Keeping pay to those in control under control

Posted on 4 Jan 2012

An overview of the Government’s discussion paper on executive pay

It has become easy, indeed second nature, in the aftermath of the recent financial crisis, to question huge payouts to executive directors. But it is only really those pay increases which do not correlate with company performance that legitimately warrant our criticism and call for reform.

The harder question is what should be done to resolve remuneration problems?

The Government recently published a discussion paper on executive remuneration in conjunction with its consultation on narrative reporting. The response period for this has now closed, with implementation being proposed from 1 October 2012.

So what are the main proposals made in the discussion paper in relation to executive pay and what are their likely implications?

Improving Transparency:

Directors’ remuneration reports are often lengthy and complex making it difficult for shareholders to effectively scrutinise and challenge executive pay.  The Government have therefore proposed that information be presented in a more direct and useful manner including displaying a single figure summarising the total remuneration for each director (and how this is calculated) thus improving disclosure of the relationship between executive pay and performance.  While this may seem like a very simplistic step, any increased transparency should help raise awareness, and therefore challenge, of the bottom line figures.

The Role of Shareholders

The Government recognises that shareholders play a central role in tackling the issues around executive remuneration and have therefore made proposals seeking to increase their involvement with this issue. These include making the advisory vote that shareholders have on the directors’ remuneration report binding and giving them rights to vote on all termination payouts, not just those that exceed the director’s contractual entitlement. Again the accountability is to be praised, but there is a real risk that such provisions would unduly fetter the ability of the directors to effectively run the business.

The Remuneration Committee

There is a suggestion that making the remuneration committee more diverse will help in setting a realistic, and more grounded, figure for executive pay. Their proposals include having independent members on the committee who will bring with them a fresh set of views outside of the usual corporate sphere, and presumably the ability to challenge any internal views.

The Structure of Remuneration

Establishing some general principles on the structure of remuneration to help encourage long-term interest in the company and demonstrate a clearer link between pay and performance have also been highlighted as areas where improvement can be made.

These proposals include using more tailored performance measures, deferring a larger proportion of pay over more than three years or paying a substantial proportion of remuneration in shares to be held for several years before realisation and making provision to allow the company to ‘claw back’ remuneration in exceptional cases involving misstatement or misconduct.  Schemes such as this have already been implemented in many sectors where high pay is prevalent, such as investment management businesses, but it is too soon to judge the longer term effects of their success.

Promoting good practice

The Government have invited views on how to research and promote good practice in executive remuneration and have suggested establishing an independent body to take responsibility for improving the quality of information on, and practice in respect of, executive pay.

In conclusion, while the practical and legal implications involved in implementing the proposals may make some of them too onerous to take forward, they are, at the very least a recognition that reform is needed and provide a basis from which to discuss and debate the issues before any firm proposals are pursued. A move towards any increased transparency or external scrutiny is generally to be welcomed, but not at the expense of the operation of the business involved.

Contact: Esther Smith, partner, Thomas Eggar LLP on [email protected]  or 023 8083 1203