Government proposals to review NED pay have caused shareholder unrest. A proportionate approach holds the key

July 19, 2022

Recently, the FT reported on investor concerns about Government proposals to review current rules on paying NEDs in shares or share options. The Government wants to see if they impose any unnecessary restrictions on NEDs becoming fully invested in the future success of the companies of which they are directors.

This raises questions about the independence of NEDs, the increasing demands on their roles, the ability of companies to attract NED talent and the imperative for businesses to maintain board quality. It’s not easy to square this circle.

In the November 2021 edition of our Newsletter, we commented that UK practice on NED pay is out of kilter with US practice and suggested that the time might be right to revisit UK rules and guidance.

Whilst not making a case for the UK to adopt US remuneration practices as a matter of course, our comment was made in the context of recent experience advising early-stage, often AIM-traded, pre-revenue technology companies seeking high-quality, experienced non-executive support, sometimes from overseas, to develop the technology and prove it works commercially. Increasingly, potential NEDs are looking for an equity stake.

Our November 2021 article was prompted by responses to our 2021/2022 survey of NEDs and Chairs, “Life in the Boardroom”. Whilst the need for regulation and oversight is recognised, disclosure requirements and oversight frameworks are significantly more robust today than they were when the UK Corporate Governance Code (itself the subject of review) was first published in 1992 by the Cadbury Committee. NEDs contributing to our latest Life in the Boardroom report feel that the increased burden of regulation, greater personal liability and time commitments have led to a sense that the risk/reward balance has shifted more towards risk which is not matched by reward.

The recent FT article refers to NEDs as having a “watchdog role”. English law makes no distinction between executive and non-executive directors in terms of their fiduciary duties to their companies. Clearly, individual directors have defined roles but can it be said that a CFO is any less of a “watchdog” (and must act diligently and with integrity) in relation to the financial affairs for the company? Promulgating a contentious atmosphere between executives and non-executives, when both are charged with acting in the best interests of the business is not constructive. It may deter talented individuals from wishing to become NEDs, potentially prejudicing diversity and risking a long-term decline in board quality.

It is the role of NEDs constructively to challenge management. Greater diversity might help to create an atmosphere in which challenge can be delivered constructively without giving rise to confrontation. Greater use of objective, external evaluation of board performance might also help to identify situations which require greater levels of challenge and to educate individual NEDs on how best to conduct challenging discussions with executive colleagues.

Investors’ concerns about paying NEDs in shares are centred on arguments about independence. The arguments do not recognise, however, that many NEDs are encouraged or required to build up a personal shareholding in their company, thereby accumulating a potentially increasing geared interest in those shares – whilst also taking a risk, like any shareholder, that the value of that interest might fall. Is there any material difference between that situation and the situation of a NED who receives awards of, say, restricted shares or share options over time?

As we highlighted last November, there is already a two-tier approach to NEDs receiving share awards. The provisions of the Quoted Companies Alliance (QCA) Corporate Governance Code, designed for smaller quoted and AIM companies, are not as prescriptive as the UK Corporate Governance Code provisions on paying NEDs in shares. 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.”

Proportionality is the key. It appears to symbolise the Government’s current approach to corporate governance, as seen in its recent response to proposals for audit and governance reform, which were the subject of an article in our June Newsletter. It makes sense to take a similar proportionate approach to share awards for NEDs, which should not compromise the ability of NEDs to make sound decisions and challenge executives. It should also have a positive effect on the ability of, particularly,  young companies to attract NED talent and on the maintenance of board quality.

To discuss or comment on this article, please contact Paul Norris.

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