Powers of the Board of Directors and Remuneration

Insights / By
  1. Introduction:
    1. Separation of Ownership and Management – the Role of Shareholders and Board’s Directors:

Corporate governance holds that shareholders are company owners and the management of the company is the function of directors[1]. The separation of duties between the executives and shareholders is as a common practice regulated by articles of association, and companies partially or wholly adopt them from therein. Berle and Means[2] contributed a good thesis on the subject as early as in the 1930s. The works of Berle et al is however limited to countries on common law systems.

Corporate Governance Code[3] (the “Code“) and the International Accounting Standards[4] have improved the transparency of running a company and disclosures therein. In other words, directors have more to reveal and disclose to shareholders than at any historical time in the development of corporate governance.

  1. Protection of Minority Shareholders:

The Shareholders operate on a democracy principle of majority rule, whereas the Board of Directors apply managerial principles in running the daily day to day activities of the company. However, It was held in a case of Foss v Harbottle[5] that running a company is not a business of the minority shareholders. Although the Court of Appeal in case of Edward v Halliwell[6] identified four exceptions to the rule as drawn in case of Foss v Harbottle.

  • Remuneration of Senior Executives:
  • When the Board of Directors wishes to increase remuneration to retain highly valued staff, according to Villiers (2010)[7], to stave off any shareholder resistance to a new remuneration policy, the board should recognize that any revision needs to take into account the interests of the shareholders.
  • As in Gower et al. (2016)[8] there have been high criticisms of executives pay schemes, as the gap between executives pay and average salaries continues to widen. Burgess (2016)[9] highlights that while the FTSE is currently trading at similar levels to 18 years ago, executives pay have trebled, which certainly points to a lack of alignment. According to Joseph (2012)[10], executive remuneration policies which are not linked to the performance of company, may result in reduced profits and shareholders’ returns.
  • Framework and Controls on Board and Executive Remuneration:

To assist companies in this matter, the Financial Reporting Council’s Corporate Governance Code, (“CGC“)[11] 2016 and 2018, advises companies to adopt a number of principles and provisions on executive remuneration.

According to the CGC (2018) there are three main remuneration principles for companies to follow; firstly, remuneration should be linked to long term strategy, purpose and values; secondly, remuneration policies should be independent of executive involvement, formal and transparent; and thirdly, should take into account company and individual performance.

According to provision 32 of the CGC (2018), a board must establish a remuneration committee consisting of a minimum of three non-executive directors, who should be entirely independent of Westland with a directive to formulate a remuneration policy in line with the long term strategy of Westland and its shareholders.

The remuneration policy should be clear, transparent, easy to understand, with targets, outcomes and performance measurements[12]. Moreover, some executives have significantly benefited from excessive remuneration schemes in the past, not through their own or company performance but through general stock market events and economic cycles[13].

Therefore, Gower et al. (2016)[14] believes that remuneration should be linked to performance and Mallin (2011)[15] states that the remuneration policy should include performance measures such as revenue, return on capital employed, earnings per share and individual directors performance. Buck et al. (2003)[16] also believes that the remuneration policy should take account of the values and strategy of the company to ensure goal alignment with the shareholders and employees. 

The CGC (2018)[17] and Gower et al. (2016)[18] states that the remuneration policy should include claw back clauses to insure against future deficiencies in perceived performance and also guard against excessive contributions to pensions and a limit on contract periods. UK house builder, Persimmon, who’s CEO recently received a £100M bonus has come under significant criticism for allegedly benefitting from the UK governments help to buy scheme. As such, Neate (2018)[19] states that the CEO is now viewed as profiteering from government grants, damaging the reputation of Persimmon which led to a substantial share price decline in 2018. As such, according to Rovnick et al. (2017)[20], the CEO and two members of the remuneration committee at Persimmon have now resigned, the latter admitting that the remuneration policy should have included a cap on pay. 

