2016 has seen a significant number of papers from pressure groups and investor bodies to try and shape the future direction of quoted company director pay. Last week’s long-awaited Government Corporate Governance Green Paper made what is likely to be the final contribution this year.
Theresa May’s campaign speech contained some very firm commitments to remuneration reform, but the Green Paper generally appears to support the changes that investor groups such as the Investment Association subsequently proposed. Click here to read our Law-Now on the final Investment Association proposals. To that extent, companies will be relieved that Government interest in this area may not involve separate legislation, and that the Government may well be content for change to occur through compliance with Investment Association proposals rather than initiating proposals of its own. However, there are a few areas where the Government may find it difficult to row back – particularly on pay ratios and employee involvement with the Remuneration Committee.
This Law-Now looks at the remuneration issues which arise in the Green Paper. (A subsequent Law-Now will consider the Green Paper’s proposed options for giving a stronger voice to stakeholders in listed companies and for improving corporate governance in larger private companies.) The remuneration part of the Green Paper starts by making the now all too-familiar comment in these sorts of papers that executive pay has lost the trust of society. It goes on to repeat that the differentials between normal pay and executive director pay at quoted listed companies are larger than they have ever been. Despite being formally linked to performance through bonuses and LTIPs, executive pay also seems to have increased substantially more than underlying corporate performance.
While the paper notes that substantial reforms were made in 2013 (when a binding three yearly remuneration policy vote was introduced) and that investor bodies are also proposing change themselves to address many of the “trust” issues that shareholders themselves have with current pay arrangements, the Government wants to launch its own review here to understand if and how the issues should be addressed. It is not clear in the paper whether the Government includes AIM companies as potential targets or just companies on the Main Market.
The Government seeks views on:
How to increase shareholder control of pay
Four options are set out (although the Government invites others options being put forward and does not commit to making any change at all):
- making some or all of a director’s pay conditional on shareholder approval at the end of the year, although this proposal might only apply to companies that had already experienced serious shareholder dissent. The inevitable consequence of this would be that a substantial amount of a director’s pay would be subject to what shareholders think at the AGM after the year in question
- setting tougher maximum limits on pay
- requiring a binding shareholder vote more frequently than the current three year period and
- amending the Corporate Governance Code to deal with how companies should engage with shareholders on pay, particularly where issues have been identified (which is the gentlest proposal)
The problem here, as the Government identifies early in its paper, is that a few difficult cases do not necessarily justify a regime which all companies would have to have to apply with added expense and complexity, particularly at a time when greater simplicity in pay is being sought. The vast majority of companies have extremely strong support for their pay arrangements and shareholders themselves rarely find the currently available tools inadequate. Making an executive director’s pay conditional until the end of the year is also likely to be fiercely resisted. It has not been requested by any shareholder group either, and so may have been included just to favour other proposals. Companies and investors are likely to favour the final proposal over all others, if any change at all needs to occur.
How to increase shareholder engagement on pay
Three options are set out (although again as above they are not indicative of what if anything may be chosen as the way forward):
- disclosing fund managers voting records and the extent to which they have made use of proxy votes
- establishing a senior “shareholder” committee to engage on remuneration arrangements
- specific provisions to involve retail investors
Remuneration proposals are already heavily discussed with shareholders – indeed the Investment Association is trying to limit the volume of consultations in favour of more focused approaches. From companies and shareholders’ point of view, there seems little evidence of a real problem here or that the solutions proposed would help solve the problem without creating others in their wake.
Role of the remuneration committee
- requiring the remuneration committee to consult shareholders and the wider company workforce in advance of preparing its pay policy
- requiring remuneration committee chairs to have served on the remuneration committee for at least 12 months before taking up the role
The first proposal already happens insofar as shareholders are concerned, but consulting the workforce on this subject would be difficult (although not impossible) and in practice just bring foreword the timing for finalising the proposals rather than change them in any material respect. The second proposal, to ensure that the Rem Com chairman has experience of remuneration before stepping up to his/her role, is an Investment Association proposal anyway.
Transparency in pay
- CEO pay ratio reporting
- disclosure of bonus targets
- using restricted shares as opposed to LTIP awards and having five year vesting terms (instead of three years)
These are proposals that have been fiercely resisted in the past but, at least on disclosure of bonus targets, market practice is moving to greater disclosure all the time due to continued pressure on this from investor groups. Many companies and investors are sceptical of the value of pay ratio reporting, but would rather fight other battles now. There are mixed views on the use of restricted shares (awards without performance conditions) and also five year vesting terms, in particular that this may actually lead to greater remuneration needing to be offered, and so there is any unlikely to be any consensus on these proposals either.
In summary, companies and institutional investors are likely to have similar views, which are that although current pay arrangements are not ideal, legislation or Government intervention is not the answer. Instead new Investment Association guidelines, which were formalised in response to shareholder pressure in response to largely the same issues, should be given time to work. However, this whole area has the personal interest of the Prime Minister, who has written the foreword to the paper. Whatever the outcome of this consultation, this will therefore at the very least be a warning to companies and investors that if they do not follow the investor proposals, the possibility of Government action is not far away.
Click here to read the Green Paper.