KCB revision - SLIDE DECK 5 - Remuneration of directors and snr exec.

Question 1

Why is remuneration an important corporate governance issue?

Answer 1

1. Companies need to attract and retain talented executives.
2. Remuneration incentives can be used to motivate executives to achieve better results for the company.

3.Those incentives need to be aligned with the interests of shareholders and promote the success of the company

4.Directors should not be rewarded for failure.

5. Directors should not be able to decide or influence their own remuneration.
6. High levels of executive pay undermine public trust in large businesses.

Question 2

What governance frameworks apply to what types of companies around the subject of remuneration?

Answer 2

The CA2006 requires all companies to make certain disclosures regarding directors’ remuneration in their annual reports and accounts. Quoted companies are required to publish more detailed information in a separate report in directors’ remuneration as part of their annual accounts and reports.

The CA2006 also gives shareholders a say in directors’ remuneration by prohibiting quoted companies from making remuneration payments to directors unless they are in accordance with a directors’ remuneration policy approved by shareholders. The policy must be approved by shareholders at least once every three years.

UK companies with a premium listing of equity shares have to comply with the statutory rules set out in the CA2006, the listing rules requirements and the rules set out in the UK Corporate Governance code around reporting on remuneration.

The Listing Rules require UK companies with a premium listing to obtain shareholder approval for most long-term
incentive schemes in which the directors may participate.

In summary
ALL - CA2006
LISTED PREMIUM - CA2006, LISTING RULES, UK CG CODE
LARGE PRIVATE - WATES PRINCIPALS
QUOTED - Schedule 8 of The Large and Medium- sized Companies and Groups (Accounts and Reports) Regulations 2008

Question 3

What two elements can a directors remuneration be divided into and what do they include?

Answer 3

Remuneration can be divided into two elements:

FIXED (Regardless of performance)
Basic Salary
Pension scheme payments

VARIABLE (Performance based)
Bonus (short-term incentive)
Share options/ long-term incentive schemes (long-term performance)

Question 4

How may companies measure financial performance (or non financial performance)?

Answer 4

1. Earnings Per Share (EPS)
2. Total Shareholder Return (TSR) Share price & Dividend
3. Profit PBIT or EBITDA
4. Return on Capital Employed (ROCE)
5. Others (including Non Financial such as ESG, employee retention, customer / employee satisfaction scores)

Question 5

What are problems with linking reward to performance?

Answer 5

Selecting the right performance measures
Setting the thresholds at which rewards are paid
Deciding whether to place a cap on any rewards under the incentive and determining the level of that cap
Ensuring that the targets used for short-term incentives like the annual bonus promote the long-term success of the company
Ensuring that the targets used for incentive schemes do not promote bad behaviour
Preventing executives who did not perform well from piggy-backing on the success of their colleagues
Preventing the ‘legacy effect’
Executives may develop an expectation that they should receive annual rewards regardless of the actual performance of the company
Designing a scheme that will be satisfactory to shareholders

Question 6

What are the drawbacks of share options schemes?

Answer 6

Share options reward holders for increases in the share price, when this may not always relate to the executives, or indeed the company’s performance (ie ‘Bull’ market )

When the stock markets are in a bear run and prices are declining, share options lose value, and may even become worthless, irrespective of executives or company’s performance.

Option holders do not benefit from dividend payouts.

Executive directors may prefer a long-term incentive scheme involving the grant of shares, since the shares will always have some value once they have vested.

Question 7

What principals in the UK CG Code touch on remuneration?

NB - You will have access to this. Don’t need to learn off by heart but for ease, know letters!

Answer 7

Principles P / Q / R

P. Remuneration policies and practices should be designed to support strategy and promote long-term sustainable success. Executive remuneration should be aligned to company purpose and values and be clearly linked to the successful delivery of the company’s long-term strategy.

Q. A formal and transparent procedure for developing policy on executive remuneration and determining director and senior management remuneration should be established. No director should be involved in deciding their own remuneration outcome.

R. Directors should exercise independent judgement and discretion when authorising remuneration outcomes, taking account of company and individual performance, and wider circumstances

Question 8

What does the Wates Code say in regards to remuneration?

NB - You will have access to this. Don’t need to learn off by heart . Available through FRC website.

Answer 8

Principle 5

A board should promote executive remuneration structures aligned to the long-term sustainable success of a company, taking into account pay and conditions elsewhere in the company.

Appropriate and fair levels of remuneration help companies to secure and retain high-quality directors, senior management and their workforce. Remuneration for directors and senior managers should be aligned with performance, behaviours, and the achievement of company purpose, values and strategy. In setting director and senior manager remuneration consideration should be given to remuneration throughout the organisation to reinforce a sense of shared purpose.

The board should establish clear policies on remuneration structures and practices which should enable effective accountability to shareholders. This should take account of the broader operating context, including the pay and conditions of the wider workforce and the company’s response to matters such as any gender pay gap

Question 9

What does the UKCG Code say in regards to remuneration committees?

