These Red Lines have been developed in accordance with the Financial Reporting Council’s UK Corporate Governance Code
| Board election
G1.) If the chair of the board of directors and the position of chief executive have been held by the same person for more than one year, vote against the re-election of the chair of the nomination committee.
It is generally agreed in the UK that chief executives should be accountable to the board for the day to day running of the company and be supervised by a non‑executive director chairing the board. The concentration of power in the hands of a single individual is prone to encourage abuse, or at least restricted vision, of the interests of the company and its shareholders. Provision A.2.1 of the Code states that these roles should not be combined.
Provision A.3.1 of the Code recognises, however, that exceptionally a board may decide that a CEO may take on the chair. It is evidently considered justifiable only in exceptional circumstances and the Red Line envisages that they should arise only on a transitional basis.
See the introductory guidance note on page 5 of the Red Lines download.
G2.) If a full-time director of the company concurrently holds the chair of another public company or is a director of more than one other public company, vote against that person’s re-election.
It is in the interests of shareholders that directors have adequate time to fulfil the responsibilities of their office. While a concurrent non‑executive responsibility may bring advantages of cross fertilisation to both companies, it is important that this is not substantially at the expense of commitment to the director’s full-time responsibilities.
A director should be treated as full-time if he or she is contracted to devote substantially all his or her working time to the company and/or to companies within the same group or otherwise “connected” with the investee company within the meaning of sections 252 to 255 of the Act. This Red Line does go beyond Provision B.3.3 of the Code because it does not confine its relevance to other companies within the FTSE 100.
In the absence of evidence to the contrary an executive director shall be taken to be full-time and a non‑executive not; if it is not clear from the remuneration report whether a director is executive, he or she shall be taken to be so.
G3.) If it is not clear which of the existing directors of a company, and which of any current candidates for election to the board, are independent vote against the adoption of the report and accounts.
According to Provision B.1.1 the annual report should identify which directors the board determines to be independent. Without this information it is difficult to judge whether the board has the balance between independent and other directors set out in the Code and hence to determine whether Red Lines G4 and/or G5 have been breached.
If, exceptionally, the report and/or accounts were laid before a general meeting of the company without a motion being put for their adoption, vote against the approval of the remuneration policy, for which a motion is statutorily required.
G4.) Vote against the re-election of any non-executive director if it could result in that person’s continuous service as a director of the company exceeding nine years, unless it is not intended that he or she be treated in future as an independent director.
As an initially independent director’s tenure goes on, it may be expected to become more difficult to maintain that independence from the outlook of the company’s executive which the shareholders need.
If an individual was identified as an independent in the latest directors’ report, it is to be assumed that he or she will continue to be so treated, unless documentation circulated to the shareholders in connection with the relevant meeting makes clear that this is not the intention.
G5.) Vote against the re-election of the chair of the nomination committee if the company does not have the minimum number of independent non-executive directors required by Provision B.1.2 of the FRC’s UK Corporate Governance Code.
It is in the very clear interest of shareholders that the outlook of the board is not dominated by the group of the people who are running the business day to day. It is for this reason that the Code says that in companies which are in the FTSE 350 for at least part of the year immediately prior to the reporting year, or since later listing, at least half the board must be independent non‑executive directors; and that any other company should have at least two independent non‑executive directors.
The chair of the board, though he or she should be independent on appointment, is not to count as independent in this context.
A person is to be treated as a non-independent non‑executive director if any of the following issues apply:
- Has been an employee of the company or group during the last five years;
- Has, or a connected person has had, within the last three years, a material business relationship with the company either directly, or as a partner, shareholder, director or senior employee of a body that has such a relationship with the company;
- Has received or receives additional remuneration from the company apart from a director’s fee, participates in the company’s share option or performance-related pay schemes, or is a member of the company’s pension scheme;
- Has close family ties with any of the company’s advisers, directors or senior employees;
- Holds cross-directorships or has significant links with other directors through involvement in other companies or bodies,
- Represents a significant shareholder;
- Is attested by the board to be a non-independent non-executive director;
- Is a former board chair;
- Has a substantial personal shareholding of ≥ 1%, or
- Has been on the board for nine years or more.
