In recent times, the trend towards accountability and transparency in respect of corporate governance (in particular for quoted and traded public companies) and the increase in shareholder activism means that companies not only have a statutory duty to comply with rules in relation to the remuneration of a company’s directors but that they also have to be responsive to the cultural demand from stakeholders to be seen to be acting openly and fairly. This article discusses the various ways in which the remuneration of a company’s directors is regulated, in particular for quoted and traded companies.
- What is directors’ remuneration?
- What regulations apply to directors’ remuneration?
- How to put together a remuneration policy
- Who decides directors’ remuneration?
- What about disclosure of directors’ remuneration?
- What you need to include in your directors’ remuneration report
- How should you calculate directors’ remuneration?
- Is director remuneration tax deductible?
What is directors’ remuneration?
Directors' remuneration is the way that directors of a company are compensated, either through fees, salary, or through other benefits with approval from the company’s shareholders, the board of directors, and in some circumstances, designated committees. The size of the company and whether it is a private or public company will dictate what the directors’ remuneration process should be for that company.
What regulations apply to directors’ remuneration?
There are several regulations that apply to directors’ remuneration and the key regulations are set out below:
Companies Act 2006 – model articles of association
For companies that are governed by the Companies Act 2006, model articles of association, which are standard default rules that govern how a company is to operate and be governed, can be used. A company can amend or replace the model articles with their own articles of association, so to a certain extent, can create bespoke rules for their company.
The model articles for companies incorporated on or after 28 April 2013 (the ‘model articles’) set out requirements relating to company directors’ remuneration. They state that directors are entitled to the amount of remuneration as the directors determine for their services to the company as directors, and for any other service which they undertake for the company.
Under the model articles, the remuneration can take any form, and can include any arrangements in connection with the payment of a pension, allowance or gratuity, or any death, sickness or disability benefits, to or in respect of that director. Unless the directors decide otherwise, directors’ remuneration accrues from day to day and directors are not accountable to the company for any remuneration which they receive as directors.
In relation to expenses that directors can claim, the model articles state that a company may pay any reasonable expenses which the directors properly incur in connection with their attendance at meetings of directors or committees of directors, general meetings, or separate shareholder meetings, or otherwise in connection with the exercise of their powers and the discharge of their responsibilities in relation to the company.
Companies Act 2006 – requirements for listed companies
The Companies Act 2006 sets out specific requirements for listed companies regarding the remuneration of directors, including imposing obligations on such companies to prepare a directors’ remuneration report and to provide information on directors’ remuneration in the company’s strategic report and accounts.
A listed company is one that is listed on the Financial Conduct Authority's (‘FCA’) Official List to trade its securities on a stock exchange for public trading in the UK and will have been admitted to trading with either a premium listing or standard listing.
Companies (Miscellaneous Reporting) Regulations 2018
The Companies (Miscellaneous Reporting) Regulations 2018 (‘2018 Regulations’) places obligations on what information a quoted company should include in its directors’ remuneration report, for financial years beginning on or after 1 January 2019.
A quoted company is a company whose equity share capital has been included in the FCA's Official List or who is officially listed or admitted to dealing in an EEA state, the New York Stock Exchange or the Nasdaq.
The 2018 Regulations were amended by the Companies (Directors’ Remuneration Policy and Directors’ Remuneration Report) Regulations 2019 to extend certain regulatory obligations to unquoted traded companies for financial years beginning on or after 10 June 2019.
A traded company is a company whose shares carry rights to vote at general meeting and are admitted to trading on a regulated market in an EEA state.
UK Corporate Governance Code
The 2018 UK Corporate Governance Code (the ‘Code’) is a set of standards published by the Financial Reporting Council that apply to companies with a premium listing on a UK regulated market under the UK Listing Rules for financial years beginning on or after 1 January 2019.
The Listing Rules (‘LR’) are a set of regulations from the UK Listing Authority that apply to any company listed on a UK stock exchange. To be ‘listed’ a company needs to apply to the FCA to be put on an Official List of entities that can trade on a market and the FCA sets out the criteria that those companies have to comply with to be accepted onto the Official List (the LRs are part of this criteria). Companies have a choice under the LRs as to whether to apply for a standard or premium listing – the type of listing a company chooses will dictate the level of requirements that it has to comply with.
