3.1 This Guidance is intended to emphasise certain aspects of the Combined Code and where appropriate provide guidance as to shareholders’ expectations.
3.2 Contract policy including terminations and the approach to mitigation should be clearly explained in the Remuneration Report. Also, corporate objectives set for executives by the Board should be clear. The more transparent and understandable the objectives, the easier it is to determine how an executive has performed and therefore prevent payment for failure. Wherever possible, objectives against which performance will be measured should be made public.
Contract Terms
3.3 Remuneration Committees should ensure that the policy and objectives on directors’ contracts are clearly stated in the Remuneration Report. Shareholders will take account of contracts and the way they are implemented in considering their vote on the Remuneration Report and the re-election of members of the Remuneration Committee.
3.4 When contracts are being negotiated, boards should consider and avoid the reputational risk of being obliged to make large payments to executives who have failed to perform. Contracts should be reviewed periodically and Remuneration Committees should consider whether the contract provisions are in line with their policy and this Statement.
Notice Periods
3.5 The Combined Code states that under normal circumstances directors should be retained on contracts of one year or less. However we believe that a one-year notice period should not be seen as a floor, and we would strongly encourage boards to consider contracts with shorter notice periods. Compensation for risks run by senior executives is already implicit in the absolute level of remuneration, which mitigates the need for substantial contractual protection.
3.6 If it is necessary to offer executives longer notice periods, for example for incoming executives at companies in difficulties, we would expect the length of the contract to be justified. In that case the termination provisions attached should be fully disclosed and the length of the contract should reduce on a rolling basis in line with the recommendations contained in this Guidance.
Severance Payments
3.7 Remuneration Committees should have the leeway to design a policy appropriate to the needs and objectives of the company, but they must also have a clear understanding of their responsibility to negotiate suitable contracts and be able to justify severance payments to shareholders.
3.8 From the outset, Boards should establish a clear policy to ensure any non-contractual payments are linked to performance. No director should be entitled to discretionary payments in the event of termination of their contract arising from poor corporate performance. Remuneration Committees should consider retaining their discretion to reclaim bonuses if performance achievements are subsequently found to have been significantly mis-stated.
3.9 Contracts should not provide additional compensation for severance as a result of change of control.
3.10 Remuneration Committees should ensure that full benefit of mitigation is obtained. This includes the legal obligation on the part of the outgoing senior executive to mitigate the loss incurred through severance by seeking other employment and reducing the need for compensation. Phased payments are generally appropriate for fulfilling compensation on early termination. The ABI and NAPF are not supportive of the liquidated damages approach which involves agreement at the outset on the amount that will be paid in the event of severance.
Pensions
3.11 Pension entitlement or contributions on severance can represent a large element of cost to shareholders. Remuneration Committees should identify, review and disclose in the Remuneration Report any arrangements that guarantee pensions with limited or no abatement on severance or early retirement. These pension arrangements are no longer regarded as acceptable, except where they are generally available to all employees. Where opportunities arise, existing contracts should be amended. Such conditions should not be included in new contracts.
Inspection Arrangements
3.12 Directors’ contracts and any side letters relating to severance terms and pension arrangements should be readily available for shareholder inspection.