Executive pay proposals could be misunderstood by shareholders says expert

Share plans and incentives expert Matthew Findley of Pinsent Masons, the law firm behind Out-Law.com, said that the supplied figure may be "misunderstood" by shareholders and "cause conflict rather than aid transparency", particularly with regards to more complex arrangements. He was speaking at the end of a Government consultation period on the changes.

"Directors' remuneration packages are designed to pay out for performance over the longer term," he explained. "That inevitably means that in a bad financial year a director may be getting rewarded for the value they had added over previous years. However, there is a risk that stakeholders will focus on one single figure and ignore the components of the pay package - which tell a truer story and should more clearly highlight the link between pay and performance."

The proposed changes will require companies to enter into "significant dialogue" with shareholders to avoid misunderstandings, he added. Further changes, to be introduced as part of the Enterprise and Regulatory Reform Bill, will require shareholders to conduct binding votes on executive pay policy – including exit payments made to dismissed directors – at least once every three years.

The draft regulations (54-page / 472KB PDF), published for consultation in June, are intended to "streamline" the information companies must disclose and clarify the link between pay and performance. Under the new regime businesses will have to publish the criteria that guide their pay policies, including factors taken into account when deciding on those rules, and then explain how those policies have been followed on an annual basis.

Details of actual payments made by the company to directors over the course of the year - including bonuses, long-term incentives and pension provision – will be set out as a single figure. The report will also include information on how well the company performed that year and what impact, if any, its performance had on pay. It will also specifically compare the chief executive's pay to company performance, and provide details on how shareholders voted on pay the previous year and any action the company took in response.

The changes are anticipated to come into effect from October 2013, alongside the changes in the law which will introduce a binding shareholder vote on the pay policy report.

Findley said that although the Government had outlined the framework within which a company should formulate its policy, it would be the job of companies and their shareholders to "flesh out the detail". This could, he explained, lead to "tension" between companies' desire to implement a more flexible policy to reflect the commercial needs of the business and the shareholders' need for clarity on how directors would be paid.

"The binding nature of the shareholder vote on pay policy means that voting the policy down is the nuclear option," he said. "Shareholders may be cautious about using it for this reason and because they do not want to micro-manage companies - they will nevertheless want the businesses they invest in to know that they carry a big stick. UK businesses already have a good record on transparency, but now the additional reporting requirements mean that they face a big challenge to adapt their reporting systems for the new regime."

The proposals would also, he added, make businesses "think twice" about exit payments to departing directors, particularly as those payments would have to be in line with the shareholder-approved remuneration policy.

"The challenge for businesses is to propose a policy that is broad and flexible enough to deal with all types of exit situation," he explained. "The new rules could make it difficult for businesses to construct suitable exit payments. Businesses already have to report how much they've spent on exit payments, but the proposals mean they will have to reveal much more information about the actual calculation and structure of such payments. Businesses may also have their discretionary powers severely constrained too."