  • Potential Reaction of Shareholders:

The CGC (2018)[21], requires the company directors to publish an annual directors Remuneration Report for presentation at the company’s AGM. As commented in Morris (2012)[22] s420-422 and s439 of the Companies Act, while shareholders have a right to vote on the Remuneration Report, they cannot call on statutory legal powers to enforce their view. Cornish et al. (2017)[23] believes this to be highly controversial as many executives continue to receive unjustified large payouts and despite government promises, there has been a distinct lack of statutory powers awarded to shareholders to prevent it. Therefore, according to Villiers (2010)[24], despite the shareholders having a right to “say on pay”, the vote is purely advisory and there is no legal requirement to comply with the opinion of the shareholders should they disagree with the recommendations of the board or remuneration committee.

Price Waterhouse Coopers “PWC” (2018)[25] and Gower et al. (2016)[26], state that there are non-statutory powers which can apply if Westland is a premium listed company on the London Stock Exchange (“LSE”). Under rule LR9.4 premium companies are required to seek shareholder approval for any employee remuneration and/or incentive scheme, failure to do so may result in the company being delisted. Even if a company held a premium or standard listing with the LSE, implementing a remuneration scheme without shareholder approval could have a severe impact on the share price due to the negative media reaction.

However, as stated in Gower et al. (2016)[27], if disputes between the board and shareholders cannot be reconciled, the shareholders can threaten to implement s168 of the Companies Act, which allows for shareholders, by majority vote, to remove directors by ordinary resolution. In addition to the above, Financial Reporting Council’s CGC (2016)[28], Section E pays particular emphasis on the boards relationship with shareholders, encouraging a dialogue based on mutual understanding, should there be any further issues or disputes in order to avoid or minimize the risk and/or avoid loss of shareholders’ confidence. Therefore, according to Mallin (2011)[29], if the shareholders vote against the remuneration proposal, such decisions should not be made.

  • Issues relating to Executive and Non-Executive Directors are addressed as follows:
  • Number of Directors and Their Roles:

As per Section 154(2) of the Companies Act all public companies “must have at least two Directors”[30], and the number of Directors may be increased or decreased by appointing new Director(s) or removing existing Director(s), by passing an ordinary resolution at a general meeting[31]. If the number of Directors in the Board falls below two, the Board would have no power to act on any issues except to appoint new Directors in order to make up the minimum number of directors. However, there is no regulation as to maximum number of Directors.

The Code further states that number of Directors should be of sufficient size to meet company’s objects and to carry out duties of the Board[32]. At the same time, the number of Directors “should not be too large to be unwieldy”[33]. If the company adopted the model Articles for Public Companies[34], new Directors may also be appointed by decision of the existing Director(s).

To decrease the number of Directors, the members may remove existing Directors by passing an ordinary resolution at a meeting. A special notice is required to be issued by the Company to the Director being removed[35], and the Register of Directors kept by the Company will need to be updated by inserting the particulars of any new Director(s) appointed or removing the particulars of any Director(s) being removed[36].

The main role of the Board is to provide leadership management of Westlands within a set of prudent and effective controls, to assess and manage all forms of risk[37], included mismanagement by the Board.

  • Role of Executive Directors:

Executive Directors are employees of the company and their role is to make day to day decision for the company. Very often for large corporation, they are full time employees of the Company that goes to office daily to carry out management task for the company. There are numerous sources that describe or list the task of Executive Directors in difference iterations. But it is generally understood that the main role of Executive Directors is to run the business for the company.

  • Role of Non-Executive Directors:

Non-Executive Directors are the Directors those are not full time employees of the Company. Their main role is to “scrutinize the performance of management in meeting agreed goals and objectives and monitor the reporting of performance”[38]. Non-Executive Directors’ role also include the need to challenge proposals or develop their own proposals on strategies of the Company.

Based on the Code, it is suggested that Non-Executive Directors should also determine the levels of remuneration of Executive Directors. Non-Executive Directors also have the main role of appointing or removing Executive Directors from the Company. Such powers when given to Non-Executive Directors will be effective to ensure that no individual Executive Director or small groups of Executive Directors have unfettered powers to make unchecked decisions for the Company. The board is required to “identify in the Annual Reports each Non-Executive Director that is considered to be independent”[39].

