Executive pay disclosures – impact of new corporate governance codes
January 25, 2024
On 22 January, the FRC published an updated UK Corporate Governance Code (FRC Code), following publication last November of the QCA’s revised Corporate Governance Code (QCA Code) .
The 2024 FRC Code is a cut-down version of the revised code the FRC had initially intended to publish. Its principal focus is on companies’ internal controls. It also emphasises that the FRC Code is not a rigid set of rules and reinforces the principle of ‘comply or explain’, urging investors and their proxy advisors to give thoughtful consideration to explanations for non-compliance, taking account of company circumstances.
Malus and clawback provisions in the FRC Code will result in additional remuneration disclosures. Remuneration disclosure and shareholder voting provisions in the QCA Code will alter the governance landscape for adopters of that Code, particularly AIM companies who will be required by AIM Rule 26 to explain how they have complied with the provisions of their adopted corporate governance code. Interestingly, 73% of NEDs representing AIM companies, who participated in our 2023/24 survey of Board Chairs and NEDs, ‘Life in the Boardroom’, reported, prior to the publication of the QCA Code, that their companies were not proposing to subject their directors’ remuneration policy to a binding shareholder vote. Learn more about Life in the Boardroom here.
So, formulating and reporting on executive remuneration policies remains complex, wide-ranging and nuanced. We recommend approaches to four remuneration-related topics, of interest to regulators, for companies to consider when forming their policies and disclosures:
- Remuneration committee discretion: set out how the committee approaches the exercise of discretion and a framework within which decisions about bonus and LTI awards will be made
- The exercise of remuneration committee discretion to adjust incentive outcomes (up or down) is a current focus area for UK corporate governance regulators. But, demonstrating alignment with the investor experience and transparent investor engagement on incentive policies are essential
- Adjustments to incentive outcomes for write-downs that might not affect cash flows, if non-cash items, but are likely to affect earnings, need to be handled carefully; investors are not likely to look favourably on proposed adjustments to disregard write-downs that could/should have been flagged by properly functioning risk assessment and management procedures
- Our experience is that the strongest negative stakeholder reactions arise when there has been inadequate transparency about disclosures, including incentive policies and the remuneration committee’s decision-making process
- A pre-existing (and communicated) framework for the exercise of discretion about bonus and LTI decisions which explains the factors considered by the committee when deciding on adjustments to incentive outcomes, informs both executives and investors and gives them confidence that decisions are based on a transparent and logical process.
- Strategy, purpose and values: provide clear explanations of how both financial and non-financial metrics are linked to long-term strategy, company purpose and values
- The 2023 FRC Review of Corporate Governance Reporting (a study based on disclosures by 100 premium-listed companies from the FTSE100, 250 and Small Cap indexes) Annual Review of Corporate Reporting (frc.org.uk) found that only a minority of companies give a clear explanation of links between financial and non-financial metrics and strategy, purpose and values.
- The challenge is greater in relation to non-financial metrics. It is not the purpose of this article to delve into ESG policies, performance measures and targets. We would recommend, however, that companies identify those ESG elements on which their business has/can have an effect and the measures they can reasonably take to make some improvement.
- MM&K, along with our global partners in the GECN, has produced a detailed report on the way global businesses use and disclose ESG factors in relation to their executive incentives.
- DE&I and climate top the lists. Practice adopted by large companies eventually filters down to others. A copy of our latest report can be obtained free of charge here.
- Malus and clawback: be clear about the circumstances in which malus and clawback apply, how they work and the period for which they apply
- Under the FRC Code:
- service agreements and/or other documents relating to director remuneration must contain details of malus and clawback provisions
- annual remuneration reports should include:
- a description of malus and clawback provisions
- the circumstances in which they apply
- the period for which they apply and why it is considered appropriate
- a statement as to whether they were used in the preceding year and, if, so, an explanation of the reasons.
- It is important to get malus and clawback provisions right. The related corporate governance is tightening but the case of Steel v Spencer Road LLP (t/a Omerta Group) 2023 also confirms that employees would be wrong to assume malus and clawback provisions are unenforceable, whilst employers must ensure that the provisions are reasonable.
- Workforce engagement: give a clear explanation in the remuneration report of how executive remuneration is aligned to workforce pay
- Remuneration committees are required to take into account workforce pay and disclose how it aligns with executive pay. Many companies provide details of their workforce engagement activities in their stakeholder engagement statements but the 2023 FRC Review notes that only 18% of companies disclose how they explain to the workforce the alignment between executive pay and workforce pay.
MM&K is a full-service adviser on executive remuneration, performance and governance. We should be pleased to discuss any of the topics written about above. To do so, please contact Paul Norris.