The UK government’s executive pay law proposals – going further than the Australian laws
26/01/2012
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On 24 January 2012, the UK Secretary of State, Business, Innovation and Skills Vince Cable announced a package of measures the British government will take forward regarding executive pay.

The measures won widespread praise from both business and unions. Interestingly, investor groups had more mixed reactions.

The measures are more radical than those implemented in Australia on 1 July 2011, which were broadly condemned by both the majority of company directors and institutional investors. Predictably, the criticism of Australian executive remuneration in the media and from the broader public has not gone away as a result of these laws, which suggests there may still be votes to be won for politicians who “act” further on executive pay. Given the UK proposals for a binding shareholder vote and employee consultation go that step further, it would be instructive for all Australian stakeholders to be aware of what could happen next.

Mr Cable’s proposals are a package of measures to tackle executive pay issues on four fronts:

  • to boost transparency;
  • give shareholders more effective control;
  • increase the diversity of remuneration committees; and
  • encourage major businesses and investors to lead by example.

Transparency

When reviewing the UK’s initiatives in transparency, readers should keep in mind that the Australian government is still to respond to the CAMAC report on remuneration reporting (see HERE).

The UK government is proposing new rules that will require remuneration reports to be split into two sections:

  • one detailing the proposed future policy for executive pay;
  • the other setting out how pay policy has been implemented in the preceding year.

Mr Cable has said that “too many reports are currently an unintelligible mix of the two”.

When outlining future policy, boards and their remuneration committees will be expected to explain in the report why they have used specific benchmarks and how they have taken employee earnings – including pay differentials – into account in setting pay.

Contrary to suggestions from trade unions and others, the report will not be required to disclose pay ratios between CEO and average employees. But companies will have to explain how they have consulted with employees and taken account of their views. But, already in the UK, employees in large companies have the right to set up Information and Consultation Arrangements, allowing them to receive information and discuss issues about the company for which they work – including their bosses’ pay. This mechanism is not being extensively used at present.

The UK government has suggested that “here is a useful mechanism that already exists and it is more practical and less problematic than trying to put worker representatives on boards”.

Reflecting what has been a feature of Australian remuneration reports since 2005, the UK government also wants remuneration reports to explain clearly and succinctly how the proposed pay structures reflect and support company strategy; how performance will be assessed; and how it will translate into rewards under different scenarios.

In particular, UK remuneration reports will need to open up the performance criteria for bonuses. Australian reports already require a “detailed summary” of performance criteria for bonuses, yet most companies fail to provide enough detail to show how the bonus was worked out. It will be interesting to see how the UK legislation tackles this.

The UK will require greater openness on exit payments, including the contractual terms offered to executives, as now required in Australian remuneration reports.

In the backwards-looking section of the report, (and some would argue a backwards step towards greater opacity!) UK companies will have to provide a single figure for total pay for each director, and explain how pay awards relate to the company’s performance. Mr Cable has indicated in interviews that the report should not show the separate elements of pay.

UK companies will also have to produce a distribution statement, outlining how executive pay compares with other dispersals such as dividends, business investment, taxation and general staffing costs.


New shareholder power over pay

Mr Cable is proposing to give shareholders a binding vote on pay, with specific options for which the details are still to be worked out including:

  • Binding shareholder votes on the future pay policy for the board as a whole (keeping in mind that there are more executive directors on UK boards than in Australia), including details of how performance will be judged and real numbers on the potential pay-outs directors could receive. Companies will have to include a statement on how they have taken account of shareholder views and the result of previous votes.
  • A requirement, copying Australia’s termination payment laws, for binding shareholder approval for any directors’ notice period longer than a year and on exit payments of more than one year’s “basic salary” or the minimum contractual amount, whichever is the lower – which gives shareholders more say over payments for failure;
  • A vote on how the company has implemented the approved pay policy in the preceding year, including the amounts paid out. Some have said making this vote binding would not be workable; it would create a lawyers’ charter, as the right to payments already earned could be challenged in court. Nevertheless, further sanctions that could be applied if a significant number of shareholders dissent in the advisory vote are being considered.

The government will also be seeking views on the thresholds used to determine whether a vote has succeeded. For example, the future pay policy might require approval by 75% of the votes cast. Obviously, there is a vocal minority in the UK that believe that the 18 majority “no” advisory votes on UK executive remuneration cast over the past 8 years is not enough.

The UK government wants to make it easier for companies to withhold or recoup pay awards when performance has not lived up to expectations. Mr Cable will be asking the Financial Reporting Council to consult on amending the UK Corporate Governance Code to require all large public companies to adopt clawbacks. The US experience indicates that the legal issues in this regard are close to insurmountable.

Finally, shareholders will be “incentivized” to use the new powers that will be available to them through an updating of the Stewardship Code, first introduced in July 2010, which sets out how institutional investors should exercise their shareholding rights effectively, and requiring them to publish their voting policy on issues such as pay.

Opening up remuneration committees

Following the Australian lead, UK companies will be required to report on their boardroom diversity policy from October this year.

Remuneration consultants

In addition, in contrast to the highly prescriptive nature of Australian law telling directors how they should receive advice, the UK will require greater transparency through disclosure of the role of remuneration consultants, including how they are appointed, to whom they report and whom they advise, and their fees.

Another quango

Surprisingly for a government with a deficit problem, (or is it that surprising?), the government will be dipping into the public purse to establish the High Pay Centre. It will monitor the state of pay at the top. Mr Cable indicated that this spending of public monies will “make a valuable contribution to this important area and keep it high on everyone’s agenda”.

We watch with interest to see how much higher on the populist agenda it can go.

See Mr Cable’s speech introducing these reforms HERE

You can also see the follow up parliamentary debate HERE.  Please note the comment from the Rt Hon Mr Philip Davies, who, as a conservative in the coalition government, should be on Mr Cable’s side.

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