Proposed rules on directors’ pay could be just the start

Shareholders have only limited power to control executive remuneration. Listed companies must hold a shareholder vote on their directors’ remuneration report at their annual general meeting, but the vote is advisory, with no binding effect.

However, shareholders are to be given a binding vote on their company’s pay policy under proposals in the Enterprise and Regulatory Reform Bill, now going through Parliament and which is expected to come into force in October 2013.

The pay regime will apply to all companies with shares on the FSA’s official list, most of which are traded on the main market of the London Stock Exchange. About 25 Scottish listed companies will be affected.

It will not directly affect AIM companies, other public companies in the private sector, or public sector enterprises, but it is likely the pressure for pay transparency and control will increase on these companies.

Listed companies will have to put their pay policy to a binding shareholder vote every three years, or when any change is proposed to the policy. All remuneration paid to directors will have to be in line with the approved policy, unless specific shareholder approval is sought.

Payments made to directors under existing contracts will be exempt from the restrictions, but only where the contract was made before 27 June 2012. Companies should note that directors lose this protection if an existing contract is varied after that date. A salary increase or other change to remuneration may be viewed as a change in the contract.

If an unapproved payment is made to a director, he or she will be required to repay the amount and the directors who approved the payment will be liable to indemnify the company for the loss caused.

Although policy will be subject to shareholder approval, the detail of individual pay packages will remain under the control of the company’s remuneration committee.

There will continue to be an annual vote on how the remuneration policy has been implemented in the preceding financial year. If this vote is lost, it will not affect any payments made to directors but the remuneration policy would have to be put to a binding vote at the next AGM.

The requirements for director’s remuneration  reports are being amended  to reflect these changes,  with separate sections for policy and implementation. A single figure for the total remuneration received by each director must be given.

Listed companies will need to consider carefully the terms of the remuneration policy put to the shareholder vote. A careful line will have to be steered between exposing the company’s negotiating position when recruiting directors and ensuring the agreed remuneration is within the terms of the approved remuneration policy. Early engagement with investors  will also be key.

The government is clearly aiming to strengthen the  hands of investors, in the expectation that they will  curb exorbitant pay.

Research in June by consultancies Manifest and MM&K revealed that FTSE100 chief executives were last year awarded on average a total remuneration of £4.8 million, a rise of 12 per cent.

A surge of investor action at this year’s round of AGMs may indicate that some at least will seize on these new powers.

Despite the headlines and expressions of outrage there is still some way to go before we reach the level of investor rebellion experienced in 2002.

The average level of dissent registered in all explicit votes on remuneration that year was 16 per cent. The current level has risen to 11.7 per cent from 9.6 per cent last year.

It may be that investors, especially overseas investors who now hold more than  40 per cent of UK-listed shares, simply do not have the appetite to hold executives to account.

But amid wider public concerns over pay levels, these proposed reforms may not yet be the end of the story.

l Danielle Harris is a professional support lawyer in the corporate department at Maclay Murray & Spens LLP.