Hewitt: Laying down the law would be a mistake

We all know the history on directors’ pay. Longstanding mutter- ings about excessive salaries for poor performance became a loud chorus of disapproval in the wake of a run of excessive payoffs. This sparked a discussion about whether directors could be trusted to clean up their act, or whether government should step in.

The government has already taken significant action. The directors’ remuneration report regulations, introduced in 2002, require quoted companies to produce a detailed annual directors’ remuneration report and to submit it to shareholders at the agm.

These regulations give the UK a corporate governance framework for directors’ pay that leads the world in terms of transparency and accountability.

They have had an immediate impact, increasing the focus on directors’ remuneration by shareholders and promoting constructive dialogue between them and companies about remuneration strategy and practices.

Following calls for further action, I published a consultation document on last June seeking views on the extent to which further measures might be required to enable shareholders to ensure that any compensation paid reflects performance when directors’ contracts are terminated.

This generated a large response from institutional investors, companies, trades unions, accountants, remuneration advisers and many representative organisations. This demonstrates the interest in this issue and the concern about cases where poor company performance is accompanied by excessive remuneration.

The full impact of the 2002 regulations, however, cannot be measured after one year alone. For this reason, I have commissioned a detailed assessment of compliance with the regulations in the course of this year’s agm season, and an assessment of changes in remuneration practices.

The challenge for remuneration committees and their advisers is to produce rewards packages that tie pay and performance targets to the creation of long-term value for shareholders and are transparent.

Directors deserve rewards for good performance, but companies need to think creatively about the design of remuneration packages with those objectives in mind. It is also important that the pay of other employees should be taken into account. Directors should not be getting richly paid off when workers are getting laid off and the company is failing.

The improved design of all aspects will play an important part in creating an environment where good businesses can prosper; businesses that produce goods and services of high quality; are honest and fair in their dealings with consumers, employees and suppliers; and careful with their reputation, thereby creating sustainable, long-term value for shareholders.

Building on the regulations, the consultation document set out a range of options for tackling the problem of excessive compensation payments.

Most respondents considered that this was an area where the focus should be on promoting the take up and implementation of best practice.

In particular, there was support for reducing notice periods and the use of mechanisms, such as phased payments and liquidated damages, to reduce the problem of rewards for failure when contracts are terminated.

There have been positive developments on guidance on directors’ contracts, both from the Association of British Insurers and National Association of Pension Funds, and separately by the Confederation of British Industry.

I welcome their contributions and commend them to remuneration committees and their advisers.

Shareholders also have an important role to play in holding boards to account for policies in line with the code on activism agreed by the Institutional Shareholders’ Committee.

We carefully considered whether to introduce further legislation in this area, and have concluded that it is not necessary at this stage. I agree with the comments of trade and industry committee chairman that ‘the recent examples of increased activism by institutional investors, and the promotion of best practice has the potential to remedy the situation. The government should wait to see the effect of these developments before it considers legislative remedies’.

We specifically ruled out legislation of the type introduced by Archie Norman MP in his company directors’ performance and compensation bill.

The majority of respondents to the consultation felt that this would be unworkable for a number of reasons.

It would interfere with the operation of existing contracts, create unnecessary uncertainty and complexity in the negotiation of contracts, would be incapable of taking account of recruitment circumstances, act as a deterrent to the recruitment of good-quality directors and could potentially lead to lengthy litigation.

Of course, we are not complacent. I will be paying close attention over the next 12 months. The best way forward is through the development of best practice in negotiating contracts that deal with performance issues effectively, not for companies to enter into inadequate contracts in the hope that legislation will rectify any problems.

But if the monitoring demonstrates that changes to the Companies Act are required, I will not hesitate to take appropriate action.

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