Shareholders to conduct binding votes on executive pay policy at least once every three years, Government announces

Executive remuneration policies will need to be approved by a majority of shareholders at least once every three years, with the option of an annual vote if changes are proposed. Companies will not be able to make payments to directors outside of the scope of the policy once it has been approved.

What the Government called the "most comprehensive reforms of the framework for directors' remuneration in a decade" would address "failures in corporate governance" and "maintain recent activism" by shareholders, dubbed the 'shareholders' spring', it said.

"At a time when the global economy remains fragile, it is neither sustainable nor justifiable to see directors' pay rising at 10 per cent a year, while the performance of listed companies lags behind and many employees are having their pay cut or frozen," said Business Secretary Vince Cable. "I have been greatly encouraged by the 'shareholder spring' and I want to see that momentum sustained."

The changes, which will be introduced as amendments to the Enterprise and Regulatory Reform Bill currently before Parliament, should be in force by October next year, he said.

The reforms are substantially different to those proposed by the Government during its consultation in March, which suggested that up to 75% of shareholders would have to vote in favour of the plans before they could be approved. In addition, a proposal that exit payments amounting to more than a director's annual salary would need to be approved by a binding shareholder vote has been dropped.

An approved policy, which will apply to existing directors as well as any new hires during the life of the policy, must also set out a binding framework for exit payments. An additional annual remuneration report will have to state executive remuneration as a single composite figure and explain whether companies have met their performance targets, as well as indicate how executive pay relates to the pay of the wider workforce.

In addition to the binding vote, shareholders will retain an annual advisory vote on how the company's remuneration policy has been implemented over the previous 12 months. If that vote is lost, the company will have to carry out a binding vote on future pay policy the following year.

Tax law expert Lynnette Jacobs of Pinsent Masons, the law firm behind Out-Law.com, said that if possible changes to the Corporate Governance Code, to be consulted on by the Financial Reporting Council (FRC), are enacted companies could also run into problems if a vocal minority were against a pay policy that made it past the majority vote. The proposed changes require companies to issue a statement explaining how they propose to address "shareholder concerns" in the event that a "substantial" minority vote against a policy, with what constitutes 'substantial' as yet undefined.

"A vote against a company's pay policy will require the company to apply the existing policy, which may have been designed up to three years previously, until an amended policy is approved - a wait of a year for the next AGM, unless the company has the time and resources to convene an earlier general meeting," she added. "Rather than binding votes against, the preferable result would be increased prior shareholder consultation resulting in appropriately designed remuneration policies which are duly approved by shareholders."

Share plans expert Judith Greaves of Pinsent Masons said that the need to report directors' pay in the form of a single figure could have a significant, unexpected impact on non-salaried incentives. Companies would have to invest time developing an approach to "situations that may never happen" in case they were prevented from reacting as quickly as they needed to by the structure of the vote, she said.

"The Government's announcements raise many questions in the context of share plans and other long-term incentives - for instance, it looks as if the performance-related outcome for 2012 awards may need to be included in the 'single figure' for a director's remuneration for 2015, reported in 2015," she said. "The time lag may result in big apparent fluctuations in pay, which could be misleading and would need to be explained.