Guest post by Damien Knight, Director, MM&K Ltd
The Coalition Government, through the Department for Business, Innovation and Skills (BIS), has been consulting regularly since September 2011 about what it could do to reign in ‘excessive’ executive pay and strengthen the link between pay and performance in major companies. Today (June 20th 2012) the Business Secretary, Vince Cable, announced to the House of Commons the Government’s final proposals for change. New legislation will be incorporated in the Enterprise and Regulatory Reform Bill and enacted in October 2013 (we understand it will apply to companies with year-ends after that date).
What has emerged demonstrates that Mr Cable has been listening hard to both companies and shareholders and has produced as rational and constructive a set of proposals as could be expected. There are also some clever devices in the construction of the proposals that will encourage both shareholders and companies to err on the side of higher engagement and regular votes whilst giving apparent discretion and flexibility.
Some months ago BIS decided that the route to dealing with apparent excess was to strengthen shareholder powers in relation to directors’ remuneration, and the new proposals do that – but it is clear from the structure of the proposals that Vince Cable is not only empowering shareholders but putting pressure on them to engage more fully and to use their voting powers.
Not all shareholders or remuneration committees will welcome every aspect of the proposals. The forum discussion at the Manifest/MM&K Remuneration Briefing Seminar on 12th June revealed that some shareholders and shareholder advisors would have preferred more time to make the existing shareholder pressures work, whilst some remuneration committee chairmen cannot see that the proposals will help them make better decisions. Nevertheless, Vince Cable was probably right when he said in a Commons reply today that the ‘Shareholder Spring’ has been encouraged by the Government’s proposals.
A guide to the Government reforms can be found at: http://www.bis.gov.uk/assets/biscore/business-law/docs/d/12-900-directors-pay-guide-to-reforms.pdf
The stated aims are to:
- restore a stronger, clearer link between pay and performance
- reduce rewards for failure
- promote better engagement between companies and shareholders
- empower shareholders to hold companies to account through binding votes.
But Vince Cable put it more succinctly in the Commons when he said the test for the success of the proposals will be whether they encourage restraint and encourage strategic thinking in pay (a test which few people would disagree with).
The proposals centre around two reports to be included in the annual report to shareholders.
(1) The Policy Report – a binding vote
This proposal, which has been trailed for some months, requires companies to make a completely new type of report on future policy and put it to a binding vote of shareholders. The final proposal differs in a number of respects from earlier versions:
- The vote will be on a simple majority basis
- The previously-mooted separate binding vote on exit payment policy is now covered by the same policy report vote
- Companies can put their policy to the vote every three years (rather than every year) but the BIS proposal cleverly allows this only if the policy does not change and if the company passed the advisory vote (see below) the previous year Many companies might find it simpler to call for a future policy vote every year
- The report must include material factors taken into account in setting pay policy, specifically employee pay generally and shareholder views.
The detailed proposals have yet to be published and it is going to be interesting to see how the Government expects the policy constraint to work in practice. No doubt many companies will write their policy in such a way that allows plenty of flexibility. An example is to set a grant maximum in a share plan which is well above normal grant levels. Questioned about how the Government would avoid such flexibility and headroom, Mr Cable replied it would be the shareholders’ job to ensure their powers were not being usurped in this way.
(2) The Implementation Report – an advisory vote
In many ways this comes close to the audited part of the current remuneration report and the current advisory vote in so far as that vote applies to remuneration practice in the reported year. But there are some differences:
- It is a simple majority vote. But a failed vote triggers a new binding policy vote the following year
- A single total figure of remuneration for each director must be published
- Full information on exit payments for the year
- A chart comparing company performance and CEO pay
- Details of remuneration committee advisors (we think with fees charged).
MM&K has been lobbying actively during the BIS consultation, and we have strongly advocated a report comparing company performance and CEO pay, although a five-year historical record is necessary for shareholders to make sense of the data.
Manifest and MM&K have been successful in predicting the definition of the single total figure, which the FRC’s Financial Reporting Lab has been working on for the Government. We correctly predicted that this would include the actual value of long term incentives realised (ie vesting) rather than the expected value of new grants. There are some details that will cause problems: the Government seems to be going for reporting long-term incentives in the final year of the performance period. This could result in a mis-match between the performance year and the vesting year. The pension definition will prove the most controversial when we learn the details.
We have always argued for reporting both the ‘realised’ and ‘granted’ totals. But if the Government is wed to one figure the realised amount is the right one as it is the figure that should correlate to performance. We have included in our June 2012 Executive Director Total Remuneration Survey a list of single figures for FTSE 100 CEOs in the latest year up to December 2011.
The Business Secretary also mentioned an announcement by the Financial Reporting Council that it will consult on changes to the Corporate Governance Code in relation to the outcome of votes including those with substantial minority dissents.
The legislation is expected to cover all large and medium sized companies currently covered by Schedule 8 (of The Large and Medium-sized Companies and Group (Accounts and Reports) Regulations).