One of the central themes of the corporate governance reform is that of proportionate remuneration supporting long term success of the company. Building on previous articles which set out the key features of the wider, redefined corporate governance framework, this article specifically explores the area of remuneration, the expanding role of the remuneration committee and pay reporting requirements.
The UK Corporate Governance Code:
Section 5 of the updated UK Corporate Governance Code (the Code) sets out remuneration principles and provisions which work to emphasise the importance of fair pay; covering both the structure of the remuneration committee and the remuneration schemes themselves. The key updates to this section of the Code can be summarised as follows:
- the chair of the remuneration committee should have previously served on a remuneration committee for at least 12 months;
- the remuneration committee will have a wider remit to review workforce pay and the alignment of incentives and rewards with the culture of the business. Going forward, committees should be mindful of the relationship between pay, strategy, values and culture when setting executive pay;
- recommended minimum vesting periods will be increased from three to five years to encourage longer term goals;
- remuneration policies and schemes will need to provide the flexibility for boards to override formulaic remuneration outcomes, building in discretion when it comes to calculating final quantum; and
- pension contribution rates for executive directors (or payments in lieu of such contributions) should be aligned with those available to the rest of the workforce.
The general theme is that the changes broaden the remit of the remuneration committee and expand its role. With the introduction of the 2018 Code there will be increased emphasis on the need for independent judgment within the remuneration committee and the need for committees to take ownership of the decisions they are making.
The comply and explain approach has been retained by the 2018 Code. This means that if it becomes apparent that compliance with an element of the Code is not appropriate for a particular business then there is scope to explain as to why that business has deviated from that principle or provision. For example, it may be that someone is well placed to be chair of the remuneration committee due to their intimate knowledge of that business or perhaps the field in which the company operates, however, they may not have the requisite 12 months' experience on a committee. The board and/or committee will need to consider how to manage such circumstances, carefully weighing the advantages and disadvantages of the candidates and be able to demonstrate that they have done so by signposting and cross-referencing to the relevant sections in the company's annual report.
In addition to the above, there is also a link to increased employee engagement and investor engagement. Remuneration committees should be mindful of promoting effective shareholder engagement through the company's remuneration arrangements.
Additionally, it is likely that this widening of the remuneration committee's remit will involve more in the way of time commitments. For example, should committee chairs be making statements at annual general meetings going forward? It is also likely that there will be an increased expectation that remuneration committees and their chairs will engage and act where there are significant votes against remuneration decisions.
Why have these changes been introduced?
The reform of the corporate governance framework stems from various high profile examples of poor governance decisions that have contributed to the downfall of large businesses, both public and private. Examples include BHS and Carillion, both of which have been subject to extensive criticism for the role that their lacking corporate governance regimes played in their demise.
There have been calls for more transparency and accountability and the changes to the role of the remuneration committee and pay reporting requirements seek to address this.
Listed UK companies will be subject to a greater reporting burden and must include enhanced disclosures in their annual report. Amongst other things, the report should include:
- a description of what engagement has taken place with the workforce and key stakeholders to demonstrate how executive remuneration aligns with the wider company pay policy;
- a description as to how the remuneration committee has addressed the different factors that the Code requires it to consider (clarity, simplicity, risk, predictability, proportionality and alignment to culture) when determining executive remuneration policy and practices and examples of how these factors have been taken into account;
- information as to the chief executive pay ratio in the directors' remuneration report for financial years commencing on or after 1 January 2019; and
- an explanation as to what discretions have been applied to remuneration arrangements and the reasons why.
What should you be doing to prepare?
These changes will apply to accounting periods beginning on or after 1 January 2019. In order to prepare, you should start consulting internally and considering existing remuneration policies and the constitution of your remuneration committee. Do your policies meet the standard required? If not are you able to explain why?
Additionally, it may be prudent to consider whether any upskilling of your remuneration committee members is required. They should also be consulted and prepared for the increased time commitment that is likely to ensue from the implementation of the broader requirements. This is also likely to impact upon meeting timetabling due to the increased material for consideration by the committee.
As well as training for your committee members, it may also be worth considering whether any other teams within the business need to be educated in light of these changes. Particularly executives who should be prepared for the remuneration committee's increased role in relation to senior management pay decisions and HR/reward teams who will need to understand the new corporate governance processes and work closely with the remuneration committee.
These are all factors that you can and should be considering to ensure that your business is ready for the changes coming in January2019.