DIRECTORS' REMUNERATION
A Consultative Document issued by the Department of Trade and Industry
Comments from the Association of Chartered Certified Accountants
March 2002
Executive Summary
ACCA is pleased to have the opportunity to comment on the DTI's proposals for the disclosure by companies of information on directors' remuneration.We believe that the companies covered by the regulations should be required to set up remuneration committees. Without such a requirement, the draft regulations can only assume that listed companies will have set up such committees in accordance with best practice guidance. If companies have not done so, for whatever reason, their reports may well be inconsistent with the guidance and spirit of the Combined Code. In particular, the companies' policies on pay, and in particular the executive packages, may not have been determined by independent non-executive directors, as we believe is desirable.
We agree with the proposal to allow shareholders to vote on their company's remuneration report. We believe that this measure has the potential to be a positive step towards the encouragement of responsible governance on the part of the board and more active involvement in the governance process on the part of shareholders. This initiative should not, however, be seen as an end in itself. It is, rather, a means by which shareholders can exert further influence with respect to matters such as share options and compensation packages. The measure will at the same time provide welcome enhancement of the status of the AGM.
The regulations should make it clear that the vote should provide an opportunity for discussion of the report's contents. Although it is inferred that shareholders should be able to discuss aspects of the report before the vote takes place, there is no actual requirement for this to be arranged. We suggest, therefore, that the board should be required to invite comments and questions on the report before the vote takes place.
It should be understood that, when providing comparative information in connection with share options and long-term incentive schemes, information on changes in the market value of a company's share price may not provide a wholly reliable indicator of changes in a company's overall value or of whether any given trend is likely to continue. Forward-looking and qualitative criteria may be helpful as additional indicators of the company's present and prospective financial standing.
Specific Comments
Our comments on specific questions posed in the consultative document are as follows:Q2: Do you agree that, subject to Parliamentary approval, the draft regulations should have effect as respects companies' financial years ending on or after 31 December 2002?
The main innovation envisaged by the regulations is the production of a statutory report. The financial information to be included in it should for the most part be already available. Whether or not a listed company is already complying with the guidance of the Combined Code, it will be quite possible for a listed company to take the necessary steps to produce a remuneration report on the proposed lines following the implementation of the regulations. Accordingly, we see no problem with the proposed time-scale.
Q3: Do you agree with the definition of 'quoted company' in the draft regulations?
We agree with the proposal to apply the regulations to UK-registered companies with full listings on the London Stock Exchange or the major exchanges in EEA countries and the US. We also think that there is a case for bringing companies which are listed on AIM within the scope of the regulations. If it is thought desirable that shareholders in a publicly-quoted company should be allowed to supervise boardroom pay policy, there is no difference in principle between this happening in companies which have a full listing and in those that have an alternative listing. Companies listed on the smaller exchanges are likely to have smaller shareholder structures in which the proposed shareholder vote might conceivably have more of a practical impact on boardroom pay practice than it will have in larger companies.
Q4: Do you agree that the auditor should not be required under the regulations to consider whether the disclosures made under Part 2 of Schedule 7A are consistent with those provided in the annual accounts or under Part 3 of Schedule 7A?
We agree that the information set out in Part 2 of the draft regulations covering the company's policy on remuneration should not form part of the auditor's responsibility. The information contained in the proposed performance graphs will, however, be conditioned by the company's choice of comparator company or index. Given that this information might be open to manipulation, there is an argument for requiring the auditor to report on whether it has been properly prepared.
Q5: Do you agree that all 'existing directors' should be required to ensure that the vote is put to the vote of the GM?
The Department's intention to make 'existing directors' (only) responsible for the circulation of the remuneration report and the accompanying resolution amounts to nothing more than a re-statement of standard current practice. At present, the approval and circulation of the accounts and directors' report is the responsibility of the company's 'existing directors', even if none were in office during the year being reported on. We agree that this is the correct approach to take in framing the new provisions. Given that this is standard current practice, we query whether sub-paragraphs 9-11 of the proposed revised s241A need to be so explicit as to the responsibility of 'existing directors'.
