A government review of information about executive pay in annual reports finds that firms have generally complied with regulations introduced in 2013. A significant omission however is the disclosure of the maximum salary increase that executives can receive. The review recommends changes to the regulations to ensure that firms do publish this information in future.
New directors remuneration reporting regulations for UK listed companies came into effect in October 2013. Now that firms have completed at least one full reporting cycle since then, the Department for Business Innovation & Skills (BIS) has undertaken a review of how they have adapted their reporting practices to fit with the new regulations. While not quite ten out of ten, the BIS report, which was published earlier this month, finds that compliance levels across the sample of firms whose annual reports it reviewed was generally good. However there was one significant failing.
Of the 19 questions posed by the review with a pass or fail assessment, BIS reported a 100% or very high pass rate on 15. For three of the questions with a lower pass rate (the provision of a breakdown of pension entitlements, the reporting of payments to past directors, and the reporting of payments for loss of office), the principal issue was a failure on the part of firms to state that there had been nothing to report during the year. The report concludes that this probably meant that these firms, indeed, had nothing report against these categories, especially as all three questions are subject to audit (and therefore it seems reasonable to suppose that an auditor would have picked up any omission before the report was published). However, according to BIS, as the reports had not positively confirmed that there was nothing to report, shareholders couldn’t be sure, and therefore these responses were failed.
This left only one pass/fail question about which the BIS review felt that there was a serious and widespread failure to disclose the right sort of information. Under the regulations, firms must publish a summary of future remuneration policy, in which each element of the executive pay package is explained. This section must include, for each element of pay, a statement of the maximum amount that may be paid during the life of the policy (generally three years). The BIS review found that, while firms found this aspect of the regulations easy enough to comply with in respect of bonus or long-term incentive plans, only 7% of the reports sampled specified a limit on potential salary increases, either in percentage or absolute financial terms.
To most of us, this probably isn’t so surprising. Firms generally like to set their salary increase budgets relatively close to the point at which salaries will increase, based on prevailing economic conditions at the time. Most firms certainly wouldn’t contemplate setting a salary increase up to three years in advance in normal circumstances. And even if they did, they would be very reluctant to allow the budget to become public knowledge. Nevertheless, this is what the regulations require firms to do, albeit just for directors.
According to BIS, most firms have tried to work around this aspect of the regulations, for example by stating the principles that drive the level of salary increases awarded to directors, such as linking the increase to the amount awarded to other employees, or to inflation. In practice the trend has very clearly been to bring salary increases for executives down to a level which is no higher than, and often less than the increases awarded to other employees. This in itself ought to be a welcome development for the government in terms of the original, rather political context of the regulations.
BIS however is having none of it. The review recommends that the regulations are tightened up so that the letter of the regulations is followed in future years. And the regulations have the force of law – a breach of the regulations is a breach of the Companies Act 2006.
All of which means that firms will have to find a way to set a budget for senior executive pay increases that neither sets unrealistic expectations, nor constrains the company’s ability to reflect market movements in executive pay levels in the short- to medium-term. The main challenge will be one of communication. And arguably the best way for firms to achieve this will be through greater transparency – about how and why a budget is set, about the factors that determine actual salary increases, and about why actual salary increase might be less than the budget. Which is, after all, what the regulations set out to achieve in the first place.