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Executive pay and corporate governance back in the spotlight

Posted on 01 December 2016

Executive pay and corporate governance back in the spotlight

Following much debate on curbing excessive executive pay and putting workers on company boards, earlier this week the Government launched the eagerly awaited consultation paper on corporate governance reform. The paper, which is part of wider work on enhancing public trust in business, looks at three key areas:

  • Ways to strengthen shareholder influence and engagement on executive pay.
  • Extending the corporate governance rules that currently apply to listed companies to include the largest privately-held companies as well.
  • Strengthening the voice of stakeholders such as employees and consumers.

Executive pay

In relation to the first area, which focuses on the executive pay framework in quoted companies, proposals put forward in the paper include making executive pay packages subject to a binding vote. This would be either (i) generally on an annual basis, (ii) only where there has been shareholder opposition or (iii) in relation to exceeding a pre-set threshold on total pay.  It also includes discussion on better shareholder engagement by encouraging greater use of current voting rights and through "shareholder committees".

The paper also poses the question of whether the often complex long-term incentive plans (LTIPs) awarded to executives can be simplified and better aligned with the long-term interests of companies and shareholders. Ideas put forward include increasing the holding period, before the end of which incentives will not vest or be paid out, from the current three year minimum to five years, or replacing LTIPs with share options that are linked only to increases in the share price over a longer period. The latter would no doubt be simpler, dispensing with intricate performance criteria and thought to motivate executives by the longer term increase in share value rather than short-term gain. It also reflects the updated Investment Association Principles of Remuneration, which for the first time includes the possibility of including non-performance related restricted share awards (click here for our previous article on this topic). However, there would be less scope for designing more tailored performance targets and, arguably, even where there is a fall in share price over the longer term this alternative could still provide some form of guaranteed return, potentially providing executives with rewards for failure.  

Furthermore, the paper calls for greater transparency on executive pay, and in particular puts forward a proposal, much reported on in the press, that companies should publish the ratio between CEO pay and the pay of the median employee. This follows concern that, while workers' pay has stagnated over a significant number of years, executive pay has continued to soar - it is now estimated that the average executive earns 130 times more than the average worker (up from 40 times 20 years ago). Whether an obligation to publish the ratio will help reduce the gap is another matter. While in the short term companies are unlikely to slash executive pay, or award big increases to their workers, over the longer term forcing boards to justify the ratio, particularly against the performance of the business and the rewards to the workforce as a whole, may help shareholders take a more informed view as to what level of remuneration may be appropriate. Provided there is a like for like comparison (for example within the same sector), the publication of the pay gap will also enable shareholders, employees and the wider public to judge how executive pay compares across different companies. As with the gender pay gap reporting, it is perhaps the reputational risk that could provide the biggest motivator for change.

Corporate governance in private companies

Another area of focus for the consultation is a proposal to extend the higher standards of corporate governance, that currently apply only to listed companies, to large private companies. There is a strong argument that for the largest privately held companies, many which operate on the same scale as public companies, good corporate governance is essential to rebuild trust and to provide reassurance to the wider stakeholders that the business is not opting out of the higher level of scrutiny to which listed companies are subject. The options outlined by the government include either extending the existing UK Corporate Governance Code to these companies or implement a new code that is specifically tailored but that will no doubt borrow a number of principles from the existing Code. A question that has been left open is which businesses should be in scope. The paper mentions the "largest" privately-held businesses but is inviting responses on where any size threshold should be set.

Workers on boards?

The biggest headline grabbing aspect of the consultation is the controversial issue of placing workers on boards (read our previous article on this topic here). Many have accused the Prime Minister of backtracking on her pledge, expressed both in her campaign speech and at the Conservative party conference, to put workers and other stakeholders on the boards of large companies. The option of directly appointed employee representatives on boards does appear in the consultation as one of several alternatives for employees' voices to be heard in the decision making process. However, the Government is at pains to point out that, while this model may work for some, there will be no requirement for companies to appoint representatives of employees (or any other interested party) on boards.

Having said that, the consultation paper does put forward other options for strengthening the voices of employees and other stakeholders. One of the proposals is the creation of advisory panels so that boards can hear directly from employees (and others) on particular issues. Directors could seek views from the panel or invite the panel to board meetings to offer views on relevant agenda items, including on remuneration policies. Alternatively, companies could be required to designate a non-executive director with responsibility for ensuring that the voices of employees in particular are heard at board level.

There is growing support for greater involvement of employees in the decision making process of businesses. Not only would this allow for more diverse voices with different backgrounds to be heard at the highest level (enabling more balanced decisions and, it is hoped, providing a break on excessive executive pay) but could also encourage better engagement by the workforce which in turn can lead to improved productivity. While each of the proposals will involve the ironing out of a number of issues, including the question of which companies will be subject to the proposed changes, perhaps the most effective option would be a combination of an advisory panel and a designated NED as highlighted in the paper. This would enable the NED to use the advisory panel to gain an understanding of the issues that concern employees (and others) and place some onus and accountability on at least one board member to ensure their views are represented at board level.

By introducing stronger reporting requirements in relation to the engagement of employees and stakeholders (another proposal in the paper), companies could also be forced to provide visibility on the steps taken and the mechanism by which those voices are heard. Again, protecting reputation may well provide an incentive for change.

The consultation closes on 17 February 2017. We will respond to the consultation and are keen to hear your views to make sure they are reflected in our response. If you would like to contribute please get in touch with Stephen or Åsa or with your usual Mishcon contact.

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