G6.) If any director of a company will have served continuously as such for more than three years without having been re-elected at a general meeting, vote against the re-election of the chair of the board.
It is in the interests of shareholders that directors be held to account by reasonably frequent elections.
Provision B.7.1 of the UK Corporate Governance Code prescribes annual elections of all directors of FTSE 350 companies; and any guarantee to a director that his or her term will, or may, last for more than two years requires shareholder approval under section 188 of the Act.
G7.) If competition for appointment as statutory auditor has been restricted to the “big four” accounting firms, vote against the re-election of the chair of the audit committee.
Competition encourages businesses to improve the quality of the goods and services they sell in order to attract more customers and expand market share. In a competitive market there will be more choice and more innovation and the competition for business could encourage lower fees. It is therefore in the shareholder’s interest that competition for the role of auditor is not restricted to the “big four” accounting firms and that greater competition for this work is encouraged.
The issue of auditors’ conflicts of interest and the concentration of the industry has been an important one that has not been tackled with the serious reforms called for after the Enron scandal of 2001.
This Red Line will come into effect with regard to appointments made in any financial year starting in 2016 and thereafter.
G8.) If the appointment of the company’s statutory auditor or auditors has not been the subject of a formal tender process within the past10 years, vote against the re-election of the chair of the audit committee.
Shareholders need to have full confidence in the reliability of the company’s accounts, so it is in the shareholders’ interests that a company does not develop so close a relationship with its auditors as to risk compromising the independence of their role. Provision C.3.7 of the Code requires this of FTSE 350 companies.
If it is not apparent from the material circulated to the shareholders in connection with the company’s accounts meeting whether this Red Line has been breached, it should be assumed that it has, unless the person exercising the vote has knowledge that it has not.
If, at the time of the vote, a formal tender process has been scheduled to take place within the next financial year, a vote under G8 will not be triggered.
G9.) If the company’s statutory auditors have for a period of 15 years or more been the same, or drawn from the same firm, vote against the re-election of the chair of the audit committee.
It is in the interests of shareholders that a company does not develop so close a relationship with its auditors as to risk compromising the independence of their role.
If it is not apparent from the material circulated to the shareholders in connection with the company’s accounts meeting whether this Red Line has been breached, it should be assumed that it has, unless the person exercising the vote has knowledge that it has not. A firm formed by the merger of predecessor firms is to be taken to be the same as each of those.
G10.) If over the reporting period relevant to the latest accounts meeting of a company its auditors (including any of their associates) were due to be paid an amount in fees for non-audit services greater than that properly fixed as remuneration for audit work, vote against the re-election of the chair of the audit committee.
The closer the involvement of an auditor or a firm of accountants with the company, the greater the strain on the independence of the auditors and the risk to the interests of the shareholders. The independence of an auditor may be questionable if it receives more money for its non‑audit work for a company than it receives in audit fees.
Associates of the auditor or of any other entity are in this connection those so defined in Schedule 1 to the Companies (Disclosure of Auditor Remuneration and Liability Limitation Agreements) Regulations 2008 (SI No 489), e.g. partners, subsidiaries. Remuneration for audit work should be taken to mean that receivable for the auditing of the company’s (or relevant group) accounts, aggregated with any for the auditing of accounts of any associate of the company. Non-audit services constitute all other services to be reported under regulation 5(3) of those Regulations (as amended by SI 2011 No 2198) – a comprehensive list is set out in Schedule 2A to them.
The “accounts meeting” of a company is that defined as such by Section 437 (3) of the Companies Act 2006.
G11.) Vote against the re-election of the chair of the board and any non-independent members of the audit committee if that committee is not to consist of a majority of independent non-executive directors.
