January 31, 2012
The Business Secretary of the British government ("Government"), Vince Cable, announced a week ago a package of controversial plans in a bid to transform UK executive pay culture[1]. Under a new-four-pronged approach, shareholders would for the first time be given a binding vote on executive pay packages. Executive boards may also need to become more diverse — including at least two individuals that had not previously been on a board of directors, and people from a broader range of professional backgrounds.
The Government is to finalize the detail of these plans over the coming weeks. Mr. Cable was careful to admit that "no proposal on its own is a magic bullet". There is however real concern that in the quest for the perfect alignment between pay and performance, the seemingly scatter gun approach taken by the coalition government has failed to hit the mark. This alert provides an overview of the proposals, and looks at some of the questions and concerns that they have raised.
A four-step-plan
The Government’s announcement follows a number of discussion papers, which explored executive pay, company performance, and a consultation on improving company reporting[2]. Although the Government stopped short of implementing more radical changes[3], it has revealed its plans for a four–step package that would:
- Give a Binding Shareholder Vote on Pay: Shareholders would have binding votes in respect of future executive pay policy, including how performance would be judged, and the amount of remuneration paid. Executive payout packages would also be subject to a vote — any notice period longer than one year, and any exit payments of more than one years’ salary would be subject to prior shareholder approval. Although companies could be required to obtain 75% shareholder approval to pass any vote approving such packages, it is uncertain whether these new voting powers will be utilized effectively in practice. Shareholders have always had the "tools to say no", and express discontent with executive performance, by for example, voting against re-electing directors, and voting against a company’s annual report and accounts. This is seldom utilized in the UK[4]. There is a view that more often than not, shareholders are not inclined, nor available to crack down on pay, and most prefer to ‘vote with their feet’ if they are unhappy[5]. Other shareholders face real and legitimate concerns relating to engaging with companies in this way. For instance, some shareholders may not want to be deemed to be acting in concert with other shareholders by taking collective action in respect of board changing proposals[6]. Even so, it is not quite clear what the effect of a "no" vote would be — could there be repeated votes until there was shareholder agreement or would the executive director’s package default to the previous years’ approved pay?
- Require More Diverse Boards: The Government considers that a more diverse board would lead to a more diverse remuneration committee, who in turn could scrutinize executive pay more effectively. In a bid to change the status quo on executive pay, the Business Secretary has said that he would like to see boards made up of more public servants, academics and at least two individuals that have not been board members before. This will dovetail with the new requirement[7] in the UK Corporate Governance Code for companies to report on their board diversity policy from October 2012[8]. Whilst a range of professionals could diversify the breadth of board knowledge, current plans could be somewhat fanciful. The fact remains that companies need a strong unitary board, with appropriate skills and experience in order to effectively oversee risk and long term performance. This is indeed an express requirement of the UK Corporate Governance Code[9]. Government’s current proposals do not sit comfortably with such requirement.
- Require Greater Transparency: Secondary legislation is to be unveiled later this year that would require companies to present a single figure for each executive director’s pay, and to explain how rewards are linked to company performance. Companies would also need to produce a distribution statement, detailing how executive pay compares to other expenditure such as business investment, taxation and staffing costs[10]. This information is to be found in a new look remuneration report, made up of two sections: one dealing with future policy for executive pay, and the other setting out the performance criteria used to determine executive packages, particularly bonuses. The Government also noted that it expects to see greater openness on exit payments, including the contractual terms offered to executives. The Government’s intention here is to curb the consensus that remuneration reports are too dense, with ‘too much data and too little information’. However, there is a risk that new plans could contradict this intention in practice. If requirements are too prescriptive, there is a risk that remuneration reports would simply become a mechanical document, losing the opportunity to provide shareholders with a real quality insight into remuneration arrangements. Furthermore, requiring companies to compute pay into a single figure would only compound this problem. Executive director packages are often made up of contingent remuneration, which could prove difficult to value reliably and objectively[11].
