MM&K remuneration dinners re-start on the topical, if controversial, theme of share options for NEDs, sparking a lively discussion on this complex issue

November 22, 2022


Last month, we restarted our series of remuneration dinners for Board Chairs, CEOs, Remuneration Committee Chairs and committee members. The format is that about twenty diners participate in what is usually a spirited discussion on a topical remuneration-related theme. This occasion was no exception.

The theme for the evening was provided by the Government’s proposed review of current rules for paying NEDs in shares or share options. The Government wanted 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. Despite the Government stating that it is not seeking to increase NED pay, only to look at whether there is a case for adjusting the proportion that might be paid in shares or options, its proposal has sparked a sharp reaction from investors.

The question for debate was; “Are shareholders right to be concerned about the Government’s proposed review?”

The Chatham House Rule applies to our dinner discussions, so we are not able to report on individual views and comments. However, it is clear that investors do not have a monopoly on expressing strong views about this subject.

To introduce the topic, we pointed to the absence of a level playing field, highlighted by the different approaches taken by UK corporate governance guidance depending on the type of company. The UK Corporate Governance Code, aimed principally (but not exclusively) at large premium listed companies, contains a clear prohibition, stating that remuneration for all non-executive directors should not include share options or other performance-related elements. The QCA Code, applicable to smaller listed and AIM companies, takes a more nuanced approach. NEDs should not normally participate in performance-related schemes or have a material interest in share options. Any performance-related pay should be proportionate and shareholders must be consulted. According to the Wates Principles, applicable to large private companies, boards should consider appointing NEDs and board remuneration should be aligned with performance, behaviours and achievement of company purpose. There is no expressed prohibition on NED participation in share schemes.

A large private company is one which has either 2,000 or more employees globally or global annual turnover exceeding £200m and balance sheet totals of more than £2bn. Many listed SMEs/AIM companies will fall within those parameters. Were they privately held, the environment for NED pay would be more liberal.

Internationally, approaches to NED pay also differ (as do board structures). This may assume greater relevance as UK businesses enter more diverse markets and developing companies need to make decisions about where to list their shares in order to recruit the NED talent needed to help them move their businesses forward to the next stage.

The US is held up as the benchmark regime for enabling (non-executive) directors to receive shares, share options or restricted shares as part of their annual remuneration.  In Europe, Germany, Austria and Spain (subject to a holding period) allow share-based payments to NEDs. In other parts of Europe, shareholders require both executive and non-executive directors to hold shares to promote diversity and attract talent and numbers of UK companies either encourage or require their NEDs to acquire and hold shares.

So, the question is not an easy one to answer, even if it is boiled down to what is the core concern for investors (and some NEDs) namely that awards linked to share price performance risk placing NEDs’ independence and objectivity at risk.

Some may find it hard to identify a greater risk to independence and objectivity in the case of a NED who is granted a share option, exercisable in the future by paying market value on the grant date, compared to a NED who, using personal funds, purchases shares at market value and retains them. Arguably, the option holder, who is not at risk until their option has been exercised might be said to be able to retain greater objectivity, at least until that point, than a NED who is a shareholder and whose financial position will have been at risk from the date they bought their shares. If the argument that acquiring any interest in shares is prejudicial to a NED’s independence and objectivity prevails, it would create the absurdity that no NED should be a shareholder in any company of which they are a director. Surely, a NED or prospective NED who feels that their independence and objectivity would be compromised by an interest in shares should not purchase any or accept the grant of an option. An interesting challenge in this debate is to resist applying subjective, personal views to a complex problem requiring the application of objective considerations to reach an objective solution.

Proportionality, perception and politics will be important considerations for the Government, as will the need of UK companies to attract both executive and non-executive talent to ensure they can compete and remain competitive in a global context. London, as a leading financial centre, will want home-grown businesses to choose to list on their home market and to attract overseas businesses to list here. It is important, too, that NEDs are and are seen to be, part of the checks and balances necessary for sustaining and developing their businesses for the benefit of all its stakeholders and that the UK regulatory environment shows itself to be attractive to both national and international issuers. Would it be too simple an approach to allow companies individually to put their case to shareholders and seek shareholders’ approval in general meeting for granting share options to NEDs?

That would be consistent with the core “comply or explain” principle of UK governance but would still leave open the question of how to deal with NEDs whose independence and objectivity is seen to have been compromised. A strong, fair and effectual corporate governance framework with oversight from the FRC, soon to be ARGA, is also required – a framework within which the regulators have the relevant powers and are seen (judiciously) to exercise them. The FRC has started the process of reviewing the UK Corporate Governance Code. Publication of the revised Code is planned for late 2023. We will be watching progress and will take all opportunities to participate in consultations.

The Government is right to review current rules and regulations for NEDs, as investors are right to express their concerns. The issue is complex. But the process is under way. Two MM&K partners were included in a panel of NEDs and expert professionals convened by the QCA to discuss the Government’s approach to paying NEDs in shares or share options with two BEIS representatives. The discussion, like our discussion over dinner, elicited strong views. Assuming the Government proceeds with its proposed review, there will be a consultation process in which we will also participate and on which we will keep readers informed.

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

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