New directors remuneration guidance emphasises need for companies to justify pay awards, says expert

Matthew Findley of Pinsent Masons, the law firm behind Out-Law.com, was commenting as the GC100 published its guidance on what would be expected of companies under the new regime. The GC100 is the Association of General Counsel and Company Secretaries of the companies listed on the FTSE 100, and worked alongside investors to produce the influential guidance.

“The guidelines set the benchmark in terms of best practice expectations and will be a key reference point for companies when they prepare their directors’ remuneration report,” Findley, a share plans and incentives expert, said.

“They emphasise one of the key themes underlying the new regime - that companies need to justify as well as report executive pay. Remuneration committees will need to be mindful of this increasing focus on accountability,” he said.

With the new regime due to begin on 1 October, Findley said that companies should “begin the process of preparing their remuneration report - and the pay policy to be put to shareholders” now. This would “allow sufficient time for engagement with both internal and external stakeholders”, he said.

Under the new remuneration reporting regime, companies’ annual reports must contain more information about how directors have been and will be paid along with how this relates to company performance. This information can then be used by company shareholders when exercising their new legally-binding vote on the company’s executive pay policy. The new regime comes into force on 1 October for quoted companies whose accounting period ends on 30 September, and the Government published final regulations governing the changes (24-page / 114KB PDF) last month.

The creation of best practice guidance, developed by industry, was envisaged by the Government when drawing up its original proposals although the document is neither legally binding nor intended to be exhaustive. David Jackson and Guy Jubb, co-chairs of the GC100 and Investor Group, added that the guidance was not intended to “prohibit or preclude innovation in reporting”.

From October, directors’ remuneration reports will be split into two parts: a forward-looking pay policy report, which will be subject to the binding shareholder vote; and a report on how that policy was implemented over the previous year, which will be subject to an advisory vote. The implementation report must include details of actual payments made by the company, set out as a single figure for the total pay directors are treated as having received in the year. Companies will be able to provide additional information about how this figure was calculated, both as part of the single figure remuneration table and elsewhere in the report. Payments to former directors must also be included.

According to the guidance, a company’s remuneration policy is expected to last for three years. Companies must set out details of “material changes” to the remuneration structure within the approved policy and, where applicable, specific details of performance measures and targets for the current year subject to commercial sensitivities. The regulations do not define what makes a change ‘material’, but the guidance states that companies could consider changes in basic salary and in maximum short-term and long-term incentive awards, even where these changes fall within the maximums set out in the future policy table.

The regulations also do not set out what information will be considered “commercially sensitive”; a change which was introduced since the first draft of the regulations. A possible interpretation given in the new guidance is that a measure or target will be considered to fall within the exemption is if its disclosure is “likely to damage the company’s commercial interests”. If material is considered to be commercially sensitive, reasons for its omission from the report must be disclosed.

The forward-looking pay policy part of the new report must set out every element of pay that a director could be entitled to, including any entitlement to an exit payment, and what performance measures will be applied. Each element should include a maximum potential value, which may be expressed as a percentage of salary.

The regulations specify five specified headings of remuneration that must be included: salary, benefits, short-term incentives, long-term incentives and pensions. Other “items in the nature of remuneration” must be included in additional columns. The guidance suggests that companies obtain written confirmation from directors that they have not received any remuneration above that disclosed in the single total figure table “as a matter of good practice”. They then may wish to consider disclosing that they have done this in the annual remuneration report.

Companies can set a ‘de minimis’ threshold in accordance with the regulations, giving them the flexibility not to disclose immaterial amounts that investors would not expect to feature in the remuneration report. According to the guidance, if companies will likely choose to change this from one year to the next they should consider explaining this. One example given in the guidance of an incentive which may not need to be disclosed is healthcare premiums, although in cases where companies have long-standing healthcare arrangements in place for former directors, particularly those overseas, which are of significant value these should be disclosed in at least the first report after that director leaves.