Late last year, in response to the collapse of Thomas Cook, the House of Commons BEIS Select Committee wrote to the Government setting out a series of recommendations on corporate governance, executive pay and audit reform. The Government response has now been published.
The most high-profile aspect of the Government's response relates to the reform of the audit process, with the Committee accusing the Government of dragging its feet on this. However, the Government also addresses a number of issues in relation to executive pay. Essentially the message is that recent reforms are starting to make a difference in reining in excessive pay and reward packages and that further improvements will be seen when a new audit regulator is in place. Nevertheless, there is an underlying suggestion that further regulation may need to be introduced in some areas if the changes the Government is looking for do not materialise.
We summarise below the Government's response on matters relevant to executive pay.
Scrutiny of pay disclosures
The Government is committed to the creation of a new audit regulator with stronger powers to scrutinise and enforce compliance with reporting requirements on executive pay and corporate governance. This new body, which will replace the Financial Reporting Council, will be known as the Audit, Reporting and Governance Authority (ARGA). The establishment of ARGA requires legislation which the Government says it will introduce when time allows. With the Covid-19 crisis and Brexit on its plate, this may still be some time away.
Attention is drawn to the recent reforms strengthening the corporate governance framework and increasing transparency and accountability for executive pay. The Government believes these have had an impact in reducing executive pay, citing figures showing that median FTSE 100 CEO pay fell from £4.5 million in 2012 to £3.46 million in 2019. Nevertheless the Government says that it is actively considering what else can be done to ensure that remuneration is aligned with performance.
Pensions
The Committee recommended that changes to executive pension contributions are needed to create a fairer system. The Government acknowledges the steps that have already been taken to achieve this. Under the revised 2018 UK Corporate Governance Code (the Code), which took effect for financial years beginning on or after 1 January 2019, pension contribution rates for executive directors should be aligned with those available to the workforce generally. Moreover, institutional investors - notably the Investment Association - have made this one of their key areas of focus with change expected by the end of 2022. More than 30 FTSE 100 companies have already made significant changes to their pension policies and more companies are expected to do so as they put their remuneration policies to a binding shareholder vote. No further reform is proposed in the Government response.
Bonuses
The Government agrees with the Committee's recommendation that bonus targets should be linked to a range of financial, non-financial and strategic measures designed to deliver long-term value and also that metrics need to be reliable and credible. In his report, Sir Donald Brydon recommended that performance indicators used to calculate executive remuneration should be audited. The Government recognises that this could deter "gaming" in order to hit bonus targets but does not give any commitment on this as yet. We will need to wait for it to respond to the Brydon review before we see if this will become policy.
Companies' remuneration policies are already required to disclose the financial and non-financial performance indicators used for bonus and LTIP awards and how they align with long-term strategy. This is one of the areas which ARGA is expected to focus on.
Malus and clawback
Another of the Committee's recommendations was that provisions to enable companies to clawback bonuses after they have been paid should be strengthened and be enforceable. Again, the Government agrees in principle. The Code requires malus and clawback provisions to be included in remuneration schemes and policies and, although this is a "comply or explain"" obligation, the Government expects companies to act on it and for shareholders to use their binding vote on remuneration policies to ensure compliance. Research from 2018 shows that 90 per cent of FTSE 350 companies already operate malus and clawback provisions but the Government says that further improvement is needed. No specific new measures are mentioned, with the Government saying only that it "is committed to improving incentives to tackle the problem".
Further information
For more information about any of the issues raised in this briefing, please speak to your usual Ashurst contact or anyone who is mentioned below.