More widely on the issues discussed in the passage before Q5, we agree with the Department that the proposed shareholder vote should encompass not just the policy aspect of the report but the actual packages paid. The validity of policy positions adopted can only be assessed by reference to actual decisions taken within the framework of those policies.
As regards the status of the shareholder vote, we agree that ultimate authority concerning remuneration issues should rest with the board itself. In view of this, it is right that the shareholder vote should be 'advisory' only. (The more correct term might, in fact, be 'non-binding'.) It would be impractical, as well as wrong, for shareholders to be in a position to avoid contractual commitments already entered into between the board and individual directors.
We believe, however, that the vote can serve a real governance-related function. Even though the board of directors is normally entitled to exercise all the management powers of the company, it exercises these powers on behalf of the company, and at all times directors are stewards of the company's assets. The knowledge that shareholders, both institutional and 'ordinary', will have the opportunity, at a later stage, of passing collective comment on the remuneration decisions which directors make is likely, in our view, to have a positive and healthy influence in terms of reminding directors of their stewardship function. We do not believe that directors of any company need be concerned about shareholder reaction to their reports so long as their pay policies and packages can be justified by reference to the company's actual commercial circumstances.
Q7: Should companies be required to disclose (a) other services provided to the company by the firm(s) which provide remuneration advice to members of the board; and (b) who appointed the remuneration consultants?
Yes.
Q8: Do you agree that companies should not be permitted to withhold details of the performance criteria used in long term incentive schemes … on the basis that such information is commercially sensitive?
Yes.
Q9: Do you agree that companies should not be permitted to withhold details of comparator group(s) of companies on the basis that such information is commercially confidential?
We consider that many companies will indeed be reluctant to disclose information on 'comparator' companies. We query also whether the 'comparator' companies themselves will wish to be named and their details discussed in the reports of other companies. The objective of the comparative performance information is to give shareholders a reliable basis for assessing the performance of their company, and the terms of service of its directors, by reference to the circumstances of other companies. The achievement of this objective is not necessarily helped by naming names. We would prefer it if this aspect of the remuneration report did not require publication of details of other companies. One possibility would be for details of the comparator company information used by the company to be reviewed by its auditor, and for the auditor to report to shareholders that this had been done.
Q10: Do you agree that it would not be appropriate to require companies to disclose performance conditions in relation to annual bonuses?
No. We consider such information to be relevant and do not see why it should be withheld.
Q11: Should there be [specified] disclosure requirements? If so, should companies be permitted to select (and required to disclose) their own basis for calculating the value of future awards?
Yes.
Q12: Do you agree that total shareholder return is the most appropriate default criterion for the performance graph?
On the face of it, a figure for total shareholder return would be an appropriate default criterion for this purpose, not least because it would allow shareholders to gauge the performance of their company in terms of the value of their own investments. This figure should, however, be treated with caution.
Recent corporate collapses have followed periods of sustained growth in the share prices of the companies concerned, calling into question the reliability of the share price as a measurement of true value. Clearly, the share price in itself does not necessarily amount to a wholly reliable indicator of underlying performance and corporate value. The information in the performance graph will also be retrospective in nature, with no guarantee that any increases in value will not be reversed at any point in the future. In view of this, we suggest that it would be appropriate for some form of 'health warning' to be associated with the shareholder return graph. Additionally, the performance graph could be supplemented by information on a company's performance which is of a more qualitative nature: for example, information on order levels, staff turnover rates and customer satisfaction levels.
As a wider point, we believe it is desirable that director incentive schemes should be constructed so as to give the individuals concerned a continuing and long-term incentive to bring about improvements in the company's value and profitability. The risk inherent in schemes which encourage directors to achieve fixed targets in share price as a condition of exercising options is that a share price can be artificially inflated, at least in the short-term. Directors should be encouraged to achieve improvements in levels of performance which are sustainable and which continue after the point at which their rewards are activated. The information to be disclosed in the remuneration report should be consistent with this objective.
Additional point
One other specific point which we would wish to make is that the draft regulations do not require companies to differentiate, in their remuneration reports, between executive and non-executive directors. In the circumstances, we consider that it would be informative if companies were to be required to do this.