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'Executive pay' regulator needed, say MPs

Recent changes designed to increase transparency on directors' pay at UK public companies are unlikely to go far enough on their own to curb "executive greed", a committee of MPs has said.02 Apr 2019

In a new report, the Business, Energy and Industrial Strategy (BEIS) Committee raised its concern that "executive greed" had been "baked in to the remuneration system", and that this had spawned a public perception of "institutional unfairness" that could develop to "undermine social cohesion and support for the current economic model". It set out a range of recommendations aimed at aligning executive pay more closely with the pay of workers.

Remuneration and incentives expert Lynette Jacobs of Pinsent Masons, the law firm behind Out-Law.com, said: "Excessive remuneration has had a negative impression on the public's perception of executive remuneration, and so it is no surprise to see the Committee urge simplification of executive pay and for it to be 'more obviously geared to promoting companies’ long-term objectives, and be linked more closely to that of the workforce as a whole'."

New legislation requiring UK quoted companies with over 250 UK-based employees to be more open about their remuneration of boardroom executives came into force earlier this year. Those reforms require these companies, amongst other things, to set out how the pay awarded to their chief executive compares to that of representative UK employees, with related explanations and disclosures. Specifically, the pay ratio regulations require the companies to disclose and explain the ratio of their chief executive's total pay over a financial year to the median and 25% and 75% interquartile threshold total pay of the company's UK employees for the same financial year.

The same companies also need to show what effect a substantial increase in share prices over the vesting period would have on the value that executives could realise from any new long-term incentive awards. Along with many other large UK companies, they will also need to report on how their directors took into account employee and other stakeholder interests when making decisions during the relevant financial year.

In its report, the BEIS Committee said that while it welcomed the corporate governance reforms, for which statutory disclosures must be made in companies' directors' remuneration reports, its view is that, on their own, they are "unlikely to be an effective driver of change".

The Committee said that the scope of the pay ratio reporting requirements should be extended to cover "all employers with over 250 employees", and not just those that are publicly quoted, and that the figures should show a comparison between the chief executive's pay and those in "the lowest pay band".

"There is no reason why companies, including major legal partnerships, that can readily calculate these pay ratios should not report them first in their 2019 annual reports and we recommend that they do so," the BEIS Committee said.

The Committee said a new "more empowered, aggressive and proactive regulator" is needed on issues of executive pay.

The new regulator should engage in closer monitoring of "how remuneration reports and better reporting … meet the aims of increased transparency and alignment of pay with objectives", and said companies that "ignore shareholder concerns on pay" should face "more effective sanctions than a letter from the Investment Association". The Investment Association's Principles of Remuneration set out investor expectations and best practice on how FTSE companies should pay their top executives in line with the revised Corporate Governance Code and other legal requirements.

Any business that fails to "explain adequately how they have taken into account pay ratios when determining levels of remuneration, particularly when pay ratios significantly exceed sector norms" should be taken to task by the new regulator, it said.

The Committee spelled out what simplification of executive pay should look like in its report.

"We favour a simple structure based on fixed basic salary plus deferred shares, vesting over a long period, but subject to conditions to avoid 'rewarding failure'," the Committee said. "Care needs to be taken to ensure that reforms are coherent as a package and do not permit gaming."

"We also support the greater use of profit sharing or other schemes designed to share profits more evenly. Over time, the proportion of variable pay (including bonuses, share options and profit sharing) should be reduced substantially. The increase in certainty associated with proportionately more fixed pay should, if well managed, lead to a reduction in total remuneration awarded," it said.

"We believe that the performance measures governing the payment of annual bonuses should be aimed at encouraging and rewarding increased productivity and also support the company’s wider responsibilities under section 172 of the Companies Act to have regard to the interests of its customers, suppliers and workforce," the Committee said, calling for new guidance to be developed by the new regulator on bonuses "to ensure that they are genuinely stretching and a reward only for exceptional performance".

On the report's recommendation for the greater use of profit sharing schemes or other schemes designed to share profits more evenly, Lynette Jacobs of Pinsent Masons pointed to the positive impact that tax-advantaged UK all-employee 'Sharesave' and 'Share Incentive Plans' have on employees, increasing their motivation and strengthening their identity with their employer company.  

Action for remuneration committees should include placing an "absolute cap on total remuneration for executives in any year" and publishing and explaining that cap, the Committee said. This follows from the Committee's view that adequate provisions in contracts for the capping of pay-outs could have prevented the Persimmon "pay scandal".

Jacobs said that the report's view that "there is a strong case" for the imposition of a cap on variable pay, as applies in financial services sector whereby 'variable pay' is capped at 100% of total fixed pay or, with shareholder approval, 200% of total fixed pay, if adopted, would be in line with the application of other remuneration requirements initially implemented in financial services, such as malus and clawback and retention periods, to remuneration across other sectors.

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