Out-Law Analysis | 01 Jun 2017 | 4:45 pm | 8 min. read
Politics and public opinion were already engaging with issues of pay inequality and corporate governance, especially executive directors' pay at quoted companies, even before the snap UK election was called. Their pay has been growing disproportionately to both average pay and company performance for some time, with share incentives making up a significant proportion of remuneration and also widely seen to be part of the 'problem'.
In its manifesto, the Conservative Party essentially proposes doubling down on the approach taken to the governance of quoted company executive pay over the last 25 years or more, including under the 2020-15 coalition government. This approach is to strengthen disclosure requirements, governance practice and shareholder powers, and to rely on - and possibly press - investors to deliver change. It does not extend beyond listed companies, although the Conservatives also propose a further review of private company corporate governance.
The Labour Party moves beyond this to propose a more interventionist approach: targeted taxation, and public sector procurement rules that would affect businesses of all types, including FTSE companies. Of the three main parties, Labour sets out its taxation proposals and the costing of its policies in the most detail.
The Liberal Democrat approach to executive pay is effectively a more robust version of the Conservative approach in that it extends measures beyond quoted companies. This seems to be in keeping with the fact that, under the coalition government, a Liberal Democrat minister was in charge of the quoted company directors' remuneration reforms. Similarly, the party's general taxation proposals may be seen to fall between those of the other two, although the Conservative manifesto does not contain any firm guidance on possible changes to income tax and National Insurance contribution (NIC) rates should the party return to power.
Conservative manifesto proposals
Even before becoming prime minister, Theresa May made executive pay and corporate governance reform a big part of her broad policy goal of making the economy "work for everyone". Her government followed this up with a green paper on corporate governance reform, and by commissioning an independent report on the 'gig' economy.
The Conservative manifesto includes few detailed proposals on tax rates, but notably does not repeat the party's 2015 pledge not to increase income tax, NICs or VAT rates during the following parliament. It promises to legislate to make listed company executive director pay packages subject to strict annual votes by shareholders and to make the same companies publish the ratio of executive pay to broader UK workforce pay.
Quoted companies will have to explain their pay policies better, particularly complex incentive schemes. They will also either have to appoint employee directors, an employee advisory panel or a designated non-executive director to represent employees' interests on the board. In effect, these points are all brief statements of the Conservatives' policy conclusions following consultation on their green paper on corporate governance.
The next Conservative government would also review the use of share buybacks, with a view to ensuring these could not be used artificially to hit incentive performance targets and inflate executive pay. Buybacks could do that if widely-used performance measures such as earnings per share and total shareholder return were to be calculated without appropriate corrections for any shares bought back during the performance period. The Investment Association (IA) raised concerns about this possibility in late 2016.
The proposal for 'strict annual votes' on pay could cause difficulties, even if the statutory amendments are well-drafted. After losing a binding annual vote on any element of a director's remuneration package, a company may not have any scope to offer an alternative instead of the rejected element. As companies would be most unlikely to arrange an extraordinary general meeting simply to approve a new executive remuneration proposal before the next annual general meeting (AGM), the resulting dysfunction would probably persist for at least a year, with a potentially disruptive impact on board and management performance and focus.
The likely result of this proposal, if enacted, would be that quoted companies would become more restrained and cautious in shaping remuneration packages. Quoted company consultation with investors on remuneration proposals might also become even more extensive and detailed. Investors might find that executive remuneration takes up even more of their investee engagement effort, at least at first; but also that their influence in such consultations would be considerably increased.
There would also be concerns that investors would be less likely to vote against a binding resolution on an executive director's remuneration package than they would be to vote against a non-binding resolution to approve a remuneration report including the same package, which is how the current requirements work. In other words, there could be a perceived risk that the measure would only be effective if companies moderate their remuneration proposals in line with investors' wishes, as expressed in pre-AGM consultations, and do not call the bluff of investors by proceeding to an AGM vote without consultation, or on unamended proposals that the consultees did not support.
The proposal for disclosure of the ratio of executive to UK average pay is a refinement of the green paper proposal for disclosure of the ratio of the CEO's total pay to that of the median worker in the global workforce. The amended proposal will probably be welcomed, as it should generate figures that are much more comparable between quoted companies and easier to calculate. It also sensibly focuses on the underlying UK social and political concerns. Arguably, however, those figures could also be less relevant to each quoted company's actual business, and less relevant to investors, than the global CEO/median ratio.
