Directors' pay: Guide to government reforms: It is not transparency it is simplification

I am thinking these reforms are as watered down as I was on my way to work this morning. The government has published its report on directors' pay reform proposals.

These plans are to strengthen the hand of shareholders and increase transparency. Well I think transparency is the wrong word because that implies more disclosure. Well in fact most of what is being proposed is already disclosed in most if not all annual reports. What these proposals are, is at best simplification.

I do not think I have to discuss the proposal to give shareholders a binding vote to a great extent. This is simply a bad idea. The government has pandered to its audience that believe shareholders own the company and somehow employee the directors. Quite simply they don't. The company as a separate legal personality appoints directors to undertake responsibility for its assets. It is for the company to reward its directors, not the shareholders. But for this to remain viable and for there to be a reduction in agency costs there needs to be a body of independent directors who reward the executive directors who actively run the company. This is where the real problem has stemmed from. These independent directors only became prominent on boards when they became useful to the executives, i.e. through helping in strategy and advice. Supposed independent non-executives have become increasingly involved with the running and strategy of the company which reduces their independence.

Thus I remain unconvinced that shareholders deserve a stronger hand. They buy shares in a company, they do not own it. If they do not like what the bought then they can sell it.

If remuneration is going to be managed properly you need to ensure that the non-executives who are deciding on remuneration are truly independent. This does not mean all non-executives need to take a step back, just those deciding remuneration. The Corporate Governance Code or the Financial Reporting Council is suggesting to revise the Code with measures on restrictions in regard to executives sitting on remuneration committees at other companies. This is probably a positive step, but one from the FRC rather than the government proposals. See here for relevant links.

For some of the proposals...

It would be interesting to see how the government tries to disclose details of the directors' employment contracts. Their rights as an employee are separate for rights as a director. I am not quite sure if this is something that should be published in annual reports. More information needed though before further comment.

The proposals want details of what directors will get paid for performance that is above, below or on target. Well anyone who owns a calculator could figure that out from the annual report already. They are required to disclose the shares awarded in a particular year and share price they were awarded at. They also publish the criteria that performance is measured against at the percentage that will vest depending on what targets they meet. Some firms do in fact already publish an estimated value at maximum vesting of the awards.

Thus this point does highlight that it is simplification and not increased transparency.

They also want information on the change of profit, dividends and the overall spend on pay. Well yet again this information is available through the annual reports. It is just more simplification.

They also want material facts taken in to consideration when setting pay to be published. Well let us face it, that is not worth the paper it is written on. Not to mention in most cases companies do already publish this. BP for example after the oil spill detailed their consideration of that matter in awarding remuneration. It did not stop their chief executive resigning that year on a package worth well over £5million if I remember correctly. What is the Government expecting from this proposal. A declaration that they considered these wider interests and then ignored them anyway. Increased evidence of watered-down simplification.

Table B of the proposals in the report do not seem to have any differences from what is already required of companies in annual reports. The requirement of a total single figure of remuneration does require companies to publish a single figure that includes variable pay and pensions. Again, the trusty calculator could have already done this without the need for reform. Apparently this figure will be calculated using a methodology complied by the FRC to include actual pay earned rather than potential pay awarded. However, the report does not clarify how this will then encompass pensions since this is never pay earned and is merely a debt on the company's balance sheet.

These are early days though. The next steps are for the government to bring forward reforms to the Enterprise and Regulatory Reform Bill as well as publishing revised Regulations setting out what companies must publish on directors' pay.

Do companies actually require a natural director or is Section 155 not worth the paper it is written on?

Under the Companies Act 2006 section 155 all companies are required to have at least one natural director. This is different from the common law position which allowed companies to have a sole corporate director (i.e. a company itself being a director) as established in the case of Bulawayo [1907] 2 Ch 458.

For any rule there has to be deterrent or incentive to follow it. Section 156 gives the Secretary of State power to give direction to any company where it does not satisfy this requirement. Section 156(6) makes it an offence for failure to comply with that director and is committed by every officer in default including shadow directors.

But what if the company is simply a sole corporate director that has no officers and no other directors? How can anyone commit the offence?

Naturally one may assume, well it should be the one who controls the corporate director and thus makes them a shadow director.

