Jeremy Orbell, Managing Director
Nicolas Stratford, Managing Director
David Tuch, Managing Director
March 23, 2021 / UK
This month the Financial Reporting Council (“FRC”) and the Department for Business, Energy & Industrial Strategy (“BEIS”) have each published papers with potential implications for Directors’ remuneration. In this update we summarise the key elements for Remuneration Committees and those who support them, to be aware of.
FRC – Improving the quality of “comply or explain” reporting
On 2 March 2021, the FRC published a document aimed at helping companies improve transparency when reporting against the 2018 UK Corporate Governance Code (“the Code”). A copy of the document can be found HERE.
This builds on its November 2020 review of corporate governance reporting, which found that companies tend to favour “tick-box” over high-quality governance reporting, and that too many companies strive to declare strict compliance with the Code rather than explain any departures from it.
The FRC’s goal is to encourage companies to take advantage of the flexibility offered by “comply or explain” to develop governance processes and practices appropriate to their specific circumstances and to provide better disclosures where there is non-compliance. The recommendations in the paper cover three key areas. Below we summarise those elements most relevant for Remuneration Committees:
1. Companies should offer clarity about the Provisions of the Code that they have departed from by making it easier for a reader to find this in their annual reports, by:
1. Stating in the compliance statement whether the company has
a) fully complied with all elements of Provisions of the Code or,
b) where it has departed from any of the Provisions, citing the Provision and wherein the report the explanation can be found
2) Companies should provide the explanation for non-compliance in one of the following ways
a) as part of their compliance statement or,
b) signposting to where in the report the reader can easily find the explanation
2. Companies should report any departure from any Provision of the Code
The FRC noted that too many companies claim full compliance when in fact they are not compliant with one or more Provisions and that, where companies do acknowledge departures from the Code, they may offer an incomplete or no explanation.
Of particular interest to Remuneration Committees will be the areas in which the FRC note a particular lack of transparency:
1) Provision 5 – stakeholders’ interests and workforce engagement
Companies need to give clear and specific examples of how they have considered the interests of key stakeholders in Board decisions
2) Provision 38 – executive pensions aligned with the workforce
Companies where not all executive directors’ pensions are in-line with the workforce are not compliant and should provide an explanation and a timeline for alignment for all directors
3) Provision 36 – post-employment shareholding requirements
It is not enough to state that the vesting and post-vesting periods apply after the departure of the directors from the company. The company report should reference the policy that requires directors to hold their shares post-employment. Unless such a policy is in place, companies are not in compliance with Provision 36 and need to report a departure from the Code, even if they intend to introduce a policy at their next Directors’ Remuneration Policy review date.
4) Provisions 40 and 41 – engagement with shareholders and the workforce and description of the work of the Remuneration Committee
Companies that do not effectively engage with shareholders or employees in relation to remuneration cannot claim compliance with these provisions of the Code. In order to be compliant:
a) effective engagement with the workforce requires more than seeking employee views via surveys but should be a two-sided conversation
b) an explanation of what impact, if any, engagement with shareholders has had on remuneration policy
Further, in order to be compliant with Provision 41, how the Company complies with all seven elements of this Provision must be reported on:
“41. There should be a description of the work of the remuneration committee in the annual report, including:
• 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;
• 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; and
• to what extent discretion has been applied to remuneration outcomes and the reasons why.”
3. Clear and meaningful explanations for departures from the Code
The FRC express disappointment with the quality of explanations provided by companies for departures from the Code and state that they struggled to find robust explanations in many cases. In its view, a full and meaningful explanation for non-compliance should show that an alternative arrangement is more appropriate and beneficial in upholding high standards of corporate governance. Good explanations in its view should:
a) set the context and background
b) give a convincing rationale for the approach being taken
c) consider any risks and describe any mitigating actions
d) set out when the company intends to comply
e) be understandable and persuasive
Guidance from the FRC on how to interpret and comply with the Code is welcomed.; However, the timing of the FRCs publication will be unhelpful for many companies with December year ends who will have finalised their reports for 2020 and will shortly be holding AGMs. These companies will need to address the issues in their reports for 2021. For companies with March or later year ends, who will be working on the remuneration and governance reporting, there may be a number of points to consider, particularly those companies that have not yet been able to bring pensions into alignment or who have not yet introduced specific post-employment shareholding requirements.
How can A&M’s Executive Compensation team help?
A&M Executive Compensation Services is well-positioned to advise Remuneration Committees through this period. Engagements are led by a Managing Director who attends all meetings and is actively involved in all deliverables.
This ensures you always have access to the right advice level, particularly when making critical decisions under time pressure. Our Managing Directors have a combined 80+ years of experience in advising on executive remuneration matters.