On 22 November 2012, the UK government presented its detailed response to the recommendations made by Professor John Kay in his final (July 2012) report on his review into the problems of short-termism in UK equity markets (see our newsletter article on the Kay report HERE).
Professor Kay’s analysis focused primarily on the nature of the relationships that arise between market participants, and the incentives they face. He characterized the underlying causes of these problems as the decline of trust and the presence of misaligned incentives in these relationships, without attaching blame to particular groups in the investment chain.
Accordingly, Professor Kay’s proposed solutions to these problems focus on building relationships of trust and confidence in the investment chain, and creating incentives to act in ways that support good long-term decision making by companies. Professor Kay’s report sets out a number of principles and directions that he suggests should provide the foundation for future developments in public and regulatory policy and market practice in the investment chain.
The UK government has accepted Professor Kay’s analysis, and endorsed his 10 principles for equity markets to which market practitioners, government and regulatory authorities should have regard. The government supports Professor Kay’s approach that the necessary changes in culture cannot simply be achieved through regulation, but will require the development of good practice in the investment chain. This support results from the government’s recognition that historically equity markets have existed to meet the needs of two differing groups of customers: investors and companies. It is therefore not just for government to respond to the challenges which emerge from this report, but also for companies and institutional investors.
Specifically in relation to executive remuneration, Professor Kay’s 15th recommendation was that –
“Companies should structure directors’ remuneration to relate incentives to sustainable long-term business performance. Long-term performance incentives should be provided only in the form of company shares to be held at least until after the executive has retired
from the business.”
Not surprisingly, the UK government’s response to this recommendation was that companies should, to the extent that they vary remuneration according to performance, ensure that they reward the creation of sustainable long-term value in the business and activities that contribute to this goal. However, while the government believes companies should actively consider the idea that LTI should be in the form of shares to be held beyond the individual’s departure date from the company, the UK government agrees that the structure of remuneration should be determined by individual companies in consultation with their shareholders and that agreeing and sharing good practice is the appropriate way to promote change in this area.
The UK government does not believe there is a case for blanket regulation of the structure of company directors’ remuneration and believes that companies and their shareholders need flexibility to negotiate outcomes that work for them. The government’s approach is that its reforms to the governance framework for directors’ remuneration (i.e. introducing a binding vote on pay policy and increasing transparency through improvements to remuneration reports) will help to support change in this area, by empowering shareholders to engage effectively with companies.
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