Summary: The Government has published a Green Paper considering three aspects of corporate governance: executive pay; strengthening the employee, customer and supplier voice; and corporate governance in the UK’s largest privately-held businesses. The Investment Association and the Financial Reporting Council have welcomed the publication. If you would like to respond, comments must be received by 1 February 2017.

In the introduction Theresa May makes it clear that the focus is on “ensuring that executive pay is properly aligned to long-term performance, giving greater voice to employees and consumers in the boardroom, and raising the bar for governance standards in the largest privately-held companies.”

The proposals in the Green Paper have been watered down somewhat from the original statements that came out of Downing Street when Theresa May first took office. Nevertheless the Government’s intention is clear; it wants to “stimulate debate among all those with an interest in corporate governance including businesses, employees, investors and the general public” as part of its bigger plan to “enhance public trust in business as a force for good” and “build an economy that works for everyone, not just the privileged few”.

Executive pay

According to the paper, in the last 18 years the total pay for CEOs of FTSE 100 companies has quadrupled from an average of approximately £1m in 1998 to approximately £4.3m in 2015, far outstripping growth in average pay in the UK. Despite the 2013 executive pay reforms requiring a binding vote, at least every three years, on the remuneration policy, the Government is now seeking views, in five areas, on whether these reforms require further refinement.

Shareholder voting and other rights

Option 1: make all or some elements of the executive pay package subject to a binding vote, for example the full remuneration report or variable pay elements. However this could cause practical difficulties eg. businesses may not be able to award pay before shareholder consent has been obtained;

Option 2: introduce stronger consequences when the annual advisory vote on the remuneration report is lost. For example if the vote is lost, 75% approval (as opposed to a simple majority) could be required to approve the pay policy the following year;

Option 3: require or encourage quoted company pay policies to (a) set an upper threshold for total annual pay (from all elements of remuneration), and (b) ensure a binding vote at the AGM where actual executive pay in that year exceeds the threshold;

Option 4: require the existing binding vote on the executive pay policy to be held more frequently or allow shareholders to bring forward a binding vote on a new policy earlier than the mandatory three year deadline; and

Option 5: strengthen the UK Corporate Governance Code to provide greater specificity on how companies should engage with shareholders on pay, including where there is significant opposition to a remuneration report. This could include setting out a process for remuneration committee engagement with shareholders and employees before the annual remuneration report is presented to the AGM.

Shareholder engagement on pay

Option 1: mandatory disclosure of fund managers’ voting records at AGMs and the extent to which they have made use of proxy voting;

Option 2: establish a senior “shareholder” committee to engage with executive remuneration arrangements. This could have an impact on the UK’s model of the unitary board structure; and

Option 3: consider ways to facilitate or encourage individual retail shareholders to exercise their rights to vote on pay and other corporate decisions. This could include promoting use of rights, under the Companies Act 2006, for proxy voting by investors and brokers “passing back” information rights to the underlying investor.

Role of the remuneration committee

Option 1: require the remuneration committee to consult shareholders and the wider company workforce in advance of preparing its pay policy; and

Option 2: require the chairs of remuneration committees to have served for at least 12 months on the committee before taking up the role.

Transparency in executive pay

Option 1: pay ratio reporting ie. publish ratios comparing CEO pay to pay in the wider workforce to enable shareholders and employees to judge how executive pay compares across different companies, particularly those within the same sector. This would also require boards to explain to shareholders and wider stakeholders why the ratio is appropriate in the context of the performance of the business and rewards for employees; and

Option 2: disclosure of bonus targets. Companies can refrain from disclosing bonus targets and performance measures from the annual remuneration report if they are considered “commercially sensitive”. Despite the fact that 64% of companies made full disclosure at the 2016 AGM season, the Government is seeking views on whether it should increase non-legislative pressure on companies to provide full disclosure.

Long-term executive pay incentives (LTIPs)

To better align the long-term interests of quoted companies and shareholders, should:

  • “restricted share” awards be used as an alternative to LTIPs ie. annual share options to be exercised in the future based on the executives’ continued employment; or
  • should holding periods be increased from a minimum of three to five years?

Strengthening the employee, customer and supplier voice

This section explores the options for strengthening the stakeholder voice at board level.

Option 1: Create stakeholder advisory panels. This could involve the board seeking views on particular issues from the panel or panel members could be invited to attend board meetings to offer views on particular issues;

Option 2: designate existing non-executive directors (NEDs) to ensure that the voices of key interested groups, especially that of employees, is being heard at board level. For example, each designated NED could chair a board-level committee to ensure that executive decision-making takes appropriate account of employee, supplier or customer issues;

Option 3: appoint individual stakeholder representatives to boards; and

Option 4: strengthen reporting requirements related to stakeholder engagement. Currently companies have to prepare a strategic report enabling shareholders to assess how the directors have performed their duties to “promote the success of the company” but there are no further details on how this should be done. Stronger reporting requirements could promote greater confidence in boardroom decisions.

Corporate governance in large privately-held businesses

The Government would like to learn more about how large, privately-held businesses are already applying corporate governance principles to improve the way they run.

Option 1: applying enhanced standards of corporate governance more widely. This could involve extending the UK Corporate Governance Code to these types of companies or alternatively invite the FRC to develop a separate code for them; and

Option 2: applying reporting standards more consistently. Should non-financial reporting requirements be applied on the basis of the size of a business rather than whether it is a “quoted company” or not?