Unfortunately that natural assumption is incorrect according to the courts of first instance and Court of Appeal. On a number of occasions courts have categorically denied that an individual who controls a corporate director is a shadow director "without more". What the courts have meant by without more is that it means that the individual must not simply be performing the functions of a de jure director (i.e. someone formally appointed) at another company, or simply discharging the functions of the corporate director in that capacity. For case examples of this denial see Re Hydrodam [1994] BCC 161 or Secretary of State for Trade and Industry v Hall and Nuttall [2006] EWHC 1995 (Ch)

Thus the courts have not denied that on the facts it is possible for someone to be classed as a shadow director. However, it seems fanciful that it will ever be the case on the facts when in the recent case of Holland [2009] EWCA Civ 625 at first appeal, better known for the Supreme Court ruling [2010] UKSC 51, the court found the individual was not a de facto director despite being the guiding mind behind the company and the only one involved in the process. It is most likely that the court also affirmed Holland would not have been a shadow director either if the liability in question extended to shadow directors. The obiter comments from the Court of Appeal seem to suggest as much.

Thus, whilst the common law reached the position that an individual who controls the corporate director is prima facie not a shadow director, it is possible that Parliament have altered that position through section 156(6) otherwise the deterrent of ensuring one natural director will have no substance.

However such a stance does not pierce the corporate veil, i.e. treating the individual and the corporate director as one. It recognises that section 251 of the Companies Act 2006 is designed to catch those trying to usurp the position of director without formal appoint. Section 251 defines a shadow director as someone who the de jure directors have become accustomed to act on their direction and instruction. Thus the courts would be recognising that the corporate director as a separate legal entity has become accustomed to act on the individual's instruction and direction.

Despite this the courts may still be reluctant to find as much since they were unwilling to extend the concept of de facto directorship in the Supreme Court case of Holland on the basis, inter alia, that to do so would be to say all individuals who control corporate directors are de facto directors. Thus the same would apply here that to rule as such would be to say all individuals who control corporate directors are shadow directors regardless of whether they have instructed or directed them. However, this may be defeated on the basis that shadow directorship is case sensitive and it is not to say it does extend it for every case. This would effectively reverse the ratio from Hydrodam that without more someone is not a shadow director. This is because it would create the assumption that someone controlling a corporate director is a shadow director unless shown they did not instruct or direct them, rather than the other way round that someone is not a shadow director without more i.e. they did instruct or direct the corporate director.

The distinction is very artificial that has been created by the common law and section 155 attempts to remedy that through the requirement of having one natural director responsible for every company. However, if that requirement is to have substance it must be acknowledged that someone who controls a corporate director is in some capacity connected to that company, and is suggest that connection is through shadow directorship, otherwise the common law principles will prevent that enforcement.

Executive Remuneration and banks

I have blogged elsewhere briefly about executive remuneration see here.

According to a recent survey from Manifest, see here, executive pay was up by 10% in FTSE 100 companies in 2011 but in more than 25 companies the rise was greater than 41%.

So, who is dragging this figure up? Such averages would suggest outliers. So from my data of 30 FTSE 100 companies over 5 years 2006-2010 below are two tables of accumulative executive remuneration. The first is the mean and median of executive remuneration which includes: Salary and benefits, annual bonuses, share options exercised, and estimated value of long term incentive schemes.

The second table is the mean and median of executive remuneration from the banking sector.

Executive Remuneration FTSE 100	2006	2007	2008	2009	2010
Mean	£13252224	£14015869	£12873733	£12842835	£15786086
Median	£10688919	£12181900	£11690076	£8715581	£13254605

Executive Remuneration FTSE 100 (banking sector)	2006	2007	2008	2009	2010
Mean	£26537106	£27249329	£25528610	£18476199	£25184382
Median	£23432917	£22214810	£22349487	£17130259	£22695000

Thus it is no great surprise to find the banking sector is the one that is dragging up remuneration. The mean between 2009 to 2010 itself saw an increase of 26.6%. However, this data is only descriptive and accumulative. Further evidence from the data also shows a significantly larger ratio of long term incentives to base salary in the banking sector. Thus, whilst the figures are high not all of the figure represents money earned. The long term incentive schemes is merely an award that is subject to performance and service conditions, see here for a little more detail.