Based on the criteria listed in the Code, in order to determine whether a Non-Executive Director can be considered to be independent, the Board of Westlands needs to set-out the criteria for that as given in the Code[40]. The Code is silent on the numbers of non-independent Non-Executive Directors. However, the committee of Non-Executive Directors has to be made up of independent Non-Executive Directors to a significant extent.

  • Number of Non-Executive Directors vis-à-vis number of Executive Directors:

Whilst the Code does not specify the exact numbers of Executive or Non-Executive Directors to Companies, it does recommend that the Board of Directors has to compose a mix of Executive and Non-Executive Directors to achieve balance of skill, experience, independence and knowledge. So much so that the balance in numbers is required to ensure no individual or small group of individual can dominate decision in the board[41].

The Code suggests that “at least half the board, excluding the chairman, should comprise Non-Executive Directors determined by the board to be independent”[42] or at least two for small companies[43].

  • [1] David Costa, The Separation of Ownership and Management and Theories of Corporate Governance (Salford University 2018)
  • [2] Adolf Berle, Gardiner Means, The Modern Corporation and Private Property (Transaction Publishers 1932)
  • [3] UK Corporate Governance Code 2014
  • [4] Joint Elaboration, “FRS 100 Application of Financial Reporting Requirements” (LNUK 2012)
  • [5] [1843] 2 Hare 461, CD
  • [6] 1950 2 All ER, Court of Appeal
  • [7] Charlotte Villiers, “Controlling Executive Pay: Institutional Investors or Distributive Justice?” [2010] 10(2) “Journal of Corporate Law Studies” 309
  • [8]  Gower et al, Principles of Modern Company law (10th edn, Sweet & Maxwell 2016) 484
  • [9]Kate Burgess, “BlackRock threatens action on executive pay” (The Financial Times, 7 December 2016) www.ft.com/content/2ca8a554-bba6-11e6-8b45-b8b81dd5d080 accessed 25 November 2018
  • [10] Ernest Joseph, “Monitoring directors’ remuneration, fat cat packages and perks of the office.” [2012] “Journal of Financial Crime” 11
  • [11] Financial Reporting Council, “The UK Corporate Governance Code” (2018) PL 13
  • [12] Gower et al, Principles of Modern Company law (10th edn, Sweet & Maxwell 2016) 486
  • [13] Charlotte Villiers, “Controlling Executive Pay: Institutional Investors or Distributive Justice?” [2010] 10(2) “Journal of Corporate Law Studies” 309
  • [14]   Gower et al, Principles of Modern Company law (10th edn, Sweet & Maxwell 2016) 485
  • [15]Christine Mallin, “Corporate Governance after the Credit Crunch” (31 January 2011) <www.hstalks.com/t/1936/corporate-governance-after-the-credit-crunch/ accessed 25 November 2018
  • [16] Trevor Buck, “Long Term Incentive Plans, Executive Pay and UK Company Performance” [2003] 40(17) “Journal of Management Studies” 1710
  • [17] Financial Reporting Council, “The UK Corporate Governance Code” (2018) PL 13
  • [18] Gower et al, Principles of Modern Company law (10th edn, Sweet & Maxwell 2016) 486
  • [19]Rupert Neate “Persimmon chief says he deserves £110m bonus” (The Guardian, 9 January 2018) www.theguardian.com/business/2018/jan/09/persimmon-profits-chief-bonus-scheme accessed 25 November 2018
  • [20] Naomi Rovnick, Aime Williams “Persimmon chairman resigns over £100m bonus” (The Financial Times, 15 December 2017) www.ft.com/content/c9f88bf8-e175-11e7-8f9f-de1c2175f5ce accessed 25 November 2018
  • [21] Financial Reporting Council, “The UK Corporate Governance Code” (2018) PL 13
  • [22] John Morris, Executive Pay: Power to the shareholders? (Thomson Reuters Practical Law 2012)
  • [23] Chloe Cornish,  Jim Pickard “Shareholders demand right to limit executive pay” (The Financial Times, 24 February 2017) www.ft.com/content/6df9902a-f8fc-11e6-9516-2d969e0d3b65 accessed 25 November 2018
  • [24] Charlotte Villiers, “Controlling Executive Pay: Institutional Investors or Distributive Justice?” [2010] 10(2) “Journal of Corporate Law Studies” 311
  • [25] Price Waterhouse, “Continuing obligations for companies listed in the UK” [2018] 21
  • [26] Gower et al, Principles of Modern Company law (10th edn, Sweet & Maxwell 2016) 485
  • [27] Gower et al, Principles of Modern Company law (10th edn, Sweet & Maxwell 2016) 486
  • [28] Financial Reporting Council, “The UK Corporate Governance Code” (2016) PL 22
  • [29] Christine Mallin, “Corporate Governance after the Credit Crunch” (31 January 2011) www.hstalks.com/t/1936/corporate-governance-after-the-credit-crunch/ accessed 25 November 2018
  • [30] Companies Act 2006, s 154 (2)
  • [31] Companies Act 2006, s 160
  • [32] UK Corporate Governance Code September 2014, s B.1
  • [33] ibid
  • [34] The Companies (Model Articles) Regulations 2008, s 3
  • [35] Companies Act 2006, s 168
  • [36] Companies Act 2006, s 162
  • [37] UK Corporate Governance Code September 2014, s A.1
  • [38] UK Corporate Governance Code September 2014, s A.4
  • [39] UK Corporate Governance Code September 2014, s B.1.1
  • [40] ibid
  • [41] UK Corporate Governance Code September 2014, s B
  • [42]  UK Corporate Governance Code September 2014, s B.1.2
  • [43] ibid
BIBLIOGRAPHY

