Comments from ACCA to Department of Business, Innovation and Skills
Question 1: The Government seeks comments on how well the draft regulations attached at Annex B give effect to the policy set out in this consultation document.
The Government is seeking to make the reporting of directors’ remuneration more transparent, to increase shareholder engagement, and thereby to restore the link between pay and performance.
ACCA agrees that the disclosures and enhanced shareholder voting rights, set out in the proposed Regulations, represent progress in achieving the above objectives. Companies will, however, need to remain mindful of the key principle in the Government’s proposals that the information provided to shareholders should be, and should remain, understandable (which will also achieve the aim of year-to-year consistency). The increasing complexity in remuneration reporting in recent years is not chiefly due to statutory Regulations. One factor is the increasing complexity in remuneration structures themselves, and we have previously stated that simpler structures would, in general, be desirable (in our response in November 2011 to the Discussion Paper on Executive Remuneration, dated September 2011 [“our November 2011 response”]).
Our November 2011 response also drew attention to broader factors which are essential if the proposed Regulations are to have the effects intended. These include the need for shareholders and non-Executive Directors to have (and continue to have) a challenging mind-set on issues such as pay, and a reduction in short-termism (for example, by increasing the typical vesting period for incentive schemes).
We also have the following comments in relation to individual areas of the proposed Regulations:
Regulation 2: we agree that the Government should not prescribe the contents of the summary to be given by the chairman of the remuneration committee. We do believe that guidance should be issued which lays down principles for determining the information which will be of most use to investors. We have previously commented on the need for remuneration committees to demonstrate regard for the company’s wider interests (in our November 2011 response, and our response in April 2012 to the Consultation on enhanced Shareholder Voting Rights, dated March 2012).
Reg. 6.(c)(iii): for money purchase pension schemes, the single figure for remuneration would include the additional value achieved in the year only where the company has not made a contribution to the scheme during the year. We disagree with this provision, both in respect of its inclusion in the remuneration figure, and the idea that such a disclosure would only be required when no company contribution is made. We note that Section 10(2) requires the annual disclosure of the accrued benefits under a defined benefit scheme, and believe that any disclosure of the value of a money purchase scheme should be on the same basis.
Reg. 13.(2): we support the ten-year maximum time period to be covered by the line graph. We would also recommend provision for accompanying narrative disclosures of any significant matters affecting the reported data. There may be notable changes during a ten-year period, both in a company’s industry or the wider economy, and for a company individually (such as the effects of a restructuring).
Reg. 15.(2): particular emphasis is placed on advice given to the remuneration committee by a director who was not a member of it. We believe that at least equal emphasis should be placed on the involvement of external remuneration consultants.
Reg. 16(c): in the context of reporting when there has been substantial shareholder dissent, it would be helpful for “substantial” to be clarified with, for example, an indicative percentage of the total votes cast / exercisable.
Reg. 24 (relative importance of spend on pay); and
Reg. 30 (percentage increase in CEO pay compared to employees):
These concern the reporting of actual historical data. Consequently, they would be better-placed within Part 3 (Report relating to the Financial Year) than Part 4 (The Policy Part).
Furthermore, the terms “profit” and “previous years” in Reg. 24 need to be more precisely defined. There are several reported measures of profit in the financial statements of listed companies. With respect to “previous years”, a three-year period could be stipulated, for example, which would be consistent with the maximum period of time between votes on pay policy.
Similarly, to avoid potential confusion, it would be helpful if the term “face value” for longer-term incentive rewards were to be more precisely defined (Reg. 12.(b) (iii)).
Question 2: What costs will companies face in adjusting to these revised reporting regulations?
ACCA agrees that any additional costs incurred in implementing the new Regulations should not represent a burden for companies, especially after the first year of implementation. The proposed regulations are a replacement for the existing ones, rather than an addition to them, and companies should be able to extract readily from their accounting records most of the information to be disclosed. Furthermore, as a general principle, we believe that Regulations should seek to avoid adding undue complexity to corporate reporting. If a company is not already compiling internally some of the information required by the proposed Regulations, we support, on the grounds of good practice, the fact that it will now need to do so.
Additional costs would be minimised, and possibly avoided altogether, if companies took the opportunity, when making the changes, to adopt a straightforward reporting style which continues to avoid unnecessary additional disclosures. As mentioned in our response to Question 1, this more straightforward style would also benefit the users of the financial statements, and consequently the matter would be worth mentioning in the guidance issued by the Government to accompany the Regulations.
Question 3: The Government intends to introduce a table which sets out the key elements of remuneration and supporting information on the pay policy. The Government does not propose to prescribe the specific disclosures that are required for each element of pay. Is this a practical and informative approach?
We agree that it is not practical for the Regulations to prescribe specific disclosures, suitable for all types of company, in respect of the table which explains pay policy (Part 4 of the proposed Regulations).
Whereas the report on remuneration actually earned (Part 3) should have content which is as precise as is practically possible, the policy section’s main function should be to explain and justify to shareholders the structure of remuneration, and how this incentivises the directors to contribute to the long-term success of the company.
