Investor successes in executive pay battles at listed companies in this year’s "shareholder spring" might suggest that shareholders have all the powers they need to control executive pay. However, that has not stopped the Department for Business, Innovation & Skills from publishing draft legislation to implement its final proposals for greater disclosure of, and shareholder control over, director pay in listed companies.
Investor successes in executive pay battles at listed companies in this year's "shareholder spring" might suggest that shareholders have all the powers they need to control executive pay, and that the existing framework is finally working to produce the desired results. However, that has not stopped the Department for Business, Innovation & Skills (BIS) from publishing draft legislation to implement its final proposals for greater disclosure of, and shareholder control over, director pay in listed companies (see box "Further reading").
The new rules will be brought in via changes to the Companies Act 2006 (2006 Act). Only main board directors at UK-incorporated companies which are listed on the Official List (but not AIM) will be caught. Strictly, therefore, the new rules will not apply to non-UK incorporated companies listed on the Official List (including companies that have redomiciled abroad), although such companies will almost inevitably be driven by their investors to adopt corresponding disclosure standards and approval processes. Many AIM companies might end up in the same position.
To date, the annual directors' remuneration report which listed companies have published in compliance with Schedule 8 to the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008/410) has been subject only to an advisory shareholder vote under section 439 of the 2006 Act: in other words, the vote has not had any binding effect.
The remuneration report will now be split into two: a policy report which will be subject to a periodic binding vote, and an implementation report which will be subject to an annual advisory vote. The reports will be prefaced by a letter from the remuneration committee chairman, summarising key messages and decisions.
In addition, companies will separately have to announce details of directors' termination packages after their departure, although the exact timings of this are unclear.
Policy report. The policy report will cover the current and future financial years and will need to be passed as an ordinary resolution (that is, over 50% approval is required; BIS has rejected proposals for a higher voting threshold).
It must be proposed at least every three years (a change from the earlier proposal for an annual vote). All companies will have to put forward a resolution in the first year of operation of the legislation, which raises the rather strange prospect (if companies go to shareholders only as strictly required) of 2014, 2017 and 2020 (and so on) being the years in which the bulk of these votes will be held. However, if a vote approving the implementation report (see below) is not passed, a policy report vote will be required at the next AGM.
Once the policy report has been approved, the company can only make payments in compliance with the policy unless special shareholder sanction is received or a new policy report approved. If a policy report is not passed, the previous report remains the governing policy until an alternative is approved by shareholders.
In addition to providing more detail on remuneration generally (including employee share schemes and pensions), the policy report must state:
Whether remuneration is subject to clawback (that is, compulsory repayment). The legislation stops short of requiring clawback, but the question of whether clawback should be a UK Corporate Governance Code component is being considered by the Financial Reporting Council.
Whether (and how) employees' views on remuneration policy were sought (a departure from an early proposal for an employee representative on the remuneration committee).
The approach to termination packages and, in particular, how each element of pay will be dealt with when determining the termination package, whether there is a distinction between good and bad leavers, and how performance will be taken into account. This is a considerable change from the earlier proposal that the value of any cash, shares or other benefits received on termination in excess of one times basic salary would require specific shareholder approval after the termination, which many practitioners foresaw would cause considerable tension and litigation, and probably lead to short-term pay inflation.
Where the policy report is not produced for a particular year, shareholders must be informed of where they can obtain the last policy report approved by shareholders, which will normally be on the company's website. However, it is difficult to see companies not including their policy report in each annual report (even if approval is not formally required), because cross-referencing will otherwise become very difficult.
Implementation report. The implementation report, in contrast to the policy report, must be produced each year and will need to be proposed as an ordinary resolution on an annual basis. The report will explain how the policy has been implemented in the previous year. It is, in many ways, similar to the current remuneration report but will also include:
A single figure of remuneration for each director. To ensure consistency in calculation across companies, the consultation paper sets out BIS's proposed methodology.
More information about the performance conditions for annual bonuses, options and LTIPs (long-term incentive plans), and how the company performed against those targets. This will cause some companies concern as many annual bonus targets are commercially confidential even after the year in question.
How any termination packages have corresponded with the company's policy.
A chart comparing company performance (using total shareholder return) and CEO remuneration.
How shareholders voted on policy and implementation reports at the previous AGM, the percentage of abstentions, known reasons for significant dissent (which may be particularly difficult to condense when shareholders often have divergent views), and any action taken by the remuneration committee in response.
Remuneration provided in breach of the legislation will be recoverable from the receiving director and from the directors who authorised the relevant payments.
In an unexpected departure, however, there will be some "grandfathering". Certain payments made under an agreement dated before 27 June 2012 (unless the agreement was amended after that date) will not be caught by these requirements even if they are inconsistent with current policy, although there appear to be some special disclosure requirements for "offending" agreements.
There are still a number of uncertainties, and so it seems likely that further amendments will have to be made as the legislation progresses through Parliament, including to capture share scheme awards more clearly.
The new rules apply only "after" October 2013, which appears to indicate that the first companies to be affected by the new rules will be companies with December 2013 year-ends. An annual report produced in, say, April 2014 for a December 2013 year-end company will have to report remuneration paid in 2013 using a new style implementation report and include a policy report. The 2014 AGM will have to contain the advisory vote on the implementation report and the binding vote on the policy report.
As the legislation is now in probably virtually final form (at least on disclosure), companies should start considering these proposals with their advisers.
The challenge will not be how to report and draw up a policy in a way that complies with the legislation, but to draft a policy which is commercially flexible enough to deal with sudden retention, recruitment and termination issues but not so vague or undemanding as to be at risk of being voted down by shareholders.
As shareholders' demands in this new environment are likely to vary from company to company, and there is unlikely to be any greater set of prescriptive rules than currently exists, companies will simply need to keep close to their key shareholders to avoid confrontation.
Nicholas Stretch is a partner and the head of employee incentives, and Gary Green is a partner and head of equity capital markets, at CMS Cameron McKenna LLP.
BIS: Directors' pay: Consultation on revised remuneration reporting regulations, www.bis.gov.uk/assets/biscore/business-law/docs/d/12-888-directors-pay-consultation-remuneration-reporting.pdf. Comments are required by 26 September 2012.
The proposed legislation on the binding shareholder vote and the consequences for remuneration paid in defiance of the policy report passed by shareholders is contained in proposed clauses for the Enterprise and Regulatory Reform Bill (amending the Companies Act 2006), at www.publications.parliament.uk/pa/bills/cbill/2012-2013/0007/amend/pbc0072806m.43-49.pdf.