Australia’s recent changes to legislation affecting executive remuneration are setting a benchmark as the UK government launches its own review into executive remuneration. This article examines how the UK government review is looking for the link between pay and performance.
The review, being conducted by Vince Cable, Secretary of State for Business has outlined concerns that the link between executive reward levels and corporate performance is not strong enough and that it should be strengthened to ensure that the strategic purpose of reward is evident, that the structure of remuneration is well designed and that the long term success of companies is the goal for executives as well as shareholders.
The review is considering a number of key issues:
The link between pay and performance –
Over the last decade, executive pay in the largest listed companies has increased substantially, with the median total remuneration of FTSE100 CEOs having risen from an average of £1m to £4.2m for the period 1998-2010. Growing company size, international competition for talent, benchmarking practices and the changing structure of pay are just some of the reasons cited for this trend.
The Government accepts that executive remuneration that is well structured, clearly linked to the strategic objectives of a company, and which rewards executives that contribute to the long-term success of that company, is an important way of promoting business stability and growth. It questions thought the link between pay and performance with CEO pay growing faster than the FTSE 100 index, retail prices or general wage movements…
In its drive for a stronger link between pay and performance, the government has suggested a variety of measures with the aim of gathering further evidence and stimulating debate.
The reporting of executive remuneration in company reports –
The government is also considering the issue of how executive remuneration is reported, looking for ways to improve the clarity of disclosed remuneration and processes for scrutinising remuneration.
The role of shareholders and the remuneration committee in setting executive pay –
In line with recent changes undertaken in Australia, the review is looking at the role of shareholders and remuneration committees in the process of setting pay, and how pay is structured to incentivise and reward. There has been considerable work already done in this area and a number of proposals have been put forward for comment. Almost ten years on from the introduction of an advisory shareholder vote on remuneration reports, the review asks whether the vote is effective and if a binding vote on pay or votes on exit payments would give shareholders a stronger voice. The review also considers the broader issue of shareholder engagement and whether shareholders could be more directly involved in appointing non-executive directors.
The role and membership of the remuneration committee –
The remuneration committee is certainly under scrutiny in this review. Opinion is being sought on whether independent members or employee representatives on remuneration committees would provide a helpful, fresh perspective and encourage greater challenge; as well as the potential risks and practical implications of such measures. The interaction between remuneration committees, companies and remuneration consultants is also being considered; asking whether more needs to be done to prevent potential conflicts of interest in this relationship.
The report has a useful summary of how pay is regulated in other countries:
“For more than two decades, most other countries have seen similar trends in executive pay to those observed in the UK, in terms of both quantum and structure, with the balance shifting from base salary in favour of more complicated variable and deferred pay. As a consequence, these countries have also pursued new measures to improve transparency and ensure the process of setting remuneration is robust.
While the UK has been widely regarded as one of the countries with the highest level of scrutiny surrounding executive pay, and the basic foundations of the UK Corporate Governance Code have been widely replicated across Europe, there are recent examples of other countries – particularly those with large financial and banking sectors – introducing measures that go further than current UK requirements.
In the United States, where executive pay is considerably higher than the UK, although the gap is narrowing the Dodd-Frank Wall Street Reform and Consumer Protection Act 2010 (The Act) introduced new disclosure requirements and, for the first time, shareholders ‘say on pay’. The Act, which is being implemented by the Securities and Exchange Commission (SEC), also requires disclosure of a single figure for executives’ annual total compensation, publication of the ratio of CEO pay to median employee earnings, the introduction of claw-back policies and new measures to prevent the conflict of interest that can potentially arise in the process of setting remuneration.
The Australian government has also addressed conflict of interest issues, particularly concerning the use of remuneration consultants to advise remuneration committees on pay. Reforms which took effect in July 2011 require boards to disclose their use of consultants and impose restrictions on the ability of executive directors to engage remuneration consultants. The reforms also require listed companies’ remuneration reports to contain a statement that the board is satisfied that remuneration recommendations have been made free from any undue influence by the relevant director. Australia has also taken measures to prevent rewards for failure, including a new shareholder vote on termination payments of more than one year’s base salary.
There is variation in the practices adopted across Europe, with the UK having the most developed requirements. In October 2004, the EU Commission recommended that publicly traded companies in Europe disclose their policies on executive remuneration, as well as the level and form of each individual executive’s pay. The recommendations are not legally binding, and there exists a range of mandatory disclosure regimes in Europe; although the EU Commission has recently consulted on whether there should be a unified system.
Elsewhere, policies on executive remuneration vary from country to country and are to some extent informed by wider national or cultural practices. For example in Japan, companies traditionally pay their employees based on their seniority not performance and the disparity between senior executives and the rest of the workforce is less pronounced. However, as pay has risen despite the fall in shareholder wealth, new rules introduced in March 2010 require firms to disclose details of an executive’s remuneration, including bonuses and stock options, when the total exceeds 100 million yen (around $1 million).”
The issue of executive remuneration remains topical around the world and Egan Associates will keep you informed of the findings from this review.