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EU proposes new rules on executive pay

The EU's shareholder rights directive potentially introduces some important rule changes on executive remuneration such as a limit to share-based pay and publication of a ratio between top and average

 

Calling all MEPs

This blog recently alerted readers to proposed changes in EU law that would have profound.effects on executive pay at listed companies in Europe. The vote was originally planned to take place at a plenary session of the EU Parliament in the week ending 12th June.

This important decision on the future of remuneration has now been postponed until July and the opportunity to introduce some lasting and positive changes that will have an impact on excessive pay is in danger of being missed.

Estimates put the number of MEP votes still needed to pass the amendments at 70. We all have an MEP so let yours know how you feel about their forthcoming vote on this important issue.

Support the amendments!

Paul Marsland
The attempts to amend EU rules on shareholder rights have reached the Parliamentary stage.


The latest iteration of the version going through the European Parliament includes a section dealing with remuneration and the amended shareholder rights directive (SRD) is now awaiting its first Parliamentary reading.


The current version is not expected to survive intact but there is much in it that is worth protecting. Important changes on the following issues are included amongst the many amendments proposed:


Binding vote on remuneration policy - At present the SRD includes a Binding vote on  remuneration policy. This would be a significant but welcome change for most member  states in the EU although such a vote was introduced into UK legislation in November 2013.
Pay and employment conditions throughout the organisation - The SRD continues to  require that Policy must explain how pay and employment conditions elsewhere in an   organisation are taken into account when setting directors’ pay policy .This is unchanged  from current requirements and falls short of what is needed for a robust mechanism to   ensure employee pay stays in touch with executive pay.


Share-based pay -  The amended directive states that Member States shall ensure that the  value of shares does not play a predominant role in any financial performance criteria used  to inform directors’ pay. Under this proposed amendment, Member States shall ensure that  share-based remuneration does not represent the most significant part of directors' variable  remuneration.  This would require a major shift in executive remuneration policy for practically all listed companies in Europe. The amendment is not accompanied by supporting details and much depends on interpretation, but if share-based pay is defined as  pay for which the value depends on  references to the value of shares,  the proposal  potentially introduces a ceiling for pay-outs from schemes that use Total Shareholder  Return as a performance metric. A recent study by the High Pay Centre showed TSR to be the most popular measure for companies in Europe.


Employee representation - The amended directive now includes a provision that Member  States shall ensure that relevant stakeholders, in particular employees, are entitled to  express a view, via their representatives, on the remuneration policy before it is submitted  to the shareholders - the same is true of the vote on the remuneration report. Leaving aside  obvious questions about how employee representatives might be legitimised in states  where co-determination or board representation are not already part of the regulatory  landscape, this proposal offers a way around the principle difficulty with having employees  on remuneration committees. Such committees are comprised solely of independent  directors to address the obvious conflicts of interest involved and employees cannot be  considered independent. If committee members must be directors, then it follows that  employee director members take on directors’ duties as codified by law with all the liabilities  and fiduciary duties that implies.


Pay Ratios -  The amended directive now says that companies must disclose in their  remuneration report the ratio between the average remuneration awarded, paid or due to  executive directors and the average remuneration of employees during the last financial  year where the remuneration of part-time employees is included on full-time equivalent  terms. The version proposed by the European Commission did not contain reference to pay ratios.  This new provision makes up for the laxity of the requirement to explain how pay elsewhere  in the company is taken into account. As we have seen in the US, computation of a ratio of  board to employee pay is not a trivial exercise and the way this amendment is phrased  seems likely to attract a lot of scrutiny. The real value here would be if the concept of a  ratio, however computed, makes it through the rest of the legislative process. The amended  directive also requires disclosure of the change in the executive to employee ratio over a  period of three years.


Pay awards outside approved policy – The directive proposed by the Commission permits  remuneration to be paid to a director outside of approved remuneration policy. The  amended directive seeks to limit the circumstances under which this would be allowed and  limits pay outside of approved policy to a single occurrence. It is worth noting that some of  the highest dissenting votes in the UK on remuneration have coincided with perceived  breaches of policy that had already been approved by shareholders.  Perhaps the most  significant flaw in the current remuneration model for listed companies relates to the lack of  a properly functioning market for executive recruitment and it is critical that the role played  by remuneration in supporting this distorted recruitment market is directly addressed by the  the new legal requirements.
A vote in plenary is scheduled for the 9th June. Although the positive direction being taken by the amended directive is welcome, the gains must now be defended. Public expressions of support for the remuneration articles in the amended directive in its current form will help encourage legislators to do the right thing and we encourage all interested parties to add their voices to the debate.

Posted on 27 May 2015

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