New pay ratio reporting requirements on the horizon

Paul Hally discusses the Government's latest proposals on corporate governance reform and the implications this may have on the new pay ratio reporting. 

26 September 2018

In its green paper on corporate governance reform, the Government sought views on measures designed to address "a widespread perception that executive pay has become increasingly disconnected from both the pay of ordinary working people and the underlying long-term performance of companies".

One of the proposals put forward was to require quoted companies to publish ratios in its directors' remuneration report comparing the remuneration of a company's CEO to that of the rest of its UK workforce. This is intended to enable interested parties to better understand how the pay of executives compares to that of other employees in a company and to ensure that a company’s remuneration committee can support the reasons for the ratio, and any changes to it, from year to year.

The Companies (Miscellaneous Reporting) Regulations 2018 (Regulations) were published on 17 July and set out the new financial reporting requirements.

The new reporting requirements will apply for financial years beginning on or after 1 January 2019 (so companies will report on the relevant requirements from 2020).

What is the new pay ratio reporting requirement?

Companies within the scope of the new reporting requirement must include a new pay ratios table (in the prescribed form set out in the Regulations), which broadly compares the remuneration of the CEO against UK employees whose full time pay and benefits are on the 25th, median and 75th percentile respectively in the relevant financial year.

The Regulations provide three different methodologies that companies can use to determine the pay and benefits of the company's UK employees for the purposes of calculating the ratios.

In addition to the pay ratios table, the directors' remuneration report (DRR) must set out why the company chose the relevant methodology and certain other prescribed information relating to the methodology and how the company determined the pay ratios.

The directors' remuneration report must also set out a summary explaining any reduction or increase in the pay ratios compared to the pay ratios of the preceding financial year, and whether a reduction or increase in any pay ratio is due to:

  • a change in the remuneration of the CEO, or the pay and benefits of the company's UK employees as a whole;
  • the company's employment models (including any increase in the proportion of the company's employees working outside the UK and any increase of the company's workforce that is not employed by the company under contracts of service);
  • the use by the company of a different methodology under the Regulations to calculate the pay ratios.

The directors' remuneration report should also provide an explanation of whether (and if so, the reasons why) the company believes the median pay ratio for the relevant financial year is consistent with the pay, reward and progression policies for the company's UK employees as a whole.

Whilst not relevant for reporting in 2020, in subsequent years the directors' remuneration report should also provide an explanation of any trend in the median pay ratio over the period of financial years covered by the pay ratios table.

The Government noted in its green paper that perhaps the biggest benefit for shareholders and other interested parties as a result of pay ratio reporting could be the requirement for boards to explain why the pay ratio of the company is appropriate in light of the performance of the business and the rewards of the UK workforce as a whole. The additional narrative requirements set out in the Regulations clearly seek to ensure companies provide this explanation and improve transparency.

Other financial reporting obligations?

The Regulations also require new DRR disclosures on:

  • any Remuneration Committee discretion that has been exercised as a result of a share price increase or decrease;
  • the extent to which the value of vested share scheme awards is attributable to share price growth over the period from their date of grant; and
  • the potential impact of a 50% growth in the share price in the existing "scenarios chart" contained within the directors' remuneration policy.

Next steps

The new financial reporting requirements form part of a series of new reporting obligations set out in the Regulations.  Details of these other corporate governance reporting requirements can be found in our separate briefing note which can be found here.

Companies falling within the scope of the Regulations will need to ensure that they have the necessary arrangements in place in order to report in 2020.

Please contact your usual Shepherd and Wedderburn LLP contact for advice in relation to the Regulations and new reporting requirements.