The Government’s proposals on executive pay are now out. A lot has appeared in the press today but some more interesting aspects have not received coverage.  For example, it has been widely reported that companies with less than 80 percent approval of pay will be entered on a public register. From Alexandra Beidas, Partner at Linklaters LLP.

This information is already publicly available – but the additional requirement is more interesting. The register will also need to record what the company say they will do to address shareholder concerns.

In addition, although widely reported that privately-owned companies will have a voluntary code of corporate governance principles, the more interesting requirement is that all large companies will also need to disclose their corporate governance arrangements in their report and accounts.

There will be a statutory requirement for all companies of a significant size (private and public) to set out how the board has had regard to the interests of employees when running the business as well as the impact on the community and the environment.

As expected, there will be a requirement to publish pay ratios but this only needs to include UK employees.  Such ratio rules have proved notoriously difficult to draft.  In the US  the pay ratio regulations have taken more than four years to prepare and agree.

There are also some interesting proposals on strengthening the voice of employees and other stakeholders but mostly, it looks like the government considers corporate governance should be governed and policed by the FRC through voluntary codes, and by industry guidance.

When the Prime Minister announced her original proposals earlier this last year she said they were designed to address fairness. The changes now envisaged would not restrict directors’ pay but simply require more disclosure of it, by including a new ratio of CEO pay to average UK employee pay. This may actually stoke the fire rather than addressing the perceived problem of rising board pay and stagnant employee pay.

“The requirement to publish a pay ratio may focus the minds of remuneration committees on employee pay and force them to justify the quantum of CEO pay and any increases compared to employee pay year on year. But it will also lead to arbitrary results. Companies that employ fewer low paid workers or, perversely, those that outsource low paid workers rather than employing them, will have a lower, better looking ratio. Limiting the comparison to UK employees may also have perverse results for companies with mostly a non-UK workforce, though it is touted as having the advantage of simplicity in obtaining the required data. Companies will also be required to explain the changes to the ratio from year to year and how it relates to pay and conditions across the wider workforce. Emerging patterns here may well end up being the more useful elements of this new disclosure.

“The devil will be in the detail of how the CEO:employee pay ratio will be calculated. The government will consult on methodology and on the option of reporting ratios by pay quartile. So there is still a risk that we could end up with a number of methods – extinguishing any chance of realistic comparisons between companies in the same sector. The US rules on pay ratio disclosure show that methodologies can be complex, and potentially may be manipulated. The US rules allow companies to choose how to identify the median employee, for example using a statistical sampling of employees (rather than an annual survey of the entire workforce). They also allow companies to choose the date of comparison, within three months of the end of its financial year (so companies can exclude low paid seasonal workers) and to exclude non-US employees of up to 5 percent of the workforce. It will be important for the UK rules to avoid too much of this flexibility, to avoid robbing the disclosure of much of its intended usefulness.

“As expected, many of the measures – such as designating a non-executive director to represent workers, stablishing an advisory council that would have access to board members, or appointing individual ‘director from the workforce’ – will be part of the Corporate Governance Code. If so, will companies comply? They may choose to explain instead why such requirements are not suitable for their businesses, but in the present climate it would be tricky just to ignore these Code provisions. Companies may end up having to come up with more bespoke measures, for example, to take into account employees’ views on pay. This may end up having some positive outcomes.

“At first blush, the expected changes will place further pressure on remuneration committees to consult with shareholders. Companies will not want the embarrassment of appearing on a public register designed to name and shame those with a significant vote against pay. But remuneration committees are already very focussed on significant votes against due to the bad press such votes receive, so the register may turn out to be a gimmick which does not go any further to solving the perceived problem.”

Only a minority of the proposals – pay ratios, better disclosure of potential long term incentive pay outs – will be compulsory through changes to the board pay legislation. The rest are to be implemented either via industry groups such as the GC100, the Investment Association, the Institute of Directors or through changes to the Corporate Governance Code by the FRC. The overall impression is that the government is ultimately leaving it to companies and investors to find the best way to deal with executive pay and governance issues.