The Financial Reporting Council’s new rules explained

The Financial Reporting Council (“FRC”) is responsible for developing the Corporate Governance Rules for the 1,300 largest companies in the UK.  Executive remuneration has been a hot topic for many years, most particularly in the banking sector, but the FRC’s proposed new rules mark a decisive attempt to move executive remuneration in the plc sector closer to the rules that have applied to bankers’ pay for the last six years.

At the core of the new rules is a drive to ensure that compensation paid to executives is properly aligned with the interests of the company (which broadly means shareholders).  As with bankers’ compensation, the way that the FRC have looked to achieve this goal is through four tools:

  1. The rules used to speak of compensation that would “attract, retain and motivate” the executives – now compensation needs to support the long-term success of the company;
  2. There is an expectation that significant proportions of compensation should be share based – this isn’t a material change, most senior executives already have significant amounts of compensation delivered through share schemes
  3. Bonuses should be deferred for longer periods, to ensure that the company’s medium and long term performance justifies the delivery of the bonus; and
  4. deferred elements are to be at risk of “malus”.  In this context, malus means that the company should have the express power to reduce the amount of any deferred bonus ultimately delivered to an executive to reflect relevant factors including the individual’s personal performance and the company’s subsequent financial performance.  The goal is that this will lead to a greater alignment of executive pay with longer term corporate performance and incentivise appropriate behaviours.

Unlike the Remuneration Code rules which apply to bankers, the FRC rules operate on a comply or explain basis.  This means that companies are free to ignore the requirements, provided that they have explained their reasons for their non-compliance to their shareholders.  This element connects to the FRC’s other rules recently reduced which require shareholders to have a much greater say over remuneration policies and are giving them the right to comment on annual remuneration statements.

The remuneration debate shows no sign of quietening down and it will be interesting to see how companies react to the new remuneration structure – and whether it will have the desired effect.