A premium listing requires a company to comply with the listing requirements imposed by both EU legislation and additional UK provisions set out in the Listing Rules.
A standard listing requires companies only to comply with obligations imposed by EU legislation.
There are different versions of the Code – one in 2016 and one in 2018. The 2016 version applies to financial years beginning on or after 17 June 2016 and before 1 January 2019. The 2018 version applies to financial years beginning on or after 1 January 2019. This article focuses on the 2018 version only.
The Code sets out best practices for a company’s remuneration policies and practices, which should promote the long-term sustainable success of the company and be aligned to the company purpose and values.
The Companies (Directors’ Remuneration Policy and Directors’ Remuneration Report) Regulations 2019
The Companies (Directors’ Remuneration Policy and Directors’ Remuneration Report) Regulations 2019 (‘2019 Regulations’) are reporting requirements which implement Articles 9a and 9b of the revised Shareholder Rights Directive (known as ‘SRD II’) for companies reporting on financial years starting on or after 10 June 2019.
SRD II came into effect to better enable shareholders of EU incorporated companies trading on a regulated market situated or operating within the EU to exercise their rights and to receive transparent and accessible information about how the company is operating.
The 2019 Regulations amend the Companies Act 2006 and apply to both UK incorporated quoted, and traded whether quoted or unquoted, companies. The 2019 Regulations require these companies to report to their shareholders on their statutory directors’ remuneration (both the individual remuneration and the collective policy) in the directors’ remuneration policy and the directors’ remuneration report. It also gives the company’s shareholders a right to vote on and approve the directors’ remuneration policy at least every three years. Annually, the shareholders also have the right to an advisory vote on the directors’ remuneration report.
How to put together a remuneration policy
When putting together your company’s remuneration policy, it is important to not only consider individual director’s remuneration and how that has been calculated but to demonstrate that the company has a clearly defined and transparent framework that it uses to calculate remuneration on a general basis. This illustrates compliance with UK legislation and shows that the company has a good corporate governance regime.
Companies that are required to establish a directors’ remuneration policy need to have the policy approved by their shareholders at least every three years. If your company already has a remuneration policy that received shareholder approval before 10 June 2019 (the date that the 2019 Regulations came into effect), that policy can continue for the remainder of its three-year period. If your company did not have a policy in place on 10 June 2019 and it now needs to, the company should have had a policy approved by its shareholders by 1 January 2020.
The directors’ remuneration policy is also required to contain a future policy table which describes each part of the package that makes up a director’s remuneration.
For each part of a director’s remuneration package, the table should include details of the purpose of that part and in particular how it supports the company’s strategic goals, how the component works in general, how performance is assessed (including any parts of the remuneration package that are weighted differently to others) and should detail any rights of the company to withhold or recover payments. Other general aspects that need to be included in a company’s directors’ remuneration policy include:
- An explanation on the decision-making process behind the policy and how the company is going to implement and review the policy.
- What measures the company has put in place to manage any conflicts of interest arising out of the policy.
- Details of the role of the remuneration committee (or other related committees).
- A statement setting out the principles of how the various parts of a director’s remuneration package are put together and how the company agrees each component part. The statement should also include what the maximum level of variable remuneration is (this could be monetary or include other benefits) and what payment can be made for a minimum level of performance. For each statutory executive director, a company should specify the performance targets for more than one financial year used in calculating the remuneration. The policy should also set out an indication of the ceiling on the remuneration that is available to that director, on the basis of an assumption that the company’s share price has grown by 50% during the relevant performance period.
- Information on shares or share options that have been awarded to the directors, including the vesting periods and any holding or deferral periods.
- Details of the duration of the director’s service contract and any obligations in a director’s service contract that could have an impact on that director’s remuneration or loss of office payments. The details of where the directors’ service contracts and letters of appointment (if relevant) are kept should also be noted.
Companies should also compare their future remuneration policy to the previous financial year’s remuneration policy and any significant changes to the new policy should be highlighted and explained. A ‘significant change’ is not defined under legislation however there are a number of advisory groups and industry bodies in the UK that offer guidance on how this threshold should be interpreted.