NB - You will have access to this. Don’t need to learn off by heart but for ease, know numbers

Answer 9

The board should establish a remuneration committee of independent non-executive directors, with a minimum membership of three, or in the case of smaller companies, two. In addition, the chair of the board can only be a member if they were independent on appointment and cannot chair the committee. Before appointment as chair of the remuneration committee, the appointee should have served on a remuneration committee for at least 12 months.

Provision 32, UKCG code

Question 10

What are the duties of the remuneration committee?

NB - You will have access to this. Don’t need to learn off by heart but for ease, know numbers

Answer 10

The remuneration committee should have delegated responsibility for determining the policy for executive director remuneration and setting remuneration for the chair, executive directors and senior management. It should review workforce remuneration and related policies and the alignment of incentives and rewards with culture, taking these into account when setting the policy for executive director remuneration.

Provision 33, UKCG code

Question 11

What issues should the remuneration committee be aware of when using a remuneration consultant?

Answer 11

1. May have conflicts of interest by virtue of the fact they are also engaged by the executives to advise the company on other aspects of remuneration or may have another connection with an individual director (e.g. an executive director who serves on another company’s remuneration committee).
2. There is a risk that they will make recommendations which favour the executive directors and are not necessarily in the best interests of the company.
3. May be inclined to recommend complex remuneration schemes in order to increase their fees and make it more difficult for the remuneration committee to dispense with their services in future years.
4. May put pressure on the remuneration committee to accept their advice (e.g. by failing to come up with any credible alternative).
5. Executive directors and senior management may also put pressure on the remuneration committee

Question 12

What does the UK CG Code say in respect to the use of remuneration consultants?

NB - You will have access to this. Don’t need to learn off by heart but for ease, know numbers

Answer 12

The remuneration consultants should be identified in the annual report alongside a statement about any other connection they have with the company or individual directors.

Remuneration committee members should exercise independent judgement when evaluating the advice of external third parties and when receiving views from executive directors and senior management.

Provision 35, UKCG code

Question 13

Under provision 41 of the UK CG Code, there is a description of what needs to be included in the remuneration committee report for inclusion in the annual report. What should the report include?

NB - You will have access to this. Don’t need to learn off by heart but for ease, know numbers

Answer 13

An explanation of the strategic rationale for executive directors’ remuneration policies, structures and any performance metrics

Reasons why the remuneration is appropriate using internal and external measures, including pay ratios and pay gaps

A description, with examples, of how the remuneration committee has addressed the factors in Provision 40 – clarity, simplicity, risk and predictability

Whether the remuneration policy operated as intended in terms of company performance and quantum, and, if not, what changes are necessary

What engagement has taken place with shareholders and the impact this has had on remuneration policy and outcomes

What engagement with the workforce has taken place to explain how executive remuneration aligns with wider company pay policy

To what extent discretion has been applied to remuneration outcomes and the reasons why.

Question 14

Quoted companies are required under the CA2006 to make detailed disclosures regarding directors’ remuneration in a separate section of the annual report and accounts known as the directors’ remuneration report (s. 420).

What should the Directors remuneration report include?

Answer 14

The directors’ remuneration report (the report) must include:

the DIRECTORS’ REMUNERATION POLICY of the company if that policy is to be put to shareholders for approval at the AGM; and

an ANNUAL IMPLEMENTATION REPORT giving details of remuneration payments (and any payments for loss of office) made to directors in the relevant financial year under the policies that applied during that year or previous years.

Question 15

What legislation covers what needs to be included in the Directors’ Remuneration Policy?

Answer 15

Set out in Part 4 of Sch. 8 to the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (as amended)

Question 16

What key information should be included in the Directors’ Remuneration Policy?

Answer 16

A table describing each component of the remuneration package

A statement of the principles which would be applied by the company when agreeing the components of a remuneration package for a new director.

A description of any provisions contained in any director’s service contract or letter of appointment which could have an impact on remuneration payments or payments for loss of office available.

A bar chart which indicates the maximum and minimum amount which would be payable to each executive director under the policy in the first year and the amount that would be payable to them for on-target performance in the first year.

An illustration, in relation to performance measures or targets, of the maximum remuneration of each executive director

The company’s policy on notice periods under directors’ service contracts and the principles on which exit payments will be made, including how they will be calculated, whether the company will distinguish between different types of leaver (e.g. good leavers and bad leavers) or the circumstances of exit and how performance will be taken into account.

A statement on how pay and employment conditions of employees who are not directors was taken into account in setting the directors’ remuneration policy,

A statement on whether and, if so, how shareholders’ views expressed to the company were taken into account in formulating the directors’ remuneration policy.

Question 17

For quoted companies, what additional report should they include in the Directors Remuneration Report?

Answer 17

The directors’ remuneration report must contain a statement of the company’s policy on directors’ remuneration and an implementation report for the following financial year and for financial years subsequent to that.

for each director, a detailed summary of any performance conditions to which any entitlement of the director to share options

an explanation as to why any such performance conditions were chosen;

a summary of the methods to be used in assessing whether any such performance conditions are met and an explanation as to why those methods were chosen;

if any such performance condition involves any comparison with factors external to the company a summary of the factors to be used in making each such comparison, and

if any of the factors relates to the performance of another company, of two or more other companies or of an index on which the securities of a company or companies are listed, the identity of that company, of each of those companies or of the index;

a description of, and an explanation for, any significant amendment proposed to be made to the terms and conditions of any entitlement of a director to share options or under a long term incentive scheme; and
if any entitlement of a director to share options, or under a long term incentive scheme, is not subject to performance conditions, an explanation as to why that is the case.

