The proposal, which the Government said will help reduce companies' "excessive focus on short-term earnings", forms part of its response (35-page / 160KB PDF) to Professor John Kay's independent Review of UK Equity Markets.
On executive pay, Kay's recommendation was for a proposed new system of long-term performance incentives for company directors, to be held as shares in the company at least until that director has retired. The Government has said this approach is something which companies should actively consider. However, it has stopped short of proposing "blanket regulation" on the structure of directors' pay, instead calling on companies and their shareholders to use forthcoming reforms to the governance framework on executive pay to "negotiate outcomes that work for them".
"[Kay's] insightful review calls for a shift in the culture of investment and sets a clear challenge to companies and those who invest in them," Business Secretary Vince Cable said. "His agenda is an ambitious one but I am very encouraged by the level of engagement we have seen already from investors. Not only on Kay's ideas, but through our directors' pay and shareholder voting reforms; in addressing diversity on corporate boards and through changes to the way companies report their business strategy and results."
Taken as a whole, the Government's programme of reform would help "restore trust in markets and in the system of capitalism on which our future prosperity depends", he said.
The Kay Review, which was published in July, was commissioned by the Department of Business, Innovation and Skills (BIS) to encourage long-term corporate decision-making, and restore public confidence in stock markets. The report set out 17 recommendations in the form of 'statements of good practice', which Kay said should be adopted into "clear and specific guidance" rather than "detailed regulation".
Companies are currently required to produce quarterly financial reports under the EU Transparency Directive, which is implemented in the UK by the Financial Services Authority. However, the European Commission has recently brought forward proposals to amend the Directive by moving away from mandatory reporting requirements when a company's shares are traded on a regulated market. The UK Government strongly supports this proposal, and will continue to negotiate with the Commission and other EU member states, according to its response.
The Government has also endorsed Kay's 10 'principles for equity markets', included in his report. These promote trading relationships based on "trust and respect", greater involvement by asset managers with the companies in which they invest, the use of metrics and models that provide directly relevant information on risk-adjusted long-term returns and market incentives structured so as to promote long-term rather than short-term value.
The Government said that it had asked the Law Commission, which makes recommendations for changes to the law, to review the current legal obligations on financial intermediaries. The FSA has also been asked to investigate whether the current regulatory framework promotes high standards of behaviour throughout the investment chain.
A progress report will be published by the Government in summer 2014, setting out whether Kay's recommendations have been achieved and whether companies and investors have engaged with the programme, it said.
Changes to the structure of companies' remuneration reports, requiring them to set out actual payments made to directors over the course of the year as a single figure, are anticipated to take effect from October next year. The new reports will also include information on how well the company performed that year and what impact, if any, its performance had on pay. Changes in the law which will introduce a binding shareholder vote on companies' executive remuneration policies are due to take effect at the same time.
"The reforms will empower shareholders to engage effectively with companies, both by introducing a binding vote on pay policy and by increasing transparency through improvements to remuneration reports," the Government said in its response document. "This means that what people are paid can be easily understood and the link between pay and performance is clearly drawn, and through binding votes shareholders will be better able to influence and promote change in pay structures."
Incentives expert Judith Greaves of Pinsent Masons, the law firm behind Out-Law.com, said that it was "helpful" that the Government had recognised the need for corporate flexibility when designing incentive arrangements.
"Some companies might be concerned that, if an individual were required to hold all his [incentive] shares beyond leaving but had a need for cash at a particular point in time, Kay's proposed holding requirement might encourage the individual to leave at an earlier point than he otherwise would have done in order that he could realise the cash on release of his shares," she said.