- Require Increased Employee Engagement: Whilst the City has breathed a sigh of relief that Mr. Cable has moved away from one of the earlier ideas of requiring employee representatives to sit on Remuneration Committees, there are still a number of concerns expressed on the new proposals. Companies will be required to disclose in their remuneration report how they have consulted with employees and taken account of employee pay when they set board pay. It is not clear how companies would be required to gauge employee consensus on such arrangements. What is clear however is that such requirement could be a costly process[12]. This is particularly for FTSE 100 companies who may have thousands of employees across various jurisdictions with varied forms of employee representatives. The value of the input from this broad contingent is questionable — but many recognize that the package of proposals includes measures to appease those whose bloods are boiling at the very mention of executive pay.[13]
It remains to be seen how the Government’s four–prong package will be developed over the next couple of weeks. In the interim, the Business Secretary has confirmed that he will be asking the Financial Reporting Council to consult on amending the UK Corporate Governance Code to require all large public companies to adopt claw-back policies for executive remuneration[14]. He has also confirmed that the High Pay Commission will be tasked with providing permanent on-going research and recommendations in relation to executive pay. Given the drastic nature of some of the High Pay Commission’s previous recommendations[15], it may prove difficult for the Government to find a magic bullet to current remuneration culture, whilst keeping in step with the need for companies to recruit and retain the best executives up for the job of providing effective risk management and strong leadership, inevitably creating shareholder value.
A link to the Government’s announcement can be found below:
http://www.bis.gov.uk/news/topstories/2012/Jan/government-action-on-executive-pay
[1] Amongst the many statistics coined, Government has said that the median total remuneration for FTSE 100 CEOs rose from an average of £1m to £4.2m for the period 2008-2010.
[2] Such as the High Pay Commission’s Final Report: ‘Cheques with Balances: Why Tackling High Pay is in the National Interest’, the ‘BIS Executive Remuneration Discussion Paper’, and the ‘BIS Future of Narrative Reporting: Consulting on a New Reporting Framework’.
[3] In particular, amongst other things, the High Pay Commission recommended that there should be employee representation on remuneration committees, whilst the BIS Executive Remuneration Paper considered whether shareholders should be on remuneration committees, as well as having binding votes on the previous years’ remuneration policy and packages.
[4] The Financial Reporting Council’s report ‘Developments in Corporate Governance 2011’ noted that despite the coming into force of the Stewardship Code, investor shareholder engagement is still low. Further, an analysis of the Remuneration Reports of the FTSE 350 companies for the period October 2010 to September 2011, reveal that just under 6% of shareholders voted against remuneration levels.
[5] Financial Times, 24 January 2012.
[6] If shareholders are deemed to be acting in concert, this could have adverse consequences under the UK Code on Takeovers and Mergers — in particular where the aggregate voting rights of the shareholders concerned exceed 30% (see Rule 9 of the UK Code on Takeovers and Mergers and the rules on mandatory bids).
[8] Amongst other things, the Government is also to consider mechanisms to limit conflicts of interest arising as a result of remuneration committee members sitting on boards of other companies. It has not provided much insight into how it plans to do this. The recently announced proposals are in addition to the specific gender diversity initiatives in UK boardrooms which gained traction in 2011. In particular, various changes were introduced to the UK Corporate Governance Code following the Davies Report (http://www.bis.gov.uk/assets/biscore/business-law/docs/w/11-745-women-on-boards.pdf) and Lord Davies’ call to FTSE 100 companies to aim for 25% female representation by 2015 and for one third of all new appointees to FTSE 100 and FTSE 250 companies to be women.
[9] Principal B.1 of the UK Corporate Governance Code requires board members to have appropriate skills and experience to enable them to discharge their respective duties and responsibilities.
[10] The plans are also to require greater transparency regarding the process for the appointment of remuneration consultants, how they are appointed, whom they report to, and whom they advise.
[11] Financial Times, 24 January 2012.
[12] It was argued in response to the BIS Executive Remuneration Paper, that in addition to the cost of putting in place voting/election procedures, there would also be costs involved in effectively training and providing awareness to employees on business issues/strategy so that employees could make an informed decision.
[13] UK Prime Minister David Cameron pledged this month to tackle the high levels of pay which made "peoples blood boil".
[14] Currently, the Remuneration Code only requires financial institutions to have claw-backs in relation to executive remuneration — it is questionable whether this type of mechanism is only suited to more ‘high’ risk businesses.
Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have about these developments. Please contact the Gibson Dunn lawyer with whom you work, or any of the following lawyers in the firm’s London office:
Selina S. Sagayam (+44 20 7071 4263, [email protected])
James A. Cox (+44 20 7071 4250, [email protected])
Leila Greer-Stapleton (+44 20 7071 4255, [email protected])
© 2012 Gibson, Dunn & Crutcher LLP
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