Some will have concerns about the proposal to strengthen employees' 'voice' in the boardroom, but will probably take some comfort from the fact that each quoted company would be able to choose its own preferred approach.
Labour manifesto proposals
The Labour Party proposes increasing income tax rates for the highest earners, to 45% for taxable income over £80,000 and 50% for taxable income over £123,000; but not to increase employee NICs. Notably, it does not promise to freeze employer NICs. Although the threshold for the proposed 50% rate of income tax is stated to be £123,000, the proposals would interact with existing features of UK income tax to impose effective marginal rates of at least 50% on all taxable income totalling £100,002 or more per annum.
The manifesto also implies that Labour would increase the applicable capital gains tax (CGT) rates on share disposals, unless subject to entrepreneurs' relief; from 10% to 18% for gains up to the income tax basic rate limit, and from 20% to 28% for gains above that limit. In addition, Labour proposes to close the 'Mayfair tax loophole' – that is, to further extend income tax, and potentially NICs, rather than only CGT liability, at a lower rate, on private equity executives' carried interest.
The Labour proposals include a new 'excessive pay levy' (EPL): a payroll tax, charged on all employers of individuals earning more than a defined limit "from all sources". The meaning of this last phrase is unclear, but may suggest a radical approach. The principle is to charge employers for paying exceptionally high rates to individuals, and the new tax would be levied as a percentage of the total compensation above a defined limit.
The details of the EPL in Labour's own documents are rather scant, but it appears that the tax would apply at 2.5% on an individual's pay above £333,000 per annum, rising to 5% above £500,000 per annum. This would be in additional to the increased income tax and, potentially, CGT, charged on the relevant employees, and any possible increase in the related employers' NICs.
In addition to the EPL, Labour proposes to attempt to moderate the divergence between top and average pay by establishing a 20:1 maximum highest to lowest paid employee ration in the public sector and in businesses supplying, or bidding to supply, local or national government. That ratio is far lower than the ratio of highest to average total pay at FTSE companies, let alone the ratio of highest to lowest; and would probably strike many companies and advisers as being difficult to implement and commercially unrealistic.
The EPL would have the greatest impact on certain financial services firms and others with a relatively large proportion of very highly paid employees - and probably ultimately also on their customers and owners. Labour's documents do not address some important technical tax issues about the prospective tax, which businesses and advisers should raise urgently should Labour win power. These include the exact meaning of "from all sources"; whether the tax point would be the same as for income tax on the related pay; the relationship, if any, to corporation tax relief; and whether employers would be entitled to relief for EPL on any pay subsequently clawed back.
Labour also proposes a review of all existing corporate tax reliefs, re-targeting the design of reliefs to give stronger incentives for economically beneficial business choices and to prevent abuse. It seems possible that tax-advantaged share scheme (TASS) reliefs could be among the intended targets of this review; given that, in June 2016, the shadow chancellor tabled a Finance Bill amendment to require assessment of the value for money provided by TASS. This amendment was not pursued by Labour in the final stages of the bill, although it did renew a similar proposed amendment regarding the value for money of entrepreneurs' relief.
Liberal Democrat manifesto proposals
Like the Conservatives, the Liberal Democrats propose strengthening employee participation in decision-making; specifically by ensuring employee representation on quoted company boards and by strengthening shareholder voting on quoted company executive pay. The latter proposal lacks detail. The Liberal Democrats also go further in proposing employee representation on all remuneration committees, apparently not only those of quoted companies. Again, like the Conservatives, they propose the disclosure of top to median pay, but by all 'larger employers' and not only by quoted companies.
On taxation, the Liberal Democrats propose an immediate 1% increase to current income tax rates, except on dividends, in the UK except Scotland; and to dividend income tax rates across the UK, including in Scotland. The party intends that the money raised would be used to support the NHS and social care in the relevant nations. Like Labour, the Liberal Democrats also propose increasing the rates of CGT to pre-2016 levels.
Rather like Labour's EPL, with its echo of the party's previous bank payroll tax (BPT) on bankers' bonuses, the Liberal Democrat manifesto includes a proposal that namechecks the signature employee ownership policies they pursued while part of the 2010-15 coalition government. This is to give quoted company employees a right to request that shares be placed in trust for the benefit of employees. However, it is not clear how this proposal would apply to the many quoted companies that already operate all-employee TASS, i.e. share incentive plans and SAYE option schemes.
Graeme Standen is an employment and reward expert at Pinsent Masons, the law firm behind Out-Law.com. A version of this article first appeared on LexisPSL.