Greater shareholder control of executive director pay

The Department for Business, Innovation and Skills (BIS) has published the latest instalment on legislative proposals for greater shareholder voting rights on executive director pay in listed companies. Its consultation paper follows Vince Cable’s discussion paper on executive remuneration published last Autumn and a speech in January on this subject (please click here for our earlier Law-Now).

These proposals, which now look virtually certain to take effect, will have a significant impact on executive director remuneration and also (in combination with other narrative reporting proposals) lead to major changes in listed company AGM business and their directors' remuneration reports.

One piece of good news is that only UK incorporated companies with shares admitted to the Main List (Official List) will be affected – AIM and private companies are not included in these proposals.

The current intention is that the legislation will affect year ends after 1 October 2013. We plan to send out a fuller analysis soon, but the key points on these radical proposals affecting executive directors’ financial relationships with their employers are:

Binding annual vote on future remuneration policy

Shareholders will be required to approve the remuneration policy for directors for the current financial year (see below for further discussion on what level of approval will be needed). This will cover increases in salary, the level and criteria for performance-related pay (bonuses or share awards), material changes to service contracts, pensions and other benefits.

Where the vote is lost, the company will either have to rely on the previous policy or seek approval for revised proposals within 90 days of the original vote. The default position of applying the previous year's policy addresses the fear that directors could not be paid in the event of a no vote.

Although companies’ and investor groups' responses to the proposed legislation will become clearer over time, one response may be to adopt as general an approach as possible so as to give companies maximum leeway.

Given that companies' AGMs are not held until at least four or five months into the financial year, this will mean that any changes to existing arrangements before the AGM will in effect be contingent on shareholder approval, and actions taken after the AGM will have to be in accordance with this policy or else they will not be effective.

When hiring new recruits during the year, it is proposed that the remuneration package offered must be confined to the limits and structures in the approved remuneration policy. This may give companies less flexibility when negotiating contracts with new hires than they have been used to.

Increasing the threshold of support required to approve future remuneration policy

At present, the annual advisory vote on remuneration policy is passed by a simple majority of votes cast. To encourage greater engagement with shareholders, the Government proposes increasing this threshold for approving future remuneration policy, possibly to as high as 75%. The consultation paper seeks views on what the appropriate threshold should be.

Advisory annual vote on how remuneration policy has been implemented

Shareholders will have an advisory vote on how the company has implemented its remuneration policy over the previous year, similar to the existing advisory vote.

Companies will be required to report on how they have taken into account the results of previous advisory votes when designing future remuneration policy and its implementation. Where less than 75% of votes are cast in favour, companies will be required to issue a statement within 30 days detailing the outcome of the vote, the main issues raised by shareholders and how the company proposes to work with shareholders to address them.

To facilitate these changes, it is proposed that the content of the existing directors’ remuneration report will be more focused and split into two sections. The first will outline the proposals for future remuneration policy, including details of potential payouts, but will require much more justification than at present. The second will explain how remuneration policy has been implemented over the previous year. The stated aim is that shareholders will be provided with clearer and more useful information which they can use to make more informed decisions about the way in which they should cast their votes.

Binding vote on termination packages

Shareholders will have to approve any director’s termination package which exceeds one year’s base salary before any excess can be paid or delivered. Vesting of options and LTIP awards, payment of any part year bonuses and amounts in lieu of benefits (whether they are contractual rights or discretionary entitlements) would be included as part of the value of the package. Approval will be required on a case by case basis at a general meeting after termination, with detailed explanation being given for how proposed amounts have been derived. A majority of shareholders must vote in favour of the proposals for any excess payment to be permitted.

Companies will not be able to obtain shareholder approval in advance of termination, which is the approach commonly taken in Australia, and so would, if a higher payout is proposed, need to defer making termination payments in excess of one year’s base salary until approval is received.

What executive directors can receive on termination from 1 October 2013 therefore looks highly likely to be capped at one times salary, unless shareholders permit higher payouts which seems unlikely as a matter of routine. This is considerably less than executive directors have been receiving and so is a sea change in UK remuneration practice. As most executive directors already receive one time salary in notice pay, it therefore means that receipt of any bonus or share entitlements or even cash in lieu of benefits is going to be dependent on a shareholder vote.

Timetable for change

The deadline for responding to the consultation is 27 April 2012 and final proposals are expected to be announced in the summer.

The Government intends that any legislative changes will be introduced later this year, subject to Parliamentary time being available, and will apply to financial years ending after 1 October 2013 and to directors whose contracts are terminated after that date.

A copy of the consultation paper is available here.