Remuneration for senior executives

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

www.dti.gov.uk/er

Mandy Perry, is an associate, employment, Jones Day Gouldens, www.gouldens.com