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
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
Details of the Directors' Remuneration
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
- 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
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
Comments on the draft Regulations are invited by
the DTI by 15 March 2002.
Simon Jeffreys, phone: +44 (0)20 7367 3421
Kate Kelleher, phone: +44 (0)20 7367 2860