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Directors’ Remuneration (Best Practice Guide)

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Directors’ remuneration refers to how directors of a company are compensated by a company for their services usually fees, salary, use of company property or other benefits. The packages are first approved by shareholders and the board of directors.

A number of regulations apply to how directors can be compensated, as well as best practices which together help ensure fair reward for directors’ contribution while protecting the company’s assets and interests.

 

Directors’ remuneration regulations

Companies Act 2006 – model articles of association

The Companies Act 2006 model articles of association will apply if a company has not implemented their own rules on how the organisation is governed and operated.

Model articles for companies incorporated on or after 28th April 2013, set out requirements relating to director’s remuneration and state that directors are entitled to the amount of remuneration arbitrated by the board of directors for their director services to the company, and for any other service they perform for the benefit of the company. Reasonable expenses may also be claimed by directors if they have been properly incurred during the discharge of directors’ responsibilities and the exercise of those powers.

The Companies Act 2006 sets out requirements for listed companies surrounding the remuneration of directors, including obligations to prepare and produce a directors’ remuneration report. There is also an obligation to provide the same information in the company’s strategic report and accounts.

Listed companies feature on the Financial Conduct Authority’s (FCA) official list to trade on the stock market for public trading in the UK.

 

Companies (Miscellaneous Reporting) Regulations 2018

These regulations place obligations on the information a quoted company should include within the directors’ remuneration report, for financial years on or after 1st January 2019.

A quoted company’s share capital is included in the FCA’s official list, or one that is officially listed or admitted dealing in an EEA state, the Nasdaq, or the New York Stock Exchange.

The 2018 regulations were amended by the Companies (Directors’ Remuneration Policy and Directors’ Remuneration Report) Regulations 2019 and extended to include certain regulatory obligations to ‘unquoted’ traded companies for financial years commencing on or after 10th June 2019.

A traded company’s shares hold voting rights at general meetings and have been admitted to trading on an EEA state regulated market.

 

The Companies (Directors’ Remuneration Policy and Directors’ Remuneration Report) Regulations 2019

These regulations amend the Companies Act 2006 and apply to UK incorporated quoted and traded (whether quoted or unquoted) companies. They require these types of company to report to their shareholders on statutory directors’ remuneration within both its remuneration policy and directors’ remuneration report. The regulations also convey upon the shareholders a right to vote on and approve the directors’ remuneration policy at least every three years. Each year, the shareholders have the right to an ‘advisory’ vote on the directors’ remuneration report.

 

UK Corporate Governance Code

This is a set of standards published by the Financial Reporting Council applying to companies with a premium listing on a UK regulated market governed by the UK Listing Rules (LR) for financial years, commencing on or after 1st January 2019. The LR apply to any company listed on a UK stock exchange entered on the FCA’s official list. Companies have the choice under the LR’s whether to apply for a standard or premium listing – the decision depends on the level of requirements a company has to comply with.

The code sets out the best practice for company remuneration policies and practices and aims to promote the long-term sustainable success of individual companies aligning with its purpose and values.

  • Premium listing: requires a company to comply with the listing requirements enforced by EU legislation and any additional UK provisions set out in the LR.
  • Standard listing: requires companies to comply with EU imposed legislative obligations only.

There are two different versions of the code – one in 2016, and the other in 2018. The 2016 version applies to the financial years commencing on or after 17th June 2016 and before 1st January 2019. The 2018 version applies to the financial years commencing on or after 1st January 2019.

 

Developing a directors’ remuneration policy

When drafting your company’s directors’ remuneration policy, key considerations such as how each individual director’s remuneration is arrived at by building upon a transparent and clearly defined framework used to calculate it, illustrates good corporate governance regimes and compliance with UK legislation.

Any company that is required to establish a directors’ remuneration policy needs to have it approved by their shareholders at least at three-yearly intervals. If a company already had in existence a remuneration policy on 10th June 2019, that policy can continue for the rest of its three-year period.

The directors’ remuneration policy must also contain a future policy table which sets out in detail each part of the package that makes up a directors’ remuneration. For each package, the table needs to include details of the purpose of the remuneration, exactly how it supports the company’s strategic goals, how it works in general, how performance is assessed (including differently weighted areas of performance), and any rights of the company to retain, withhold, or recover payments. Further general aspects include:

  • A detailed explanation of the decision-making process behind the policy, and how the company intends to implement and review it going forward.
  • The measures the company has put into place as to how it intends to manage any conflicts of interest arising from the policy.
  • The role of the remuneration committee (and other related committees).
  • A detailed statement setting out how the various parts of the directors’ remuneration package are put together and how the company intends to agree each component part. It should also include the maximum level of remuneration (this can be monetary or include other additional benefits) and the level of payment for stipulated minimum performance. A company should specify the performance targets for each statutory executive director used in determining remuneration for more than one financial year. The policy should also clearly state the ceiling on the remuneration available to each director, on the assumption that the company’s share price has grown by 50% during the applicable performance timeframe.
  • Provide any information on share options or shares which have been awarded to the directors, including any holding or deferral periods, or the relevant periods.
  • The duration of the director’s service contract, and any obligations within that contract which may impact that particular directors’ remuneration or loss of office payments.
  • Details of where the directors’ service contracts and letters of appointment are kept should also be marked down.

