures announced by the business secretary in January, aimed at addressing corporate governance failures in the way executive pay is set in UK publicly quoted companies.
The total package included empowering shareholders and promoting engagement through enhanced voting rights; greater transparency in directors' remuneration reports; increasing the diversity of boards and remuneration committees; encouraging employees to exercise their right to Information and Consultation Arrangements; and working with investors and business to promote best practice on pay-setting
Over the next few weeks the Business Secretary and officials will meet investors, non-executive directors, company secretaries, HR directors, lawyers and other experts to discuss the Government's proposals.
The consultation closes on 27 April 2012. BIS will then confirm the precise measures Government expects to take forward in primary legislation.
Draft regulations to determine the content of directors' remuneration reports will be published at the same time. Together, these measures will create a more robust framework within which executive pay is set, agreed and reported on.
