UK investor guidance opposes participation by NEDs in share schemes. The UK approach is out of kilter with the US. Maybe now’s the time to revisit this guidance.

November 4, 2021


UK companies with a premium listing are bound by the UK Corporate Governance Code (UKCGC). According to the UKCGC the “remuneration for all non-executive directors should not include share options or other performance-related elements.”

This explains why NEDs in the FTSE 100 do not participate in options or LTIPS and, probably, why only a small proportion of FTSE100 companies disclose that they have paid NED fees in shares. Interestingly, a greater number have adopted either a formal or informal shareholding policy for their NEDs.

The Quoted Companies Alliance (QCA) Corporate Governance Code, designed for smaller quoted and AIM companies, is not as prescriptive. The QCA code provides: “Since independence can be easily compromised, NEDs should not normally participate in performance-related remuneration schemes or have a significant interest in a company share option scheme. On occasions, where performance-related remuneration is under consideration, it should be proportionate, shareholders must be consulted and their support obtained.”

The QCA code guidance clearly contemplates NEDs may participate in share options, provided their interest in such schemes is proportionate so as not to compromise independence. The concept of proportionality also appears in other examples of good governance guidance on remuneration, including the UKCGC and the FCA remuneration guidance for financial services firms.

Why should FTSE100 companies be subject to a separate, more onerous regime? The reason is largely historical, a throw-back to scandals such as Enron and Polly Peck. Memories of those scandals linger and if a FTSE100 company were to crash, it would create a bigger economic shock than a small cap or typical AIM company.

However, disclosure requirements and oversight frameworks are significantly more robust today than they were when Enron collapsed. Of course, that is not to say that the future will be scandal-free.

NEDs participating in MM&K’s shortly to be published Life in the Boardroom survey, see the increased burden of regulation as a double-edged sword. There is widespread recognition that regulation and oversight are essential. But lurking on the other side of the coin are increased personal liability, greater time commitments and a growing sense that the reward side of the risk/reward balance is diminishing. NEDs feel increased risks and pressures are not matched by increases in remuneration. There are concerns also about the way in which governance codes are interpreted and applied, particularly by proxy agents.

Balancing risk and reward is important. If motivation to become NEDs dwindles, the quality of Boards may suffer as a result. NEDs have started to raise questions about the possibility of participating in share options and incentives and have compared UK practice with practice in the US, where non-employee directors of almost all S&P 100 companies participate, or have the opportunity to participate, in equity, sometimes in the form of share options or restricted stock awards. There is growing concern that high calibre Chairs and NEDs may be deterred from taking up appointments in the more restrictive UK regime.

That may be a greater challenge for small-cap and AIM companies, particularly early stage, pre-revenue technology companies, which may need high quality, specialist NED support for management to develop their technology and prove it works commercially.

Being able to pay in shares, share options or restricted stock conserves cash and provides an incentive to stay with the company. That word “incentive” brings us back to the fundamental concern about compromised independence and the risk it might lead to short term decision-making. But any NED who builds up a personal shareholding in a company of which they are a director, as many are encouraged or required to do, accumulates a potentially increasing geared interest in that company’s shares – whilst also taking a risk, like any shareholder, that the value of that interest might fall.

We advise a number of early-stage, pre-revenue technology companies who need high-quality, experienced non-executive support and challenge for management, to develop the technology and prove it works commercially. Potential NEDs are asking about an equity stake.

The US approach appears to work satisfactorily. I would argue that the QCA code has it about right, proportionality is key but so is Board quality and encouraging talented individuals to want to become NEDs – principles which apply to all companies.

To discuss any of the points or opinions in this article, please contact Paul Norris.

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