DTI requires more transparency on directors' remuneration

The DTI has published a Consultative Document on Directors' Remuneration, building on the 1995 Greenbury Report and the more recent Combined Code, to ensure that companies comply with the best practice principles of remuneration, namely: accountability, transparency and performance linkage. The Government intends to enact the necessary legislation before the end of July this year.

The new corporate governance requirements will apply to all UK incorporated companies quoted on the London Stock Exchange, a European exchange, the NYSE or NASDAQ (but not AIM).

The key effects on quoted companies will be that for accounting periods ending on or after 31 December 2002 (ie from 1 January 2002 onwards) they will be required to:

• publish an annual report on directors' remuneration, disclosing amongst other things details of each individual director's remuneration, share incentives and performance targets.
• put the report to a shareholders' vote at the AGM (although the outcome of the vote will be advisory rather than mandatory).

The Government's intention is that matters concerning directors' remuneration in 2002 will need to be reported in 2003.

Details of the Directors' Remuneration Report

The directors will be required to prepare the report and part of it (detailing payments made to directors) will require to be audited. Extracts from it will also be required to be disclosed in the Summary Financial Statement. The report must contain the following:

• Details of the members of and advisers to (whether remuneration consultants, professionals or other directors) the Remuneration Committee (if any) and a statement whether that Committee's recommendations were accepted by the Board and if not why not.
• A statement of the company's policy on directors' remuneration covering performance criteria for long-term and executive share option schemes (including details of comparator groups of companies) and the company's policy on contractual notice periods for executive directors and severance compensation to them.
• Performance graphs comparing the company's performance over the last 5 years with comparator companies, or where inappropriate, graphs of Total Shareholder Return (similar to the USA's SEC requirements).
• Details of service contracts of each director of the company in the preceding financial year and an explanation of any significant compensation payments to former directors.
• Disclosure of each director's remuneration in the preceding financial year including emoluments, share options (based on the Accounting Standards Board's UITF Abstract 10), long-term incentive schemes, pensions, excess retirement benefits, compensation for past directors and sums paid to 3rd parties in respect of directors services (eg as a director of a subsidiary).

Details of the Shareholders' Vote

The company must circulate a resolution approving the Directors' Remuneration Report for the preceding financial year to its shareholders prior to its AGM, which the existing directors are required to put to the meeting. The vote is however only to be advisory and would not require the directors to amend contractual entitlements, nor to amend their remuneration policy. Nevertheless, the Government envisages that in most cases the bad publicity created by a "no" vote will sway the directors to respond appropriately.

What Effect will these Changes Have?

The most likely effect of these changes will be in the areas of executive share incentives, notice periods and investor relations. Already the trend is to move away from a total 4 times salary limit to the Association of British Insurers' annual one times salary limit for share incentives. However the 40% of FTSE350 companies (according to New Bridge Street Consultants) who still use these old limits will face growing pressure to change their incentive plans with the introduction of this increased transparency. Notice periods too will face a continuing downward pressure meaning that those remaining 2 or 3 year service contracts are likely to be reduced to 12 months sooner rather than later. The potential bad publicity of a "no" vote should also aim to be avoided by more consultation with companies' major shareholders well before the Directors' Remuneration Report is published.

The new requirements on the operation and disclosure of the composition of the Remuneration Committee may well cause the most pain. A survey by the by the National Association of Pension Funds ("NAPF") in January this year found that nearly half of the UK's top 400 companies failed to meet the existing best practice that only independent non-executive directors should set directors' pay levels.

Shareholder involvement under the voluntary regime has not been good so far either, with only 13% of FTSE100 companies offering shareholders a vote in 2001 (according to a survey by EdisBates Associates). Nevertheless, that survey found that more than a third of those companies planned to give shareholders a vote on directors' remuneration this year, before the introduction of the new laws. In addition almost all of those companies are now willing to disclose the performance criteria on which pay awards were based, although they were not so keen on the idea of performance graphs (according to the survey). The TUC on the other hand has called for staff representation on the Remuneration Committee as the best safeguard against abuse.

The changes have been welcomed by the NAPF, but institutional investors generally are against moving away from a voluntary code towards compulsory legislation. According to the New Bridge Street survey, one third of investors felt the changes would fail to curb perceived abuses and a further 70% plan to publish their own alternative guidelines. By contrast, the same survey revealed that over half of FTSE350 companies have welcomed the proposals.

Comments on the draft Regulations are invited by the DTI by 15 March 2002.

Simon Jeffreys, phone: +44 (0)20 7367 3421

Email: [email protected]

Kate Kelleher, phone: +44 (0)20 7367 2860

Email: [email protected]