The Financial Reporting Council has revised its guidance on the UK Corporate Governance Code (Code), making it clear that the remuneration of non-executive directors in shares is appropriate, enhancing the ability of UK-listed companies to attract directors of the highest calibre.
The revised Code guidance indicates that:
- Many companies encourage non-executive directors (NEDs) to build a personal shareholding in the company, to foster alignment between independent NEDs and shareholders and reinforce long-term commitment and engagement.
- Boards may choose to pay non-executive directors (NEDs) a portion of their fees in shares (e.g. purchased at market price).
- In some circumstances boards may consider that alternative approaches to remuneration of independent NEDs are desirable. However, performance-related remuneration is not appropriate, as it may compromise the director's ability to provide independent oversight and challenge when considering executive decisions. If companies consider offering independent NEDs options or similar rights to acquire shares, they should not be performance-related (e.g. they should not have a meaningful exercise price which would impair director independence). Care should always be taken to ensure the structure does not incentivise short-term decision-making, create conflicts of interest or impair independence.
- The approach taken may vary depending on the specific nature of the NED's role, time commitment, company size, sector, and board composition, and should be considered within the broader context of governance and wider remuneration arrangements.
- Companies are encouraged to set out the approach taken in their annual report. A description outlining the rationale and process for allowing a portion of NED fees to be paid in shares, along with any associated restrictions on the sale of the shares, helps to ensure clarity for stakeholders.
The revised guidance applies to companies with UK-listed shares which apply the Code.
To date, payments to NEDs have generally been limited to fixed fees. The articles of many companies cap the aggregate fees payable to directors each year. Any shares awarded to NEDs have not been linked or subject to performance conditions, as the Code does not permit this:
- Under Provision 34 of the Code, the remuneration of NEDs should not include share options or other performance-related elements.
- Under Provision 10, circumstances which are likely to impair a NED's independence include whether the NED receives remuneration from the company apart from a director's fee or participates in share option or performance-related pay schemes.
The revised Code guidance relaxes the prohibition on share options for NEDs, provided the options do not have a meaningful exercise price. However, the prohibition on performance-related pay for NEDs remains in place.
Companies should bear the following in mind when deciding how to respond to the revised Code guidance:
- Remuneration levels for NEDs should continue to reflect their time commitment and responsibilities (in accordance with Provision 34 of the Code).
- Remuneration should be appropriately calibrated to attract and retain directors of sufficient calibre and experience while maintaining shareholder support by not overpaying.
- Paying NEDs in shares (and potentially imposing restrictions on sale) may help to better align the interests of NEDs with the long-term interests of shareholders.
- Performance-related share options or share awards are not permitted by the Code and should be avoided.
- Companies should consider the potential timing of any awards of shares to NEDs, taking into account possible restrictions on share dealing when inside information exists or during closed periods under the UK Market Abuse Regulation.
- Companies should check that their proposed approach is consistent with their current directors' remuneration policy and any limits on directors' fees in their articles of association. If not, companies may wish to consider amending their remuneration policy (when it next comes up for shareholder approval on a three-yearly basis, or sooner if desired) and/or their articles.
- The rationale for the company's chosen approach should be clearly explained in communications with investors, including the directors' remuneration policy and report.
- NED remuneration structures should ideally be easy to understand, explained in plain English, clearly linked to the requirements of NEDs' roles, and justified by reference to appropriate peer companies.
We expect that listed companies will closely monitor how NED remuneration practices develop, with particular focus on their peer companies and key competitors. Investors are likely to reward those companies which consistently deliver talented and well-respected Board candidates through an appropriate and thoughtful approach to remuneration.
Tom Matthews, Partner and Head of White & Case's EMEA Activism practice, commented:
"This is a win-win for shareholders and issuers and brings the UK more in line with the US and private markets. Activist shareholders and international investors with stakes in UK companies have long complained that NEDs in the UK are not given an incentive to help drive their success by owning shares. By encouraging broader levels of share ownership by NEDs, including through share-based remuneration, this should improve the quality of NEDs in the UK market and better align them with shareholders generally. This change will also allow listed companies to attract and retain the best talent on their boards without committing to pay more cash than they would be comfortable with. Additionally, it reduces the risk of overboarding, allowing NEDs to focus on fewer roles, ultimately strengthening their oversight of management teams."
Patrick Sarch, Partner and Head of White & Case's UK Public M&A practice, commented:
"Listed companies and shareholders benefit from having the highest calibre NEDs in the boardroom. However, it can be a challenging role, and there is a limited pool of talent with the requisite experience, skills and industry credibility that investors value. While the form and quantum of remuneration are only one element in securing top candidates, in a competitive market they have a role to play. The new guidance provides additional and welcome flexibility in this area, and vitally an opportunity to better align the interests of NEDs with the long-term interests of shareholders, which should appeal to boards and investors alike."
Peter Wilson (Professional Support Counsel, White & Case, London) co-authored this publication.
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