Chapter 5 +16. Directors – Duties, powers and Remuneration

Question 1

List the 7 directors’ duties under the CA2006

Answer 1

1. To act within their powers in accordance with the company’s constitution (and to use those powers for proper purposes) (s. 171)
2. To promote the success of the company (s. 172)
3. To exercise independent judgement (s. 173)
4. To exercise reasonable care, skill and diligence (s. 174)
5. To avoid conflicts of interest (s. 175)
6. Not to accept benefits from third parties (s. 176)
7. To declare any interest in proposed transactions or arrangements (s. 177)

Question 2

List 3 factors likely to be considered when adhering to s172 of the Act

Answer 2

1. The likely consequences of any decision in the long term
2. The interests of the company’s employees
3. The need to foster the company’s business relationships with suppliers, customers and others
4. The impact of the company’s operations on the community and the environment
5. The desirability of the company maintaining a reputation for high standards of business conduct
6. The need to act fairly as between members of the company

Question 3

What is the purpose of Directors’ and Officers’ insurance?

Answer 3

• The core purpose of a D&O policy is to provide financial protection for directors against the consequences of actual or alleged “wrongful acts” when acting in the scope of their duties.

These include:
– breach of trust
– breach of duty
– neglect
– error
– misleading statement
– wrongful trading

• The D&O policy will pay for defence costs and financial losses.

Question 4

Provide 4 reasons why remuneration is a CG issue?

Answer 4

1. Companies need to attract and retain talented executives.
2. Remuneration incentives can be used to motivate executives to achieve better results for the company.
3. Those incentives need to be aligned with the interests of shareholders and promote the success of the company
4. Directors should not be rewarded for failure.
5. Directors should not be able to decide or influence their own remuneration.
6. High levels of executive pay undermine public trust in large businesses.

Question 5

List 5 issues that might arise when linking reward to performance

Answer 5

1. Selecting the right performance measures
2. Setting the thresholds at which rewards are paid
3. Deciding whether to place a cap on any rewards under the incentive and determining the level of that cap
4. Ensuring that the targets used for short-term incentives like the annual bonus promote the long-term success of the company
5. Ensuring that the targets used for incentive schemes do not promote bad behaviour
6. Preventing executives who did not perform well from piggy-backing on the success of their colleagues
7. Preventing the ‘legacy effect’
8. Executives may develop an expectation that they should receive annual rewards regardless of the actual performance of the company
9. Designing a scheme that will be satisfactory to shareholders

Question 6

Provide 3 drawbacks of using a share option scheme as part of a remuneration package

Answer 6

1. Share options reward holders for increases in the share price, when this may not always relate to the executives or indeed the company’s performance (ie ‘Bull’ market )
2. When the stock markets are in a bear run and prices are declining, share options lose value, and may even become worthless, irrespective of executives or company’s performance.
3. Option holders do not benefit from dividend payouts.
4. The market price of a company’s shares may fall below the exercise price for its share options (‘Underwater’)
5. Executive directors may prefer a long-term incentive scheme involving the grant of shares, since the shares will always have some value once they have vested.

Question 7

Explain the principles of malus and clawback

Answer 7

• Remuneration schemes and policies should enable the use of discretion to override formulaic outcomes.

Include provisions that enable company to recover and/or withold sums or share awards and specify when appropriate to do so

Provision 37, UKCG code

• ’malus’ provisions allow the company, in specified circumstances, to forfeit all or part of a bonus or long-term incentive award before it has vested and been paid (also known as ‘performance adjustment’); and
• ’clawback’ provisions allow the company to recover sums already paid.
• the current market standard triggers for malus and clawback are gross misconduct or misstatement of results (Investment Association’s Principles, Nov 2020)

Question 8

What is a quoted company?

