26 June 2018 by Peter Swabey
The government has introduced new regulations around pay ratios and remuneration, section 172 and governance for large companies
In the government’s response to the Green Paper on corporate governance, prime minister Teresa May lauded the UK’s corporate governance system as ‘envied and emulated around the world’, before asserting that we must not rest on our laurels but continue to improve. Citing examples where business was falling short of the desired standards, she added: ‘In some companies, executive pay has become disconnected from the performance of the company itself.
In others, some directors seem to have lost sight of their broader legal and ethical responsibilities. There is a worrying lack of transparency around how some large privately held companies behave.’
Building on this call to action, the government tasked itself to produce secondary legislation to require:
To this end, the Companies (Miscellaneous Reporting) Regulations 2018 (the Regulations) were published on 11 June. Subject to their approval in parliament, the regulations address these actions and it should be noted that Part 4 of the regulations extend many of these requirements to community interest companies. The new requirements apply to financial years beginning on or after 1 January 2019.
Part 3 of the regulations amends the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (the 2008 Regulations), while regulations 15–19 amend Schedule 8 of
the 2008 Regulations, relating to the quoted companies directors’ remuneration report, with paragraph 17(b) introducing new paragraphs 19A–19G to the schedule.
Paragraph 19A requires that companies with an average of more than 250 UK employees must include in their directors’ remuneration report the pay ratio information specified in paragraphs 19C to 19G.
Paragraph 19B provides a detailed mechanism for calculating the average number of employees and provides that, where the company is a parent company, the average number of UK employees refers to the number of UK employees within the group.
“A remuneration report that runs to more than 20 pages is indicative of an overcomplicated policy”
Paragraph 19C gets to the nuts and bolts, with details of a prescribed pay ratios table; paragraph 19D provides details of the three approved methods of calculating the pay ratio; and paragraph 19E, 19F and 19G require further information, including an explanation of why the method has been chosen
and an explanation of significant changes.
It is all very detailed and the best suggestion that I can make is that you review the regulations yourself on the government website.
Although I understand the need to be clear about the reporting requirement, so that all companies report on the same basis, I wonder whether this is overly complex.
Given that the members of the BEIS select committee were challenging companies as to whether a remuneration report that runs to more than 20 pages is indicative of an overcomplicated policy, the necessity for reporting yet more data and tables needs explanation.
A pay ratio is certainly a useful piece of information when considering executive pay policy, but there are mixed views whether this is the best way to do it. Professor Alex Edmans at London Business School has commented that the ‘UK pay ratio disclosure is illogical’, arguing if the purpose is to address concerns CEOs have been receiving payments that are not linked to company performance, a better solution would be to report the link between pay and long-term performance than to worker pay.
On the other hand, there are voices in the trade union world that have welcomed the new regulation as a shift away from the focus on the shareholder.
In our response to the green paper, we commented that: ‘The disclosure of pay ratios would be an interesting statistic and would provide useful information for and about a company when compared over a period of time. It should not be used to enable comparisons between companies for the reasons set out below. In our view, there are a host of other metrics, disclosure of which would be more meaningful and effective.’
These would include a comparison of:
These measures are readily comparable and could be easily understood.
The main problems with pay-ratio reporting would be around how it is represented – that is, the degree to which it is assumed to mean something it does not, a problem we have seen recently with political and press reaction to gender pay gap reporting – and the potential for unintended consequences, such as incentivising outsourcing and offshoring of lower paid work and the impact on CEO recruitment and retention.
The same part of the regulations introduces other changes to the directors’ remuneration report, which are intended to offer this enhanced clarity. Regulation 16 requires that the report include ‘any discretion which has been exercised in the award of directors’ remuneration’.
“These measures are intended to prevent either companies or investors saying they never anticipated a particular pay award could be so high”
Regulation 17(a) requires that the single total figure table indicate ‘the amount of the award or, where this is not ascertainable, an estimate of the amount of the award, that is attributable to share price appreciation’, alongside how the level of award was determined and whether discretion has been exercised as a result of change to the share price.
Regulation 18 goes on to require that where a performance target or measure relates to more than one financial year, the report indicates for each executive director ‘the maximum remuneration receivable assuming company share price appreciation of 50% during the relevant performance period’ and the basis on which this calculation has been made.
It can only be assumed that these measures are intended to prevent either companies or investors saying they never anticipated a particular pay award could be so high.
Part 2 of the regulation amends CA2006 to insert new requirements for the strategic report. Regulation 4 introduces a new section 414CZA, which does not apply to medium-sized companies (as defined in CA2006) and requires the strategic report to include a statement describing how the directors have had regard to the matters set out in section 172 (a) to (f) when performing their duty to promote the success of the company. Regulation 5 provides that this statement must be made available on a website.
The government have also addressed this issue in Part 3 of the regulations. Regulation 13 amends Schedule 7 to the 2008 Regulations and will require the directors’ report of any company (or group of companies) with more than 250 UK employees to contain a statement describing the action taken during the financial year to:
It must also summarise how the directors have engaged with employees and how the directors have had regard to employee interests, and the effect of that regard, including on the principal decisions taken by the company during the financial year.
For the avoidance of doubt, ‘employees’ in this sub-section are UK employees, and there is the usual exemption from disclosing ‘information about impending developments or matters in the course of negotiation if the disclosure would, in the opinion of the directors, be seriously prejudicial to the interests of the company’.
“There is the potential for unintended consequences, such as incentivising outsourcing lower paid work”
Companies with more than 250 UK employees, or who have a turnover of £36 million or more, or a balance sheet total of £18 million or more, must also include in their directors’ report ‘a statement summarising how the directors have had regard to the need to foster the company’s business relationships with suppliers, customers and others, and the effect of that regard, including on the principal decisions taken by the company during the financial year.’ Again, there is an exemption for disclosures the directors believe would be seriously prejudicial to the company.
Regulation 14 goes on to insert a new Part 8 of Schedule 7 to the 2008 Regulations. This applies to all companies with 2,000 employees or more and/or with a turnover of more than £200 million and a balance sheet total of more than £2 billion. This is unless they are subject to the Disclosure and Transparency Rules, or are a community interest company or a charitable company.
For these companies, the directors’ report must include a statement covering which corporate governance code, if any, the company applied in the financial year and how it was applied.
Alongside this, it must also state whether the company departed from such a code – and if so, how and why. If the company has not applied any corporate governance code, the statement must explain why not and also what corporate governance arrangements they did apply. Again, this statement must be made available on a website.
All in all, there are some very complex changes being proposed here, with a variety of thresholds at which different requirements bite. Those responsible for company reporting should carefully read the regulations and make sure they will be able to comply from the effective date. The Department for Business, Energy and Industrial Strategy are publishing guidance to help.