The Three Fundamental principles of executives renumeration
The Greenbury Report in 1995 identified three fundamental principles which are accountability, transparency and performance linkage, in respect to executives’ remuneration. In UK, the current best practice disclosure pattern failed to compile with these fundamental principles therefore the government introduced certain necessary additions to the existing disclosure pattern. These latest requirements regarding disclosure of UK executives’ remuneration unifies the existing law, regulation and best practices that are mentioned in the UK Companies Act of 1985, the UK Listing Rules and the UK Combined Code of Principles of Good Governance and Code of Best Practice. The new requirement requires every company in the UK to adopt and prepare the directors’ remuneration report along with other necessary requirements.
Directors’ Remuneration Report (DRR):
Companies listed in the London Stock Exchange should prepare the directors’ remuneration report for every financial year (Section 234B Companies Act) and should publish this report along with the accounts and annual report of the company (Section 244 Companies Act). The preparation of the remuneration report is done by the board of directors and not by the remuneration committee being, a committee accountable and responsible to the board and consisting only the non executive directors of the company. The remuneration of both the executive and non executive directors is clearly mentioned in the remuneration report. The fully prepared remuneration report should be filed with the registrar of companies (Section 242 Companies Act) and made available and provided to all the parties interested in the company such as the shareholders, debenture holders, and other persons who are required to attend the general meetings (Section 238 Companies Act).
The remuneration report should contain all the information regarding the remuneration of the directors for the financial year completed i.e. the "relevant financial year" which includes disclosure of the amount receivable by the directors, whether paid or not, during the financial year as well as the disclosure of any amount paid as directors’ remuneration for any other period during the financial year (Companies Act, Schedule 7A, paragraph 19). The remuneration report should include the payments made to a third party for any services provided to the directors (Companies Act, Schedule 7A, paragraph 18(3)) and a statement showing the future remuneration policy of the directors. In UK, only the disclosure of directors’ remuneration is needed in the remuneration report. The name and information of every person who is the director, during the relevant financial year, has to be mentioned in the remuneration report.
The remuneration report contains information that has to be audited by an external auditor (Companies Act, Schedule 7A, Part 3) and information need not be audited (Companies Act, Schedule 7A, Part 3).
Information in DRR subject to audit:
With regards to information subject to audit, the external auditor in his own consent should mention whether the information provided are prepared according to the necessary requirement and if any information is not complied as needed, the auditor should provide a statement showing them (Sections 235 and 237 Companies Act). The auditor will also look into disclosure information that are not subjected to audit and verify them with the company accounts and disclosure information that are audited. The information in the DRR that are subject to audit is:
Emoluments and compensation – For the services provided to the company as an executive or any other services relating to the company’s management, the salary, bonus, fees or compensation for termination of "qualifying services" received or receivable by the executives should be disclosed in the DRR. The overall value of non monetary benefits provided to the executives should be mentioned and the total aggregate of each kind of executive compensation in the relevant financial year should be compared with the previous financial year (Companies Act, Schedule 7A, paragraph 6).
Share Options – The different types of shares options a company have should be mentioned according to their terms and conditions and besides each share option the total option each executive hold in the beginning of the relevant financial year as well as in the end should be disclosed. Detailed information of the options provided during the year, its exercise price, date of expiry, number exercised and unexercised by the executives, and options that have become void should be provided. If the share options are subject to any performance condition then the criteria is to be clearly described. For those shares that have been exercised, the market price during the time of exercise and for those shares unexercised ,the highest, lowest and the year end market prices have to be mentioned. Since the disclosure of share options is a lengthy process, the aggregate of options each director hold is done disclosure is can be made on the basis of weighted average exercise prices (Companies Act, Schedule 7A, paragraphs 7-9).
Long-term incentive schemes – Disclosure of "scheme interests" at the beginning and end of the current financial year which each executive hold must be made. Details of the type of scheme interest provided to the executives, its value and when it is vested in the year should be mentioned. If there are any conditions on the basis of which scheme interests will be granted then the relevant conditions should be specified (Companies Act, Schedule 7A, paragraphs 10 and 11).
Other Information – Details of executives’ pension scheme transfer value, any benefits that are accumulated over time and amount paid or payable by the company towards the money purchase pension scheme and retirement benefit scheme should be mentioned (Companies Act, Schedule 7A, paragraph 12). Amount received or receivable by the executives as benefits over and above the retirement benefit which he is entitled after 31st March 1997 should be included in the DRR (Companies Act, Schedule 7A, paragraph 13). If any person, who was once the executive of the company, has been given a special reward or if any third party is paid for their services provided to the executives during the relevant financial year it should be stated and disclosed (Companies Act, Schedule 7A, paragraph 14 – 15).
Information in DRR not subject to audit:
The information in the DRR that are not subject to audit is:
Remuneration Committee – If any decision regarding the remuneration of the executives is taken by a committee during the financial year then the DRR must contain the name of all the non executive directors who were the members of such a committee and also should mention the name of any other person who is not the member of the committee but has been appointed by the members to assist them with certain services and advice. The details of the services rendered by the outside party should be clearly mentioned and this is done to ensure that the executive director play no role and influence the decision making of the committee (Companies Act, Schedule 7A, paragraph 2).
Statement of policy on executives’ remuneration – A statement of future policy on executives’ remuneration for the coming financial years has to be included in the directors’ remuneration report (Companies Act, Schedule 7A, paragraph 3). The statement of policy should therefore disclose the conditions of performance, by an executive, for the entitlement of share option and long term incentive scheme along with the reasons for setting up such performance condition and the method used to assess the performance condition. If any executive fails meet the performance condition and does not benefit from the stock option grant or long term incentive scheme, the report should clearly state the conditions that are unsatisfactory. Details of the company on the basis of which the performance is measured should be provided in the report. Changes or amendments proposed to the existing terms and conditions for executive’s entitlement should be highlighted. Explanation should also provide for non-performance related remuneration and company policies on executives’ service contracts. This statement covers all directors from the end of the current financial year till the time when the report is put for voting by the shareholders of the company.
Performance graph – Publication of preceding 5 years performance graph should be included in the DRR showing the "total shareholder return" for holding shares whose listing transformed the company into a "quoted company" and for holding shares on the basis of which calculations are made for a broad equity market index. A "fair method" is used for the calculation of the total shareholder return along with various assumptions like the interest received on shares being reinvested (Companies Act, Schedule 7A, paragraph 4).
Service Contract – During the relevant financial year if any executive is provided with a service contract, the date at which the service contract has been provided, its duration and its terms and conditions should be mentioned in the remuneration report. A detail of the termination compensation the executive is entitled to receive along with the company’s liability on early termination is to be included (Companies Act, Schedule 7A, paragraph 5).
On the complete preparation of the remuneration report, in the annual general body meeting it is introduced and called for a vote by the shareholders of the company (Section 241A Companies Act). This concept of voting the remuneration report was a controversial topic as many commentators suggested the voting to be limited to only the remuneration policy rather than the whole remuneration report. The reason they point out is that the executives’ remuneration policies are futuristic in nature so the shareholders can express their opinion on the policies adopted rather than making aware of the actual remuneration paid to each individual director.
a) Along with the preparation of the DRR, disclosure of the aggregate compensation of the executive, loan given to the executives and other company transactions with the executive should be done in the notes of the annual accounts as mentioned in Schedule 6 of the Companies Act.
b) As per Section 251 of the Companies Act and Companies Regulations (1995), listed companies in their summary financial statements should as a statement, state its policies regarding the remuneration of executives and the company’s performance graph.