Provision C.3.1 of the Code requires an audit committee and envisages that it will consist of independent non-executive directors. The deployment of independents in this role, especially in managing the company’s relationship with the auditors, mitigates the risk of that relationship becoming incestuous.
If an individual was identified as an independent in the latest directors’ report, it is to be assumed that he or she will continue to be so treated, unless documentation circulated to the shareholders in connection with the relevant meeting makes clear that this is not the intention. Conversely, an individual not so identified should normally be taken to be non-independent.
G12.) If the directors’ reports do not indicate how one may readily access policy of the company in relation to the management of its tax affairs, vote against the re-election of the chair of the committee responsible for corporate social responsibility.
It is increasingly seen as good practice in the context of corporate risk management, including management of reputational risk, for a company’s board to have a published tax policy indicating the company’s approach to planning and negotiating tax matters, and to allow stakeholders to monitor its handling of risk in this area. This is not to be seen as the sole concern of the finance department.
If the company has no committee with oversight of corporate social responsibility (or, outside the FTSE 350 a director with this responsibility), vote against the chair of the audit committee.
G13.) If authorisation is sought for the directors of a company to allot shares in it without offering full pre-emption to existing shareholders, vote against giving it if the authority is to last beyond the next AGM, or if general exclusion of pre-emption is sought over more than 5% of issued share capital (or more than 10% if for a specified acquisition or capital investment), or if a specific exclusion is sought over more than one-third of issued share capital.
It is not generally in the interests of shareholders for their holding to be diluted by the issue of new shares, so if new shares need to be issued, shareholders should normally expect to have the opportunity to avoid that dilution by having first refusal, i.e. the right of pre emption. The Investment Association and the Pre Emption Group of the Financial Reporting Council, however, recognise that some flexibility is in the interests of companies and their owners.
The limits set by the Red Line broadly reflect the criteria described in the FRC Pre Emption Group’s 2015
paper Disapplying Pre Emption Rights: a statement of principles (especially paragraphs 3 and 4 of Part 2A) and in the Investment Association’s Share Capital Management Guidelines (July 2014), though it is recognised that they are more tightly prescriptive.
The reference to shares should be taken to include other equity securities.
It is possible for the articles of a company to permit directors to disapply the general right of pre-emption which ordinary shareholders are given by section 561 of the Act. Accordingly, a resolution to adopt new articles which would introduce, or maintain, such a right of disapplication should be voted against, as well as special resolutions bundling this issue with others.
G14.) Vote against any proposal for shareholder support for a dispensation from Rule 9 of the Takeover Code.
Rule 9 of the Takeover Code is designed to protect minority shareholders, as pension schemes will almost always be. It requires a person (or group) who has acquired a sizeable stake (30% or more) in a company to make an offer for all its shares and securities, but the Panel on Takeovers and Mergers will generally waive the requirement if a majority of independent shareholders vote to favour that.
In cases where it might genuinely be in minority shareholders’ interests for an offer not to be insisted upon, the Panel has power to waive the requirement without a shareholder vote, so only in the most exceptional circumstances should such a vote be supported.
| Accounting disclosure
G15.) If there is no separate resolution to approve the final dividend, vote against the report and accounts.
If shareholders are to have adequate control of the way in which profits are used, it is important that issues of dividend policy are not obscured by being bundled with other matters.
Those exercising votes are encouraged to extend the coverage of this Red Line beyond final dividends to other distributions within the meaning of Part 23 of the Act where it is practicable to do so.
G16.) Vote against the chairman of the board and the re-election of non-independent members of the remuneration committee if the committee does not consist of a majority of independent non-executive directors.
It is essential to the shareholder’s interests that the remuneration committee has a majority of independent non‑executive directors: it is not acceptable that directors should preside over their own remuneration packages.
This is in accordance with Section D of the UK Corporate Governance Code clause D.2.1 which specifies that the remuneration committee should comprise three (or in smaller companies two) independent non‑executive directors, and that the company chairman may be a member of, but not chair, the committee if he or she was considered independent on appointment as chairman.
