Recently the UK Government published a consultation paper on its proposals to give shareholders of quoted companies a greater influence over executive pay. Among the proposals are a binding shareholder vote on executive pay policy (possibly requiring a 65% or 75% super majority), a non-binding shareholder vote on the subsequent application of that pay policy and a binding shareholder vote on exit payments in excess of one year’s basic salary. These would replace the current requirement for a non-binding vote on the director’s remuneration report. I recently received this memo from our friends at Gibson Dunn discussing the proposals and what companies should be doing to prepare. Here is an excerpt:
The Government’s proposals are summarized below:
- Binding Shareholder Vote on Executive Pay Policy. Shareholders would be required to approve the company’s remuneration policy for the following financial year. This would include the composition and potential pay for each director and, in the case of bonuses and incentives, what the performance criteria will be, how performance will be assessed and the payout for “on-target” and “stretch” performance.Companies have traditionally been concerned that disclosure of prospective targets could compromise their commercial interests. A footnote to the consultation paper acknowledges this concern and indicates that the Government “will work with companies and shareholders to balance this against the need for greater transparency”.
If shareholders vote against the remuneration policy, then the Company will either have to hold another vote within 90 days or will have to “fall back on the last policy to be approved by shareholders”. If a company is to continue to use its existing pay policy, it is not clear how much discretion a remuneration committee would have within the context of that policy (the previous year’s targets are likely to be outdated and so to be meaningful are likely to have to be altered each year), but the Government acknowledges a risk that a company who has lost a “binding vote” might continue with an old pay policy which is equally unacceptable to shareholders. In such a case the Government envisages that shareholders would have to resort to their right not to reelect directors.
The Government expects that most employment agreements will not require amendment as they do not typically contain express guarantees regarding pay rises, bonuses or long term incentives. Payments made under any contracts which violate these principles could be clawed back, and the directors who authorized them will be personally liable to account for the amounts paid.
- Super Majority. Whilst shareholders have become increasingly active in recent years, the Government is conscious that many shareholders do not vote and many choose to abstain. In addition, the shareholder base of UK quoted companies has become increasingly diverse, which is significant because it is felt that UK based institutional investors tend to be the most engaged on these issues. UK based institutional investors now hold just 25% of shares (down from 50% in 1990) in UK quoted companies. For this reason the Government is also consulting on increasing the threshold for passing shareholder resolutions to be more than the simple 50% majority required for the existing advisory vote.Currently only certain “special” resolutions require a 75% majority although the Government acknowledges that this threshold may be too high. The consultation paper notes that during 2011 no FTSE 100 company failed to secure 50% shareholder support on the advisory vote for its directors’ remuneration report, but two would have failed to do so if the threshold was 65% and five would have failed to do so if the threshold was 75%. If this aspect of the proposal goes ahead, then a threshold of between 65% and 75% appears most likely.
- Non-Binding Shareholder Vote on Application of Executive Pay Policy. The Government also proposes that shareholders should be given the right to vote on the way that the (previously approved) pay policy has been implemented. As this will not be binding, executives will not be subject to claw back arrangements but companies will face the embarrassment of having to issue a circular to shareholders to explain the issues that shareholders have raised and how the company intends to address these issues.Remuneration Committees will have to keep this in mind when they consider whether performance targets are met and exercise any discretions reserved to them under bonus or incentive arrangements.
- Binding Shareholder Vote on Exit Payments. Whilst all UK companies are subject to an obligation to obtain shareholder approval for all “payments for loss of office” (i.e. including severance payments) made to directors, there are exceptions for payments which are made in discharge of an existing legal obligation.The Government is concerned that Remuneration Committees have too much flexibility to negotiate exit payments derived from existing legal obligations and that there is no legal mechanism by which shareholders can properly influence the contractual terms at the time they are entered into.
The Government proposes that quoted companies should be required to obtain shareholder approval where the total value of exit payments (including contractual entitlements and incentives) exceed one year’s basic salary. Advance approval will not be permitted and, assuming companies do not wish to hold an extraordinary general meeting solely for this purpose, directors may have to wait for the next annual general meeting before such payments can be approved.
Any employment agreements which provide for more generous payments will be void to the extent they provide more generous payments which are not approved and so the new rules would affect existing employment agreements and not just those entered into in the future. The Government has indicated that this proposal will not be implemented until October 1, 2013 and acknowledges that, in the meantime, some companies may look to buy directors out of their existing contractual rights.
The proposal would not affect accrued pension rights nor the relatively small number of directors who have contractual rights to enhanced pensions in the event of the early termination of their employment.
The consultation envisages that statutory claims (e.g. for unfair dismissal and discrimination) will be unaffected by these rules.
It is questionable whether shareholders will have much appetite to exercise any new powers to regulate directors’ pay, and some shareholders may be concerned that a “no vote” may have a negative effect on share price. The Government clearly envisage that a “no vote” will be exceptional and that in practice the possibility of a “no vote” will rather be a powerful moderating influence which will encourage companies to engage with institutional shareholders.
What Should Quoted Companies Do Now?
Whilst the proposals remain subject to consultation, quoted companies should review their existing employment agreements, long term incentives plans and other arrangements with their directors to see they are sufficiently flexible to allow companies to comply with the new rules if and when they become law. Whilst changes to existing arrangements are not immediately required as a result of these proposals, pending the outcome of consultation, it would be prudent to take the proposals into consideration when entering into new arrangements.
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