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In reward and remuneration, comply but also explain

Paul Ellerman & Jemima Coleman
employee ownership

You won’t often hear your lawyer say that, in the field of reward and remuneration, compliance with your disclosure obligations is necessary, but making sure that you have a good story to tell is more important. Contributor Paul Ellerman Partner and Jemima Coleman Professional Support Lawyer – Herbert Smith Freehills.

Increasingly, issues of fairness and diversity have gained prominence on company board agendas. The deadline for the second year’s gender pay gap reports has now passed.  Just over half of private companies reported gaps that are higher or the same as last year’s.  Further, a recent BEIS Select Committee report, entitled, “Executive rewards: paying for success”, highlights a concern that huge pay differentials “between those at the top and bottom remain the norm” which is liable to foment hostility, accentuate a sense of injustice and undermine social cohesion and support for the current economic model.

Yes, there are yet more reporting changes to digest this year, including a requirement to describe, from 2020 onwards, how discretion has been exercised in determining vesting outcomes, the extent to which share price fluctuations have affected the value of awards on vesting and, for quoted companies with more than 250 UK employees group-wide, reporting in 2020 on their CEO pay ratios (if not already doing so on a voluntary basis).

Other changes may result from the EU Shareholder Rights Directive, requiring companies to disclose total variable and fixed remuneration for each of their directors, as well as the percentage change in each director’s remuneration (rather than just their CEO) compared with that of their workforce. 

But it’s not just a matter of simply complying with the legislation on a tick-box basis.  Over recent years, companies (mainly listed companies) have been required to become ever more transparent in relation to their pay and policies, with legislation covering detailed directors’ remuneration pay reports, gender pay reporting and CEO pay ratio requirements.  In each of these cases, whether under the relevant regulations, institutional investor guidance or Government Q&As, there is a requirement or voluntary recommendation to provide an explanatory narrative.

Just look at the GC100 and Investor Group Guidance on CEO pay ratios.  In their view, best practice will be all about how the regulations have been applied to the individual circumstances of a company, as well as taking a consistent approach across multiple years.  Shareholders will pay particularly close attention to why pay ratios have changed (if at all), what factors caused any change, any noticeable trends in the median pay ratio and how this ratio is consistent with the pay, reward and progression policies for employees.  Shareholders will also want an explanation of why the median pay ratio is a fair reflection of a company’s approach to pay and if a remuneration committee thinks it isn’t consistent with pay, reward and progression policies, then a description is needed of the action that will be taken to address this. 

Be aware that reporting is only part of the picture, with employee engagement now becoming an extremely important issue for companies.  Following changes to the UK Corporate Governance Code, a remuneration committee must review remuneration elsewhere in the group and companies must engage with their workforce using one or a combination of the following methods:

– A director appointed from the workforce;

– A formal workforce advisory panel; 

– A designated non-executive director.

And, in relation to addressing the gender pay gap, having a good story to tell may not be enough. Stakeholders including investors, employees and customers are beginning to focus on what action a company is taking to address the underlying causes.  Some companies have published action plans on a voluntary basis setting out initiatives around flexible work, maternity and parental leave, support for women’s career progression through sponsorship and mentoring.  

Perhaps the Government will respond to commentators urging it to make action plans to address the gender pay gap mandatory.

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