Recent regulatory changes have also required the director’s remuneration policy to be assessed in the context of the wider labour force in the company. Companies are required to make publicly available a statement about the employee pay policy for the company as a whole, including:
- The influence of the wider employee pay policy on the directors’ remuneration policy
- If and how the company consulted with its employees when drawing up the directors’ remuneration policy
- A comparison of calculation measures (if any) between the policies and an explanation as to why
The Code also provides guidance that directors should engage with the company’s workforce so that the workforce can raise any concerns they may have on the remuneration policy.
Under the Code, a company’s remuneration committee is recommended to review workforce remuneration and related policies, to set remuneration for senior management and to factor the culture of the company into the remuneration calculations.
Pension commitments for executive directors, or payments in lieu, should also be compared and if necessary recalibrated in accordance with the pensions available to the company’s workforce.
The 2018 Regulations (as amended) require that the director’s remuneration policy contains a bar chart for each statutory director showing the remuneration that each director will receive for the first year. In particular, it should provide details on the available remuneration (including salary, fees, benefits and pension) for minimum performance, the estimated remuneration that the director is actually expected to get and the maximum remuneration available. The bar chart should also detail whether performance targets are for one or more financial years.
For non-executive directors, the directors’ remuneration policy may also set out details of how the company calculated the basic fee and any additional amounts to be paid to non-executive directors.
If a company is governed by the Companies Act 2006, the 2019 Regulations or is within the scope of the Code, that company is obliged to take its shareholders’ views and opinions on the company’s directors’ remuneration policy into account – it must demonstrate in the policy itself how this has been done. Once the shareholders have been engaged, the company’s shareholders are required to approve the directors’ remuneration policy.
The process is as follows:
Advisory vote: The shareholders of a company are entitled to an advisory vote by an ordinary resolution on the company’s report to approve the remuneration for directors on an annual basis. The vote is advisory only and the directors’ entitlement to remuneration is not conditional on the resolution being approved. What the vote does is send a clear message to the company as to whether the shareholders are in support of the company’s approach. If the company does not give the shareholders an opportunity to vote, then every officer of the company can be liable to a fine. Details of the vote must be set out in the directors’ remuneration report.
Binding vote: The shareholders of a company are entitled to a binding vote by an ordinary resolution on the directors’ remuneration policy at least every three years. Shareholders are required to vote on changes to the policy within the three-year period, or any amendments to the policy to avoid any remuneration or loss of office payments being made without approval. The company needs to provide details of how shareholders voted in its directors’ remuneration report and on its website.
The company has to provide details on its website as soon as reasonably possible of the shareholders vote (including any abstaining shareholders, who voted for and against the vote, the date that the vote took place and the results of the vote itself). If the shareholders reject the policy proposed by the company, then the company has to put forward another revised remuneration policy to the shareholders within a year of the original vote.
For the purposes of both the directors’ remuneration report and the directors’ remuneration policy, the definition of ‘directors’ include the company’s chief executive officer and any deputy chief executive officer (if the company has one).
Sometimes a company might want to continue using some parts of its previous remuneration policy and the shareholders need to be told which parts are from the existing policy and how long it is intended that they will apply for, and which parts are new.
Some companies will make provision for the directors to be able to exercise some discretion when implementing the directors’ remuneration policy. In this case, the parameters of the permitted discretion should be documented in the policy itself.
If the company does not follow its directors’ remuneration policy and remuneration or loss of office payments are made after the policy comes into effect that deviate from the shareholder approved guidelines, then there can be consequences for breaching the policy, such as fines. The shareholders of the company can however approve an amendment to the remuneration policy to allow the deviating payment to be made in line with the amended policy. Details of the reasons for the amendment will need to be published on the company’s website up to the date of the next accounts meeting. Amending part of a director’s remuneration policy does not reset the three year term of the overall policy.
If the directors’ remuneration policy is not amended, then the company has no obligation to make a non-compliant payment and any payment that deviates from the policy will be deemed to be held on trust for the payee. If a company makes a non-compliant payment, the directors who authorised the payment are jointly and severally liable and are at risk of having to repay the company if it incurs loss as a result of the payment being made. Directors have limited defences in this circumstance. Both directors and shareholders can bring legal actions to try and get the non-compliant payment back.
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Who decides directors’ remuneration?
For most companies, it will be the company itself that is in charge of determining and paying the remuneration of its directors (usually in accordance with provisions in the directors’ service contracts). But increasingly, the decision-making process is contributed to in a significant way by several stakeholders, particularly for listed companies – including the company’s shareholders (who vote on the directors’ remuneration policy), the company’s employees, the company’s remuneration committee, and the issuance of best practices by prominent industry bodies (such as the Code).