A person is to be treated as a non-independent non‑executive director if any of the following issues apply:
- Has been an employee of the company or group during the last five years
- Has, or a connected person has had, within the last three years, a material business relationship with the company either directly, or as a partner, shareholder, director or senior employee of a body that has such a relationship with the company
- Has received or receives additional remuneration from the company apart from a director’s fee, participates in the company’s share option or performance-related pay schemes, or is a member of the company’s pension scheme
- Has close family ties with any of the company’s advisers, directors or senior employees
- Holds cross-directorships or has significant links with other directors through involvement in other companies or bodies
- Represents a significant shareholder
- Is attested by the board to be a non-independent non-executive director
- Is a former board chair
- Has a substantial personal shareholding of ≥ 1%, or
- Has been on the board for nine years or more.
G17.) Vote against the remuneration policy in the case of any of the following:
• Failure to use service contracts in relation to executive directors, which should be no more than one rolling year in duration and in the case of termination be subject to mitigation;
• Awarding of a ‘sign-on’ bonus without the inclusion of any conditionality
• Service contracts with provisions that in effect reward failure;
• Basic salary increase greater than inflation or that given to the rest of the workforce;
• Layering of bonus schemes on top of existing bonus schemes;
• Uncapped bonuses
• Too wide discretion given to the remuneration committee
• No provision for claw back
• No provision for withholding of benefits on cessation of employment
It is in shareholders’ interests that remuneration packages are straightforward, clear, do not allow bonuses that are in effect unearned (such as signing on bonuses) and bonuses that have no defined upper limit. They should not reward failure, for example contracts should be no more than one rolling year in duration and there should be clawback clauses, and bonuses or Long Term Incentive Plans should be awarded pro rata.
Section D of the UK Corporate Governance Code and Schedule A: “Performance conditions including non‑financial metrics where appropriate should be relevant, stretching and designed to promote the long‑term success of the company. Remuneration incentives should be compatible with risk policies and systems. Upper limits should be set and disclosed.”
Layering of bonus schemes on top of existing ones captures instances where companies attempt to overlay a new short or long term incentive scheme (or schemes) in addition to the existing arrangements.
G18.) Vote against the remuneration report and/or the remuneration policy in the case of any of the following:
• Lack of clarity
• Lack of transparency
• Failure to include company productivity in the performance metrics
• Failure to consider vertical comparability issues
• Absence of incentives based on performance conditions over at least three years
• incentives which would have the effect of making directors focus on short-term returns at the expense of sustainable business success.
Vote against the remuneration report in the case of any of the following:
• Bonuses being awarded despite decline in the company’s performance
• Inappropriate use of discretion
• Payment of a transaction bonus
The remuneration report reports on the remuneration that has been paid in the past year.
The remuneration policy sets out the remuneration committee’s plans for directors’ remuneration packages going forward.
A transaction bonus is one that is determined on the completion of a transaction, typically merger or acquisition, rather than after any benefits of that transaction to the company have had time to show themselves (usually five years on).
Vertical comparability issues are those concerning the appropriateness or otherwise of differentials in pay within the company.
In furtherance of Section D of the UK Corporate Governance Code. The level of clarity required is that which a professional familiar with executive remuneration would expect, not that which would make the position obvious to a lay person. Lack of clarity may not include instances where companies have subsequently provided a satisfactory explanation upon enquiry. It necessarily infers the application of subjective judgement which may well vary according to individual expertise.
Lack of transparency: examples include no quantified targets disclosed or no disclosure of the peer group when using such a group as a comparison.
G19.) Vote against the remuneration report or policy if the total remuneration package of any director is more than 100 times greater than the average pay of the company’s UK workforce, other than in exceptional circumstances which must be fully justified.
The UK Corporate Governance Code makes clear that the remuneration committee “should be sensitive to pay and employment conditions elsewhere in the group especially when determining annual salary increases.” It is not in the shareholders’ interests for companies to ignore this matter as doing so may cause any of the following: internal resentment, falls in productivity, industrial unrest, reputational damage, fall in output and fall in shareholder value. If the average wage in a company is approximately the national UK median annual earnings for full-time employees of about £27,000 per year, a director earning 100 times this would be paid £2.7‑million.
