Mandy
Perry, associate in the employment team at Jones Day Gouldens, offers advice on
drawing up a guide on executive pay
Introduction
The
remuneration of senior executives continues to grab headlines. In May the shareholders at GlaxoSmithKline
mounted a successful rebellion against the company’s executive remuneration
policy and in particular, the severance package contained in the chief
executive’s contract.
This vote
came on the back of trade and industry secretary Patricia Hewitt’s announcement
that she is going to address what she terms is the “rewards for failure”
culture, by initially releasing a consultation paper this summer which will
look at ways of legislating to limit so called ‘fat cat’ salaries.
The
policy’s aims
Remuneration
issues should be dealt with in the contract of employment, and the policy
should be used as a guide for those drafting the contract to help them consider
what should be included.
During the
initial stages of the employment relationship, when an employer may have gone
through considerable efforts to get an executive on board, it is often possible
for the parties involved to produce such things as loosely worded bonus clauses
or to fail to fully deal with what will happen when the relationship ends.
It is vital
that the employer considers these issues at the beginning of the relationship
because it is often the only chance it will have. The policy will help to
achieve this.
Best
practice
In addition
to the Combined Code 1998, the National Association of Pension Funds (NAPF) and
the Association of British Insurers (ABI) released a joint statement of best
practice on executive contracts and severance in November 2002. Its main points
are:
– Phased
Payments: payments in lieu of notice should be paid in monthly instalments so
these payments can be stopped as soon as the executive finds new employment
–
Liquidated Damages: agreement at the outset on the amount that will be paid in
the event of severance is discouraged, as are change of control clauses
(severance payments on change of control of the company) other than in highly
exceptional circumstances
– Bonuses:
clear performance conditions should be attached to variable pay and boards may
also wish to specify that a proportion of the bonus is for retaining the
executive, and this should fall away in the event of severance.
–
Mitigation: every step should be taken to ensure that the company receives the
full benefit of any duty upon the departing executive to mitigate their losses.
Essential
elements
The most
important aspect of a senior executive’s remuneration package is clarity. Ambiguities can at best lead to protracted
discussions and larger pay-offs and, at worst, to litigation.
Salary
should be clearly stated with details on when and how it will be paid and when,
and how it will be reviewed. Any salary review clause should not guarantee an
increase.
Bonuses and
commission clauses should be set out in some detail. The schemes should be
clear and performance measures stated.
It is
sensible for an employer to retain a discretion to amend or remove such
schemes. Such a discretion cannot be exercised capriciously (Clarke v Nomura), but it will enable an
employer to retain an element of control. The clearer the terms of the scheme,
the less it will be open to dispute, and the more an employer can measure its
employee costs. There should also be
provision for how any bonus or commission is dealt with upon termination of employment.
Notice
periods are often viewed as their ‘golden parachute’ by executives. Employers
should think very carefully before entering into long notice periods. For
listed companies, the recommended maximum length of notice under the Combined
Code 1998 is one year, while the NAPF/ABI Joint Statement encourages employers
to consider six months.
Grey
areas
The
Combined Code 1998 sets out principles of good corporate governance for
officially listed UK companies. Compliance with the code is entirely voluntary
but companies subject to the code are required to explain any non-compliance to
shareholders in their annual report. As it only applies to UK official listed
companies, not all companies need comply.
The
NAPF/ABI joint statement also only applies to listed companies at present and
again is voluntary.
It is
unclear whether the DTI consultation paper will lead to legislation which could
apply mandatorily across the board or whether it will lead to changes to the
Combined Code only.
Key
legislation
The
Employment Rights Act 1996
The
Companies Act 1985
The
Directors Remuneration Report Regulations 2002.
Useful
links
www.abi.org.uk/members/circulars/attachment/11802a_-_ABI-NAPF_guidel1-7360.doc
Mandy
Perry, is an associate, employment, Jones Day Gouldens, www.gouldens.com
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