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Executive pay implications of the Government's consultation on restoring trust in audit and corporate governance

Posted on 25 March 2021

On 18 March 2021, the Government issued a consultation on wide-ranging proposals to strengthen the UK's audit and corporate governance framework for major companies.

The proposals include some new rules for executive pay, which we have summarised below.   

Background

The Government's proposals include an enforcement regime that will hold company directors to account for their duties in relation to corporate reporting and audits. A new regulator, called the Audit, Reporting and Governance Authority (ARGA), will be given powers to investigate and sanction breaches of corporate reporting and audit-related responsibilities by directors.

This new regime will apply to companies that are designated as public interest companies, or PIEs, which currently includes companies listed on a regulated market, credit institutions and insurance undertakings. The range of companies which qualify as PIEs will be extended under the Government's proposals to include large private companies and large companies listed on AIM.  

Executive pay implications

The Government is proposing to complement the new ARGA enforcement regime by strengthening the malus and clawback arrangements applying to directors' remuneration arrangements. They are proposing there that should be a consultation on changes to the UK Corporate Governance Code so that the Code recommends certain minimum malus and clawback conditions, or "triggers", applying to directors' remuneration arrangements. These new conditions would initially apply to PIEs but the Government may consider extending the conditions to all listed companies.

The Government's list of conditions which companies would be expected to include in their malus and clawback provisions are:

  • material misstatement of results or an error in performance calculations;
  • material failure of risk management and internal controls;
  • misconduct;
  • conduct leading to financial loss;
  • reputational damage; and
  • unreasonable failure to protect the interests of employees and customers.

The clawback provisions must apply for a minimum of two years after payment. The Government encourages companies to add to this list with conditions which reflect their own circumstances.

Many of these conditions are already included in the malus and clawback provisions of listed companies although very few companies will currently include all of these. As and when these new proposals are implemented (see below), it is likely that investors will expect companies that fall within the scope of PIEs to start including these conditions in directors' remuneration arrangements. It is also likely that these conditions will become more widely adopted amongst listed companies as they become the "new normal".   

Timing

The consultation on the Government's proposals closes on 8 July 2021 and there is currently no timetable as to when final proposals will be produced. There is also no timetable for the implementation of the final proposals, with the Government only saying that it will not add to the burden of companies dealing with the COVID-19 pandemic and that the reforms will be introduced over an "appropriate" timetable.  

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