 

Any significant changes in a directors’ remuneration policy from one financial year to another should be highlighted and explained. What constitutes a ‘significant change’ is not defined within the legislation, however, several UK advisory groups and industry bodies offer guidance on how the threshold should be interpreted.

More recently, regulatory changes have required directors’ remuneration policies to be assessed within the wider context of the company’s workforce as a whole. Companies are now required to make a statement about the company’s pay policy publicly available, including:

  • The influence of the employee pay policy as a whole on the directors’ remuneration policy
  • If the company consulted its employees when drafting the directors’ remuneration policy and if so, the manner in which those consultations took place
    A comparison of the methods of calculation and its measures (if any) between the policies and an explanation as to the reasons why

 

Ideally, directors should engage with the workforce to enable them to raise any concerns they have on the remuneration policy. It is recommended that a company’s remuneration committee should not only review workforce remuneration and related policies, but also set remuneration for senior management taking the culture of the company into its remuneration forecasts. Executive directors’ pension commitments and/or payments in lieu, should also be compared, and if necessary, adjusted in accordance with the pensions available to the entire workforce.

 

Determining directors’ remuneration

Largely, it is the company itself that determines and pays the remuneration of its directors, mostly in accordance with service contract provisions. Increasingly, however, several stakeholders (particularly for listed companies), the company’s employees, and the remuneration committee, contribute significantly to the decision-making process.

The remuneration committee’s role is to ensure that director’s remuneration is aligned to the company’s purpose, strategies, and long-term success. It composes of at least three independent non-executive directors (or two for smaller companies below FTSE 350) but does not include the chairperson of the company’s board of directors. And a Chairperson who is also an independent non-executive director. The chairperson of the company’s board of directors can only be a member if they are independently appointed by the company – they are not allowed to chair the committee.

The committee should meet at least once a year to review the directors’ remuneration report prior to it being put forward to the shareholders for approval. Minutes and attendance records should be taken of all meetings and forwarded to the board of directors (providing there is no conflict of interest). The committee should address the following principles and provisions:

  • Decide the remuneration policy for each director and decide the remuneration of the chair, executive directors, and senior management.
  • The board should be able to override any formulaic remunerative calculations.
  • Develop a policy on post-employment shareholdings.
  • Exercise independent judgment and discretion when approving directors’ remuneration considering company performance and that of each individual director, including any other relevant circumstances.
  • The Chairperson of the committee must have previously served for at least 12 months on a remuneration committee prior to their appointment.
    Non-executive director remuneration must be determined in accordance with the company’s articles of association or by the board, reflecting their time commitments and responsibilities.
  • Any remuneration consultants appointed by the committee should be disclosed.
  • The company should encourage long-term shareholdings and share award schemes as alternative remuneration for directors as this gives the workforce actual shares released on a phased basis, promoting long-term continuous performance of the company.

 

How directors’ remuneration is calculated will vary from company to company and likely to be based on the circumstances of each prevailing financial year. At its very core, the remuneration policy should reflect the strategy and values of the company with each individual policy tailored to promote ongoing successes of the company.

 

Need assistance?

DavidsonMorris’ human resource specialists work with employers to ensure best practice in HR and people management, including areas such as executive and director reward and remuneration. We offer a holistic solution to support legal risk management while protecting the best interests of the organisation. For advice on a specific issue, speak to our experts today.

 

Directors’ remuneration FAQs

What is the difference between director’s salary and remuneration?

A salaried director receives a salary and is typically considered an employee of the company. Remuneration is a wider concept and includes salary, bonuses, and other rewards which are controlled by the board of directors with the shareholders having the right to approve the report and/or sue the directors in cases of overpayment.

Is director’s remuneration the same as dividends?

Dividends are considered investment income and as such likely to yield a slightly lower tax rate than what is usually paid otherwise. Remuneration is classified as ‘drawings’ and is taxed appropriately, however, in practice, at least for the majority of smaller businesses, drawings will probably be a combination of remuneration and dividends.

Is director remuneration an expense?

A directors’ remuneration is an expense to the company and as such, as per the accounting rules, is a payment to the director so the directors’ remuneration account is debited. As cash is going out of the business upon payment to the director, the company’s cash account is credited.

How should the total figure be split?

The total figure comprises: salary and fees in the past financial year, taxable benefits (gross value of benefits before tax, including allowances and other benefits received), Annual bonus received for performance for that financial year, long-term incentive award unrelated to personal performance, and pension-related benefits (including payments made in cash or in lieu of retirement benefits).

Last updated: 19 March 2021

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