Companies’ circumstances vary, and they need to be able to decide how best to report remuneration policy in a manner which is most informative to shareholders. We believe that the content of the proposed Regulations sets out adequately the framework in which companies may do this.
Question 4: The Government intends to introduce reporting requirements on service contracts, what remuneration directors can receive in different scenarios and the percentage change in profit, dividends and overall expenditure on pay in the reporting period. Is this a practical and informative approach? If an alternative disclosure would be useful, please give details.
ACCA mainly agrees with the Government’s proposals on these matters. Whilst there is a potential separate concern that service contracts are in fact proving difficult for shareholders to access (as reported in the consultation document), it will in any case be informative for the provisions therein relating to remuneration to be additionally disclosed each year within the Remuneration Report.
The statement on scenarios in graphical form needs to be supplemented by an explanation of why total remuneration has under-performed or out-performed target in the reporting period, and whether this outcome is different from the trend in recent years. Shareholders need to be aware if, for example, actual remuneration typically exceeds the expected amount, as this may indicate that targets (and consequently, what they have been expecting the directors to earn) are being set artificially low. Alternatively, there may have been an impact from external factors not within the control of the directors.
A similar set of explanations would be advisable to accompany the reported percentage changes in profits, dividends and total remuneration in the period.
As set out in our response to Question 1 above, we believe that Regulations relating to the disclosure of actual (historical) data should be placed in Part 3 rather than Part 4 of the proposed Regulations.
Question 5: The Government proposes that a company’s statement on its approach to exit payments sets out the principles on which the determination of the payment will be made. If additional information would be useful, please give details.
We agree with the general principles in Regulation 26 concerning how termination payments will be calculated, such as how each element of the payment is calculated, and how performance will be taken into account.
Regulation 26.(b) requires the company to state whether the calculation of termination payments will distinguish between types of leaver and the circumstances of leaving. In view of the concerns over perceived “rewards for failure”, it would be helpful for companies to explain their policy decision more fully here. For example, shareholders would normally expect confirmation that the exit payment will be lower if a director chooses to leave before the end of the term of the service contract.
We note that the statement will not be individualised (para. 51 of the Consultation Document). Whilst the policy for termination payments will be more understandable when it sets out its provisions generally, rather than at much more length by director, it may be desirable (and in order) for shareholders to agree that specific terms may apply to individual directors, reflecting their particular role and what is expected of them. In this case, these specific terms should be reported (and explained) as individual amendments to the general policy.
It is also proposed that companies disclose details of any contractual provision agreed before the introduction of the Regulations that could impact on a termination payment. As exit payments are a potentially controversial matter, it would be informative for shareholders if the company were also required to explain why any contractual provision pre-dating the introduction of the Regulations would now be precluded from service contracts.
Question 6: The Government would welcome views on the proposal for the policy part of the remuneration report to include a statement on whether and if so how a company sought employee views on the remuneration policy.
ACCA supports the inclusion of this statement within the policy part of the remuneration report. Employees are stakeholders, and may also be the holders, individually, of small proportions of shares in the company. To provide balance, it would be helpful for the company to explain why it did not seek employee views on the remuneration policy. Companies may either have no consultation procedures, or may consult employees on other matters which in turn, do inform the discussions of pay policy by the remuneration committee.
This same section of the Regulations (no. 30.(1)) requires a comparison of the increase in salary of the Chief Executive Officer with that of employees generally (or a group of employees, if considered more relevant). As set out in our response to Question 14 below, we would question whether the CEO alone should be used for comparison, as opposed to a wider group of directors.
Question 7: The Government’s intention is that the single total figure includes remuneration that becomes receivable as a result of the achievement of conditions relating to performance in the reporting year where the reporting year is the last year of the performance cycle. Do the specific disclosures set out in the table below correctly give effect to this intention?
We believe that the table set out on page 24 of the Consultation Document does set out principles consistent with the intention set out above.
ACCA also supports the view that a single total figure of remuneration for each director, suitably analysed, will assist the understanding by the users of the financial statements of the rewards provided during the financial year.
Question 8: The Government proposes the application of the HMRC methodology to work out the value of defined benefit pension schemes. Is this a practical and informative approach?
ACCA agrees that the reported amount for defined benefit schemes in the Remuneration Report should be based on the value to the director, rather than the cost to the company. Consequently, IAS 19 would not be as suitable a basis for this particular disclosure as it is for the cost to the company disclosed in the statutory financial statements.
The use of HMRC methodology is practical, as it has the advantage of being readily understood and straightforward to apply. We view this is an important consideration in making the Remuneration Report itself, with its many components, as readily understandable as possible. However, directors will be interested in and - motivated by – the value of their pension fund as determined under other methods. For individuals, it is likely that transfer value will be the key measure here.
The above raises the question of how to reconcile the need for practicality and relevance in the disclosure of the value of defined benefit pension schemes. One way in which this could be achieved involves retaining the proposed HMRC method for the amount to be reported in the single figure. This could then be supplemented by a narrative statement that the transfer value, to which individual directors will probably have regard, is likely to be x times higher than the HMRC value, but is not included in the single figure for remuneration, as it is subject to volatility which is not caused by the performance of the director.