A remuneration committee is a committee that is separate from the board of directors and is set up as a best practice by a company to ensure good governance of its remuneration policy.
The role of the remuneration committee is to, by way of delegated authority from the directors, formally assess the remuneration policy for executive directors, senior management and chair of the board, independently of the statutory and executive directors to ensure that they are aligned to the company’s purpose, strategies and long-term success.
The table below sets out the recommendations from the Code for companies that are going to establish a remuneration committee:
|Composition||The members of the committee are usually appointed by the board of directors of the company (based on recommendations) for a fixed term. The committee should contain at least three independent non-executive directors (or two for smaller companies - a smaller company is one below the FTSE 350) and does not include the chairperson of the company’s board of directors. A remuneration committee should have terms of reference that govern how the committee is run and the scope of its authority.|
|Chair||The chairperson should be an independent non-executive director. The chairperson of the board of directors can only be a member if they are an independent appointment by the company and cannot chair the committee.|
|Meetings||The committee chair and members are entitled to be present at meetings. There is no fixed number of meetings – it is largely dependent on the needs of the company itself. The committee should meet at least once a year to review the directors’ remuneration report prior to its submission as part of the company’s annual report and before it is put to the shareholders for approval.|
|Reporting||Minutes and attendance records should be taken of all meetings and sent to the board of directors, provided there is no conflict of interest. The chairperson of a company’s remuneration committee has to include details of any discretion exercised by the committee when calculating directors’ remuneration.|
The Code calls on the remuneration committee to address clarity, simplicity, risk, predictability, proportionality and alignment to culture when reviewing the remuneration policy. This is intended to support the strategy of the company, promote long-term success and align the policy with company values. Some other key guidelines of the Code include the following principles and provisions that:
- The remuneration committee should decide the remuneration policy for executive director remuneration and should decide the remuneration of the chair, executive directors and senior management.
- The company’s remuneration policies should allow the board to be able to override any formulaic remuneration calculations.
- The remuneration committee should develop a policy on post-employment shareholding requirements (including relating to vested and non-vested shares).
- The remuneration committee should exercise independent judgement and discretion when approving remuneration, taking into account both the performance of the company and the individual director and any other relevant circumstances.
- The chairperson of the remuneration committee should have served on a remuneration committee for at least 12 months previous to their appointment.
- The name of each director who was or is a member of the remuneration committee must be disclosed.
- Non-executive director remuneration should be determined in accordance with the company’s articles of association or by the board and should be reflective of the time commitments and responsibilities of those directors.
- There should be a disclosure in the annual report of any remuneration consultants appointed by the remuneration committee.
- The company should encourage long-term shareholdings by executive directors and share award incentive schemes. This gives the workforce actual shares released for sale on a phased basis so that not all shares are awarded at the same time promoting the continuous performance of the company over the long-term.
- The total period from when a worker is awarded a right to shares and the length of time that those shares vest and are held for, has to be longer than five years.
- There should be disclosure in the company’s annual report of the remuneration committee’s work, including the steps it has taken to engage with shareholders on the remuneration policy and the result of that engagement on the policy.
Remuneration consultants and advisers
The company’s remuneration committee may appoint consultants to advise it with its duties and its recommendation. The Code recommends that a company makes a statement in its annual report of the consultants (which can include both internal and external advisers) that the company has used to advise the remuneration committee, including details of any other connection that they might have to the company itself in the financial year.
The Code also recommends that the following information should be contained in the directors’ remuneration report: who the consultants are and how they were appointed, the cost of their advice and the fees structure for that advice, and a statement from the remuneration committee that it considers the advice given by the consultants to be independent and objective.
What about disclosure of directors’ remuneration?
Quoted companies or unquoted traded companies are obliged by law to make their annual accounts, annual report, directors’ remuneration report and directors’ remuneration policy available on their company website for each financial year.
If a company does not do this, it is an offence and every officer in default can be fined. The directors’ remuneration report has to be available on the website for ten years and must not include any sensitive personal data such as race, ethnicity or trade union membership.