Answer 8

Includes any UK company whose equity share capital:
* has been included in the official list (includes UK
companies with either a premium or standard listing whose shares are traded on the main market of the London Stock Exchange);

• is officially listed in an EEA state (for example, a UK company whose shares are quoted on the Paris Bourse); or
• is admitted to dealing on either the New York Stock Exchange or the exchange known as Nasdaq

Question 9

Requirements of a remuneration policy (development and implementation)

Answer 9

• Part of Annual ‘directors’ rem report if wants to approve new policy or renew existing policy-If omitted, must state when policy approve and where copy of policy can be found (website)
• Directors can only be paid in accordance with directors rem policy
• SH must approve rem policy at least once every 3 years + if any revisions
• SH must approve policy approved by directors as part of rem report or as revised doc
• If resolution defeated, the directors must put existing directors’ rem policy or a revised policy to a vote at the next meeting (CA2006, s. 439A(2)).
• Rem policy available on companies website

Question 10

Content of directors remuneration policy

CPI SH MM

Answer 10

1. Table describing components of rem package
2. Statement of principles applied when agreeing components of rem package
3. Provsions which may impact remuneration payments
4. Bar chart Max and min payable to directors under policy
5. Performance measures/ targets, max remuneration assuming 50% share growth
6. Policy on notice periods
7. How pay and conditions of employees taken in2 account
8. If and how SH views taken in2 account

Question 11

Content of annual remuneration report/ implementation report

(declarations/ reporting that must be made in relation to remuneration)

Answer 11

• Annual vote is advisory
• Summary of major changes, performance measures and the exercise of discretion
• Single total figure table (total figure for annual remuneration compare to previous year)
• Why remuneration is appropriate using internal and external measures including pay ratios and pay gap
• Total pension entitlements
• Scheme interests awarded
• Payments made to previous directors
• Director’s shareholdings and share interests in the company
• Performance graph and table
• % change in remuneration of the CEO
• Relative importance of spend on pay
• Description of how the company intends to implement the approved remuneration policy in the following year.
• Details regarding the membership of the remuneration committee and any advisers.
• Statement on voting (votes for and against last rem resolution)

Question 12

Relevant Code provisions for remuneration

Answer 12

P Q R

Question 13

s.171 Features

Answer 13

Powers within articles association

Exercise powers for the purposes for which they are conferred (Howard Smith case)

Powers to delegate duties

Question 14

s.172 Features

Answer 14

Define

Annual report disclosures

s.172 in the strategic report

Enlightened shareholder approach

Question 15

s.173 Features

Answer 15

Must not fetter discretion

No bias

Can be difficult if director represents outside interests

Question 16

s.174 Features

Answer 16

Define

Two thresholds:
Objective test - skills expected minimum standard

Subjective - skills have, particular to directors skills

Question 17

s.175 Features

Answer 17

Avoid a situation in which they have, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company.

Question 18

s.176 Features

Answer 18

The duty not to accept benefits from a third party is clearly related to the duty to avoid conflicts of interest. By accepting
such benefits, directors clearly put themselves in a position of potential conflict which may compromise their independent
judgement and their duty to act in good faith to promote the success of the company.

However, directors will not be in breach of this duty if their services (as a director or otherwise) are provided through a third party, such as an outside services company.

Question 19

s.177 Features

Answer 19

Directors have a duty to declare any interests that they have in:
* any proposed transaction or arrangement with the company (s. 177); and

• any existing transaction or arrangement with the company (s. 182).

Question 20

Two elements of remuneration

Answer 20

Fixed (regardless of performance)
- Basic salary
- Pension scheme payments

Variable (performance based)
- Bonus (short-term incentive)
- Share options and LTIP (long-term performance)

Question 21

Measurements of performance

Answer 21

Earnings Per Share (EPS)

Total Shareholder Return (TSR) Share price & Dividend

Profit PBIT or EBITDA

Return on Capital Employed (ROCE)

Others (including Non Financial)

Question 22

Features of Rem Co

Answer 22

Independent NED’s

Minimum membership of 3 (2 for smaller companies)

Chair of board only member if independent on app and cannot be chair

Served on rem co for at least 12 months

Question 23

Issues with using rem consultants

Answer 23

Conflicts of interests

Recommendations that favour executives

Recommend complex remuneration

Pressure on rem co to accept advice

Question 24

Rem Co Report

Answer 24

Provision 41 (description of work of rem co in annual report)

Did policy operate as intended?

What engagement took place with shareholders

Engagement with workforce

What extent discretion applied