Table of Legislation
Model Articles of Association
UK Corporate Governance Code 2014
UK Corporate Governance Code 2018
The Companies Act 2006
The Companies (Model Articles) Regulations 2008

Table of Cases
[1843] 2 Hare 461, CD
1950 2 All ER, Court of Appeal
Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC.

Books
Berle A, Means G, The Modern Corporation and Private Property (Transaction Publishers 1932)
Gower et al, Principles of Modern Company law (10th edn, Sweet & Maxwell 2016)
Morris J, Executive Pay: Power to the shareholders? (Thomson Reuters Practical Law 2012)
Costa D, The Separation of Ownership and Management and Theories of Corporate Governance (Salford University 2018)
Joint Elaboration, FRS 100 Application of Financial Reporting Requirements (LNUK 2012)

Journals /Articles
Buck T, “Long Term Incentive Plans, Executive Pay and UK Company Performance” [2003] 40(17) “Journal of Management Studies”
Joseph E, “Monitoring directors’ remuneration, fat cat packages and perks of the office.” [2012] “Journal of Financial Crime”
Price Waterhouse, “Continuing obligations for companies listed in the UK” [2018]
Villiers Ch, “Controlling Executive Pay: Institutional Investors or Distributive Justice?” [2010] 10(2) “Journal of Corporate Law Studies”

Internet
Burgess K, “BlackRock threatens action on executive pay” (The Financial Times, 7 December 2016) www.ft.com/content/2ca8a554-bba6-11e6-8b45-b8b81dd5d080 accessed 25 November 2018
Cornish Ch,  Jim Pickard “Shareholders demand right to limit executive pay” (The Financial Times, 24 February 2017) www.ft.com/content/6df9902a-f8fc-11e6-9516-2d969e0d3b65 accessed 25 November 2018
Mallin Ch, “Corporate Governance after the Credit Crunch” (31 January 2011) <www.hstalks.com/t/1936/corporate-governance-after-the-credit-crunch/ accessed 25 November 2018
Mallin Ch, “Corporate Governance after the Credit Crunch” (31 January 2011) www.hstalks.com/t/1936/corporate-governance-after-the-credit-crunch/ accessed 23 November 2018
Neate R, “Persimmon chief says he deserves £110m bonus” (The Guardian, 9 January 2018) www.theguardian.com/business/2018/jan/09/persimmon-profits-chief-bonus-scheme accessed 25 November 2018
Rovnick N, Williams A, “Persimmon chairman resigns over £100m bonus” (The Financial Times, 15 December 2017) www.ft.com/content/c9f88bf8-e175-11e7-8f9f-de1c2175f5ce accessed 25 November 2018