What you need to include in your directors’ remuneration report
For companies that have to prepare an annual directors’ remuneration report in accordance with the Companies Act 2006, the 2018 Regulations and the 2019 Regulations, there is a wide range of guidance as what needs to be included in the report.
The report is subject to an advisory vote by the company’s shareholders. Failure to prepare and publish a report is an offence and the officers of the company may be liable for a fine.
The report should include the following:
Information relating to the remuneration of individual directors: Including actual payments (as single figures in a single total figure table) made to the executive directors (including those directors that were in office during the relevant financial year but are no longer – in addition, any person who was a director in the previous five years may also be obliged to provide information for the report where requested).
The single total figure for each director should include all amounts that make up that director’s remuneration package. The single total figure table should set out the total amount of salary and fees and the gross value before tax of all taxable benefits, in the financial year being reported on, as well as any money or other assets receivable as a result of performance, for one or more financial years, pension related benefits including payments made in lieu, any amounts that are the subject of withholding or claw-backs and the split of total fixed and variable remuneration awarded to each director.
Pay ratio of CEO: The remuneration of the CEO of the company should be compared to the remuneration of the company’s employees and the performance of the company over the last five years.
For quoted or unquoted traded companies with an average of more than 250 UK employees, the report should include a comparison table of the CEO’s pay (as a single figure) relative to the lower, middle and upper quartiles of remuneration (total pay including salary and benefits) across full time employees in the company (and its group).
The report should also provide explanatory notes that explain the table and how each element of the data was calculated. If the pay-ratio has changed from the previous year, then an explanation of the reasons for the change must be included too. Companies with 250 UK employees in one year but not the next year still need to report, but a company does not need to report unless it has 250 UK employees or more for two consecutive years.
Information relating to shares and share awards: Including any changes to the arrangements of the share awards, such as a change in price or date that the shares can be exercised and any general changes to share awards from the previous financial year.
Information should also include an estimated or actual calculation of the amount of the remuneration that is attributable to an increase or decrease in the company’s share price (and whether any discretion was used in this calculation). The report should also include details of which directors hold listed shares or shares that have been admitted to dealing and mean that the company is quoted or unquoted but trading.
Information relating to the workforce and the directors’ remuneration: Including a graph or table for the financial year and the previous financial year showing the company’s expenditure and any difference in spend on the pay of all group employees, dividend and share buyback distributions to shareholders. Plus, any other significant payments that may contribute to the directors’ decision to spend a certain amount on remuneration.
Information relating to remuneration consultants: Including details of any consultants that provide significant advice to the remuneration committee and to what extent they also provide other services to the company during the financial year, how they were appointed and by whom and what pay they received for their services. You do not have to disclose the provision of legal advice regarding complying with legislation, or if the consultant was an employee of the company at the time of providing the advice.
The directors’ remuneration report needs to be signed on behalf of the board of directors by a director or company secretary and when published, should state the name of the person that signed it.
The directors’ remuneration report must then be put before the company’s shareholders for an annual advisory shareholder vote. This should be filed with the Registrar of Companies at Companies House as part of the company’s annual accounts and reports and published on the company’s website. If the directors do not comply with these requirements, the directors may be liable for fines.
The company’s auditor can also report to the shareholders on the auditable part of the directors’ remuneration report to let them know whether that part of the report has been properly prepared. The single total figure for remuneration, total pension entitlements and payments for loss of office are some of the payments that are auditable.
How should you calculate directors’ remuneration?
How remuneration is calculated will differ from company to company and will be based on the facts and circumstances occurring in the financial year that is being reported on. A company’s directors’ remuneration policy should ideally reflect the values and strategy of the company itself and each policy is likely to be tailored to promote the ongoing success of the company.
Directors can be compensated through fees, salary, pension or through other benefits such as share aware schemes, or by a combination of all of these. One of the main reasons for the 2018 Regulations and 2019 Regulations is to ensure that the company’s reasons for making such remuneration packages available are transparent and justified to the company’s main stakeholders.
Is director remuneration tax deductible?
Certain elements of a director’s remuneration can be tax deductible and will depend on whether the director is an employee of the company, a non-executive director or an executive director.
Income tax and national insurance payments may apply to the remuneration received by company directors that are classed as employees for tax purposes. Directors may need to register for HMRC self-assessment, and it is important for both a company and its directors to each take professional tax advice on tax deductible director remuneration to ensure full compliance with their tax obligations.