The single total figure for each director’s remuneration is that required to be included in the remuneration report by paragraphs 4 and 5 of Part 3 of Schedule 8 to the Large and Medium‑sized Companies and Groups (Accounts) Regulations 2008 (SI 2008/410, as amended by SI 2013/1981). Schedule 8 paragraphs 38‑39 state that the company has to state how the pay and employment conditions of employees have beentaken into account when setting directors’ pay. Paragraph 39(b) requires that report to set out what, if any, comparison measurements were used and how.
If adopted as proposed in early 2015, the EU Shareholder Rights Directive will require disclosure of the ratio between the average remuneration of directors and that of the workforce.
The company should explain the basis of its calculations (similar to the US Securities and Exchange Commission proposed rule required under the Dodd‑Frank Act). Part‑time salaries may be calculated as pro rata full time pay.
If workforce costs are given only for a wider group than the UK workforce then the average pay of the wider group should be used.
G20.) Vote against the remuneration policy (or the Long Term Incentive Plan if there is a separate vote on it) if the LTIP could result in an award higher than 300% of salary.
Long Term Incentive Plans (LTIPs) should be aligned to shareholders’ interests – but there is evidence to show that LTIP payments to executives in the FTSE 350 increased by over 250% between 2000 and 2013, roughly five times faster than returns to shareholders, and there is negligible linkage between LTIP payments to executives and shareholder returns. This is not in the shareholder’s interests.
The UK Corporate Governance Code states: “Boards of listed companies will need to ensure that executive remuneration is aligned to the long-term success of the company and demonstrate this more clearly to shareholders.” LTIPs sometimes require specific shareholder approval and sometimes not, depending on how they are structured.
G21.) Vote against the remuneration policy if the CEO’s remuneration package does not include criteria for awards to be linked to relevant corporate social responsibility and environmental sustainability targets.
By incorporating such targets companies show that they integrate sustainability criteria into their overall business planning and that they are truly committed to acting in a socially and environmentally sustainable manner. Setting such targets also reinforces the notion that sustainability is an important driver of business value and can help shift the focus away from short‑term returns.
The integration of CSR performance indicators as direct drivers of executives’ variable remuneration is a practice that is of growing importance. This practice ‑ part of a more general trend of convergence between the fields of CSR and corporate governance ‑ has a double raison d’être. First, a remuneration policy which internalizes the interests of a broader range of stakeholders can reinforce the company’s reputational asset and improve the relationship with both its investors and communities. Second, monetary incentives linked to sustainable development can effectively contribute to improve the company’s management of ESG risks, which in turn may be associated with better financial performance in the medium to long term. Under this point of view, the use of CSR performance objectives is an innovative way to anchor the bonuses of managers to a perspective of long‑term value creation.
In the 2014 UK Corporate Governance Code the Financial Reporting Council has focussed on the risks which affect longer term viability, and (as stated earlier) “Boards of listed companies will need to ensure that executive remuneration is aligned to the long-term success of the company and demonstrate this more clearly to shareholders.” Linking executive pay to achievement of corporate responsibility and environmental sustainability performance targets is aligned with the intentions of the code and in the interests of shareholders.
G22.) Vote against the remuneration policy if the performance measures are only stock-market related such as Total Shareholder Return.
Stock market related performance metrics can be manipulated – for example a share buy‑back can raise the share price; saving money by closing an R&D department could increase short‑term profit at the expense of long-term product development. It is in the shareholders’ interests that performance metrics are linked to the company’s strategic plan and key performance indicators (KPIs) and ensure there is a strong read‑across from the company’s strategy to the drivers of executives’ remuneration.
The Code states: “Executive directors’ remuneration should be designed to promote the long-term success of the company. Performance‑related elements should be transparent, stretching and rigorously applied.”
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