Question 9: The Government proposes that claw-back is recorded as part of the single figure. Is this a practical and informative approach?
We agree that claw-back should be reported within the single remuneration figure, as it is a component of total remuneration (albeit a deduction).
However, we do disagree with the proposal that no further disclosure should be required concerning the claw-back (leaving companies a choice as to whether to disclose the circumstances, as set out in para. 73 of the Consultation Document). In view of concerns about the extent of “rewards for failure”, claw-back is likely to attract similar levels of shareholder interest as termination payments (on which we have submitted our views in our response to Question 5 above). Furthermore, whilst claw-back amounts may be smaller than exit payments, they may indicate underperformance or even misconduct, which shareholders would particularly need to be made aware of.
Question 10: The Government would welcome views on whether it would be commercially sensitive to require companies to publish full details of performance against metrics. If so, how can an appropriate degree of flexibility be achieved?
We believe that, in order to improve transparency around directors’ remuneration, particularly the element which is variable, it is necessary to explain how the pay achieved compares to the company’s performance.
It would not be possible or desirable to specify levels of detail which would, for every company, achieve a balance between commercial confidentiality and adequate disclosure to shareholders. We would not therefore propose changes to the general reporting requirements proposed by the Government.
Companies already have to disclose potentially sensitive information, such as an indication of their future prospects. There can be a tendency to adopt vague wording, in order to avoid revealing more than is absolutely necessary. However, in the case of pay, shareholders are able to secure adequate disclosure thorough having the ultimate sanction of rejecting the report on pay in their advisory vote.
It is also likely that measurement criteria and reward mechanisms are similar throughout companies in a particular industry, as norms develop and companies compete. In this respect, commercial sensitivity is unlikely to present a major issue for companies.
Question 11: Will the Government’s proposed disclosure requirements on pensions lead to reporting of sufficient information on the benefits received by directors?
We believe that the proposed requirements will mean that sufficient information is disclosed concerning accrued pension benefits. In particular, the requirements cover information relevant to shareholders (such as the pension receivable if a director was eligible to retire at the accounting date). They also do not prescribe excessive disclosures, which in the relatively complex areas such as defined benefit pension schemes, are likely to be counter-productive for shareholders.
Question 12: The Government proposes that scheme interests awarded to directors during the reporting year are disclosed at face value. Is this a practical and informative approach?
We agree that it is practical to disclose at face value the scheme interests awarded to directors during the reporting year. An expected value is less clear, due to the assumptions which would have to be both applied and explained.
However, it is important that shareholders are fully aware that face value is not the amount which will eventually be received. The additional disclosures which are proposed go some way to explaining this (such as the maximum award). These additional disclosures could be linked with an explanation of how they work in practice. Preferably, this explanation would be accompanied by information on how actual outcomes have differed from face value in the past, and the factors involved.
Question 13: The Government proposes to simplify the reporting requirements regarding directors’ interests. What are the costs and benefits of this approach? If an alternative disclosure would be more useful, please give details.
The simplified reporting requirements should save some costs, which would help to offset some of the additional costs of complying with the proposed Regulations (although, as set out in our response to Question 2, we do not believe that these additional costs should be burdensome for companies).
The information disclosed on remuneration will indicate how directors’ interests have changed during the year. When reporting year-end interests as well, we believe that comparative figures alongside the year-end ones will also be of assistance to shareholders.
Question 14: The Government proposes that the remuneration report includes a graph that plots total shareholder return, as a proxy for company performance, against CEO pay. Do you agree that this graph would be useful? If so, do you agree that total shareholder return and CEO pay are the best proxies for company performance and pay? If not, what measures would be more appropriate?
In the Remuneration Report, any proxy for company performance needs to be both relevant to shareholders, and readily understood. We agree that total shareholder return is a measure which meets these criteria.
There is no explanation why the remuneration of only one director (albeit the Chief Executive Officer) is to be plotted in the graph against the company-wide total figure of shareholder return. It may be more appropriate if, for example, the figure of total remuneration of all executive directors (at least) was used instead. This would be consistent with the rest of the Remuneration Report, which does otherwise provide information about all of the directors, rather than focussing on individual directors.
Question 15: The Government proposes that the single figure, detail of performance against metrics, total pension entitlements, exit payments made and detail on variable pay are all subject to audit. Are there any other sections of the report that should be subject to audit?
The focus of a statutory audit is principally on actual historical figures. Sections of the Annual Report which are more discursive and / or forward-looking are not as conducive to cost-effective, evidence-based auditing, but are read by the auditor for consistency with the view given by the audited financial statements. An example of the latter would be the summary of the Remuneration Report given by the chairman of the Remuneration Committee (Section 2. of the proposed Regulations).
In view of the above, ACCA agrees that the scope of the statutory audit of the Remuneration Report should be those matters set out in Sections 3 to 12 of the proposed Regulations. The reporting elsewhere, such as the comparison of overall pay and performance (Section 13), is similar to the type of information in the Annual Report which is read by the statutory auditor, but not otherwise subject to detailed audit procedures.