Question 18

Under the Companies (Miscellaneous Reporting) Regulations 2018, what information are quoted companies required to publish?

NB - TRY AND FIND OUT MORE ABOUT THIS IN REVISION - NOT SO SURE WHAT THIS IS / WHEN IT APPLIES

Answer 18

Quoted companies with more than 250 UK employees are required to publish, as part of their directors’ remuneration report the ratio of their CEO’s total remuneration to the median (50th), 25th and 75th percentile full-time equivalent remuneration of their UK employees.

Alongside this, companies have to publish supporting information, including the reasons for changes to the ratios from year to year and, in the case of the median ratio, whether, and if so how, the company believes this ratio is consistent with the company’s wider policies on employee pay, reward and progression.

All quoted companies are required to illustrate, in the directors’ remuneration policy within their directors’ remuneration report, the effect of future share price increases on executive pay outcomes.

Companies are also be required to include a summary in their directors’ remuneration report of any discretion that has been exercised on executive remuneration outcomes reported that year in respect of share price appreciation or depreciation during the relevant performance periods.

Question 19

The Companies (Directors’ Remuneration Policy and Directors’ Remuneration Report) Regulations 2019 came into affect to give shareholders of quoted companies more control over directors pay. These regulations now require Directors to do what?

NB - TRY AND FIND OUT MORE ABOUT THIS IN REVISION - NOT SO SURE WHAT THIS IS / WHEN IT APPLIES

Answer 19

The report must compare the annual change of each director’s pay to the annual
change in average employee pay, over a rolling five year period;

The report must show the split of fixed and variable pay for each director, as two additional columns to the existing ‘Single Figure’ table;

The report must set out any changes made to share options granted or offered and the main conditions for the exercise of these rights including the exercise price and date, compared to the previous year;

The report must be freely available on the company’s website for ten years;

Remuneration reports must not include any sensitive personal data, revealing racial
or ethnic origin, political opinions or religious beliefs.

Question 20

Summarise the Shareholder Rights Directive (SRD II) 2019 legislation

NB - TRY AND FIND OUT MORE ABOUT THIS IN REVISION - NOT SO SURE WHAT THIS IS / WHEN IT APPLIES

Answer 20

Regulatory definitions for the employee comparator group and directors that are required when calculating percentage change in pay.

Discussion of measures taken to avoid or manage conflicts of interest in relation to determination, review and implementation of the remuneration policy.

Extension of coverage to include those considered to be CEO or deputy CEO, even where they are not appointed as directors.

Question 21

S439 of the CA2006 requires directors of listed companies to do what?

Answer 21

The annual remuneration report of a listed company must be put to an annual vote by shareholders at the AGM

If the resolution is defeated, the directors must put the existing directors’ remuneration policy or a revised policy to a vote at the next AGM

The directors must invite shareholders to approve their policy at least once every three years whether or not it has been revised and must obtain shareholder approval for any revised policy before they can make any payments under that new policy.

Question 22

S188 of the CA2006 and provision 39 of the UK CG Code cover compensation for loss of office. Summarise each,.

Answer 22

CA2006 introduced a new legal threshold for directors’ service contracts which now states that they must not exceed two years’ duration without shareholder approval, compared to five years before (s. 188).

The UK Corporate Governance Code now provides in Code Provision 39 that:

Notice or contract periods should be one year or less.

If it is necessary to offer longer periods to new directors recruited from outside the company, such periods should reduce to one year or less after the initial period.

The remuneration committee should ensure compensation commitments in directors’ terms of appointment do not reward poor performance.

They should be robust in reducing compensation to reflect departing directors’ obligations to mitigate loss.

Question 23

What are malus and clawback provisions and where would you find information in connection to these?

Answer 23

Remuneration schemes and policies should enable the use of discretion to override formulaic outcomes. They should also include provisions that would enable the company to recover and/or with Malus and clawback provisions of sums or share awards and specify the circumstances in which it would be appropriate to do so.
Provision 37, UKCG code

‘malus’ provisions allow the company, in specified circumstances, to forfeit all or part of a bonus or long-term incentive award before it has vested and been paid (also known as ‘performance adjustment’);

and

‘clawback’ provisions allow the company to recover sums already paid.

the current market standard triggers for malus and clawback are GROSS MISCONDUCT or MISSTATEMENT OF RESULTS (Investment Association’s Principles, Nov 2020)

Question 24

Where would you find information on NED remuneration?

Answer 24

UK CG Code 34

The remuneration of non-executive directors should be determined in accordance with the Articles of Association or, alternatively, by the board.

Levels of remuneration for the chair and all non-executive directors should reflect the time commitment and responsibilities of the role.

Remuneration for all non-executive directors should not include share options or other performance-related elements.

Provision 34, UKCG Code