Instructions and guidelines for structuring and negotiation

The assistance which is provided to the remuneration committee comes in two forms: support and guidelines. Support to ensure the effective operation of the remuneration committee has been discussed156 and further assistance, consisting of instructions and guidance, is intended to help committees decide on the level and form of the remuneration. These come in the form of hard law, for example the Companies Act 2006 regulates exit payments and loans to directors; soft law, for example the Corporate Governance Code, as well as guidelines from institutional shareholder representatives such as the ABI and the National Association of Pension Funds (NAPF) designed to assist remuneration committees in reaching a fair decision for shareholders and executives. In this sub-section, the most important issues

152 ibid. 153 _{ibid 52.} 154 _{ibid 53.} 155 _{ibid 53 & 54.} 156 See section 3.3.1.3.3.

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arising from the Companies Act 2006, the Corporate Governance Code and the Listing Rules will be highlighted. Instructions to banks are discussed in the next chapter.

The most notable instructions from the Companies Act 2006 are related to exit payment and loans. The former has already been discussed;157 loans to directors will be addressed here. Loans can be used to avoid the rules on the disposal of assets and to remunerate directors by providing them with a gift in the form of loans, particularly as the position of directors will enable them to affect such transactions to suit their own interests. Unlike the US approach, the UK has changed the law from a blanket prohibition, subject to minor exceptions, on company loans to the requirement of shareholder approval, subject to certain exceptions.158 This change was a result of a recommendation from the Company Law Review.159 There is also a requirement for disclosure in the notes to the company’s accounts of the details of advances and credits granted by the company to its directors and of guarantees of any kind entered into by the company on behalf of its directors.160

The UK Corporate Governance Code contains some guidance on structuring remuneration. It does not specify any set limit on the level of remuneration, providing flexibility to enable firms to attract, retain and motivate directors. However, at the same time, the Code discourages firms from paying more than is required for this purpose, as this would be incompatible with the fiduciary duties of directors. The Greenbury Report161 recommended that a remuneration committee should take account of a number of issues, such as remuneration at other comparable firms via surveys, and the firm’s own strategy for determining executive remuneration level.However, the remuneration committee should be cautious when wishing to position the company relative to others, as this can contribute to a ratcheting up of the general level of remuneration.162 When determining remuneration

157 _{See section 3.3.1.2.}

158 _{Companies Act 2006, section 197.} 159

Company Law Review Steering Committee, Modern Company Law for a Competitive Economy: Completing the Structure (November 2000) para 4.21.

160 _{Companies Act 2006, section 413.} 161 _{Greenbury Report (n 2) section C2.} 162

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packages, the remuneration committee should be “sensitive to pay and employment conditions elsewhere in the group, particularly when determining annual salary increase.”163

In relation to pension entitlements, due to their complexity and importance, the Greenbury Report recommended that a committee should seek professional advice.164 Moreover, the report recommended that bonuses and other long-term incentive plans should not be pensionable and the pension should be calculated based on salary. However, the report warned firms of the consequences of using final salary or average salary over a certain period to calculate pensions, as the manager concerned may increase his or her salary during the pensionable period in order to gain a higher pension, which, as a result, would be costly for the pension fund and the company.165

The structure of remuneration, which is becoming increasingly complex, particularly in the largest companies in the UK,166 should be designed to link pay to performance. Therefore, it is recommended that incentive-based remuneration should form a significant part of an executive’s total remuneration, as the variable part of remuneration can be used to align the interests of directors and shareholders, and to incentivise directors to perform at the highest levels.167 In the wake of the financial crisis of 2007, it is recommended that financial firms should have a sufficient level of fixed pay to allow them to operate a flexible variable policy on remuneration, including reducing or cutting the variable components in any given year.168 This recommendation has also been reflected in the new version of the UK Corporate Governance Code.169 Moreover, as a result of the short-termist practices in the run-up to the crisis, the UK Corporate Governance Code recommends that incentive-based remuneration should not only be relevant and stretching but should also be designed to promote the long-

163 _{ibid provision D.1.}

164 _{Greenbury Report (n 2) para 6.42.} 165

ibid 6.44, 6.45 & section C12.

166 _{BIS/11/1287 (n 4) 31.}

167 _{Greenbury Report (n 2) section C4.}

168 _{FCA Handbook, SYSC, 19A.3.44; PRA Handbook, SYSC, 19A.3.44.} 169

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term success of the company. However, the Code did not introduce any performance metrics which could be used to assess long-term success.170

All incentive plans should be subject to financial and non-financial metrics and their performance conditions should be relevant, flexible, designed to promote the long-term success of a company and compatible with risk policies and systems.171 For example, guaranteed bonuses should be stopped, share options should not be offered at a discount, and the granting of shares should not be vested or exercisable in less than three years and should be phased in over time to ensure that executives are kept motivated and are not receiving a reward for doing nothing. Moreover, to ensure that directors promote the long-term success of their firm, a significant part of the short-term remuneration should be paid in shares and held for a designated period. To protect shareholder interests, any remuneration that has been granted to directors should be subject to provisions which allow the firm to reclaim it if the grant was a result of misstatement or misconduct. This provision on clawback, as it is known, was first inserted in the UK Corporate Governance Code in 2010. Unlike the US, where clawback is a matter of law,172 the UK approach is to encourage companies to use it as part of the requirements of the Code.

The FRC consulted on several issues related to the terminology used by the code and whether this should be similar to those used in the Large and Medium-sized Companies and Groups (Accounts and Reports) 2013. This is also related to whether it should specify situations under which payments could be recovered and/or withheld, and the legal considerations that may restrict the ability of the firms to do so.173 Therefore, in the new version of the Code the FRC has added that:

Schemes should include provisions that would enable the company to recover sums paid or withhold the payment of any sum, and specify the circumstances in which it would be appropriate to do so.174

170

Mertzanis (n 49) 92.

171 _{UK Corporate Governance Code (n 42) Schedule A.} 172 _{See section 6.4.4.}

173 _{FRC, Directors’ Remuneration (n 143).} 174

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