Reducing

Reducing directors’ tenure period is sought to achieve easier termination for underperforming directors by the board without the fear of paying huge termination compensation. The

45

B Tricker, Corporate Governance, Principles, Policies and Practices (Oxford University Press, Oxford 2009) 58.

46 _{ibid 57.} 47

VD Berghe and A Levrau, “Evaluation Boards of Directors: What constitutes a good corporate Board?” (2004) 12 (4) Corporate Governance: An International Review 461, 466.

48 _{D Dalton and others, “The Fundamental Agency Problem and Its Mitigation” in JF Walsh, Academy of}

Management Annals (2007) 1, 8.

49

H Mertzanis, “The financial crisis and corporate governance reform” (2011) 6(1) International Journal of Business Governance and Ethics 83, 86.

50 _{KR Rebeiz, “The two dimensions of corporate governance independence” in M Hirschey and others (eds)}

Corporate Governance (Advanced Financial Economics) (Emerald Group Publishing, Bingley 2005) 11.

51

55

Cadbury Report recommended a change to the Companies Act 1985, in line with its recommendation that directors’ contracts were not to exceed three years52 without shareholder approval.53 This recommendation is intended to restrict director ability to award themselves long-term contracts containing provisions which make it difficult and expensive for firms to terminate under-performing directors.54 The Companies Act 2006 has, ultimately, reduced this period of a guaranteed term of appointment to two years without shareholder approval.55 However, the UK Corporate Governance Code has gone even further by recommending that companies set the maximum guaranteed term or notice period to one year;56 and even if the board offers a longer period for new directors, this should be reduced to one year or less afterwards.57 As a result, the Listing Rules also require the board to provide the shareholders with:

details of the unexpired term of any director’s service contract of a director proposed for election or re-election at the forthcoming annual general meeting, and, if any director proposed for election or re-election does not have a directors’ service contract, a statement to that effect.58

Moreover, the UK Corporate Governance Code urges the remuneration committee to consider carefully the compensation commitments that directors will be entitled to in the case of early termination with a view to avoiding rewarding poor performance.59

The reform in this area was successful in reducing director tenure and the level of compensation for early termination,60 as setting directors’ contracts at a one-year period has become standard practice among companies.61 The relationship between the reduction of

52 _{The period was five years under the Companies Act 1985, section 319.} 53

Cadbury Report (n 40) para 4.41.

54 _{A Calder, Corporate Governance: A Practical Guide to the Legal Frameworks and International Codes of}

Practice (Kogan Page, London 2008) 79.

55

The Companies Act 2006, section 188.

56

This was first recommended by the Greenbury Report (n 2) para.7.13.

57 _{UK Corporate Governance Code (n 42) provision D.1.5.} 58 _{Listing Rules section 9.8.8.}

59

UK Corporate Governance Code (n 42) provision D.1.4.

60 _{S Thompson, “The Impact of Corporate governance Reforms on the Remuneration of Executive in the UK”}

(2005) 13(1) Corporate Governance 19.

61 _{HC Hirt, “Regulation of directors' remuneration: the German approach, the DTI's consultation paper and the}

56

contract or notice period and short-term practices building up to the 2007-09 financial crisis is not totally clear. It appears that reducing the contract or notice period will put executives under pressure to improve the firm’s situation over a short period of time to secure their position. This will, in turn, lead them to focus on short-term strategy and results, and also allow them to cash in their variable remuneration on a short-term basis if they are asked to leave office. Thus, it was argued that management tenure should be lengthened and this should be subject to safeguards against incompetence.62

However, it appears that this opinion was built on the assumption that directors would not be allowed to serve for a long time. The reform was intended to reduce the guaranteed term or notice period to allow the board and shareholders to terminate under-performing directors without paying a high level of compensation for the dismissal. In addition, lengthening executive contracts will bring practical difficulties with regard to what would amount to incompetence and fair dismissal and could increase the number of litigations, harming shareholder interests.

This reduction of the length of contract was also expected to increase the level of remuneration (as directors would demand higher remuneration to protect themselves against small compensation in the case of early termination).63 It has been stated that in spite of the reduction in contract or notice period and the requirement of shareholder approval for termination payment, there are still examples of huge payments being made to outgoing directors64 as a result of the exemption provided under section 220 of the Companies Act 2006, which includes payment in lieu of notice made as part of the director’s contract, damages paid for breach of contract and payments which arise pursuant to discretions in bonus or LTIP plans, which do not need the approval of shareholders.

Therefore, the government consulted on how to introduce new regulation which would give shareholders a binding vote on any exit payment exceeding the equivalent of one year’s base

62 _{A Sykes, “Overcoming Poor Value Executive Remuneration: resolving the manifest conflicts of interest”}

(2002) 10(4) Corporate Governance: An International Review 256, 259.

63 _{Company Lawyer, “DTI consults over compensation for termination of directors' contracts” (2003) 24(9)}

Company Lawyer 271.

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salary.65 However, statutory compensation for unfair dismissal, redundancy or discrimination claims, whether decided by an Employment Tribunal or agreed bona fide on termination between the company and director, were to be excluded from the proposed role.66 This proposal raised considerable concern among businesses because voting will be required in almost all cases which will restrict a company’s ability to differentiate between good and bad leavers. Moreover, it has the potential effect of raising base pay and discouraging the use of long-term incentives, resulting in a short-term focus pay setting.67

Instead, the Australasian model for exit payments was supported, asthis obliges companies to set out their policy for exit payments in the remuneration policy and seek shareholder approval, meaning that a shareholder vote is only needed if the company intends to make exit payments which are greater than company policy permits. Therefore, in a subsequent publication, the Department for Business, Innovation and Skills (BIS) clarified that it intends to include the company approach to exit payment as part of the new remuneration policy68 which will have shareholder approval through the new binding vote.69 Once shareholders approve the policy, the company will be bound to make the exit payment in accordance with the policy and publish a statement explaining what the director receives, as well as detailing this in the implementation report.70 However, it is predicted that companies will try to adopt a broad exit payment policy to retain flexibility in setting the payment.71

65 _{Department for Business, Innovation and Skills, Executive Pay: Shareholder Voting Rights Consultation}

(BIS/12/639).

66 _{Norton Rose Fulbright, “Executive Remuneration: consultation on voting rights for shareholders” (March}

2012) Available at: <http://www.nortonrosefulbright.com/knowledge/publications/64642/executive- remuneration-consultation-on-voting-rights-for-shareholders> accessed 20 March 2014.

67 _{BIS/12/918 (n 6).}

68 _{Department for Business, Innovation and Skills, Consultation on revised remuneration reporting regulations}

(BIS/12/888).

69

The Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013, SI 2013/1981, sections 36&37.

70 _{Norton Rose Fulbright, “Executive Remuneration: Reforms announced by the government” (June 2012)}

available at <http://www.nortonrosefulbright.com/knowledge/publications/68047/executive-remuneration- reforms-announced-by-the-government> accessed 16 April 2014.

71 _{Norton Rose Fulbright, “Executive Remuneration: Draft legislation published” (July 2012) available at}

<http://www.nortonrosefulbright.com/knowledge/publications/69044/executive-remuneration-draft- legislation-published> accessed 16 April 2014.

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