In its response to the DTI consultation on termination payments for directors, the CBI unveiled guidelines on directors’ severance packages. They recommend immediate disclosure of contractual terms and conditions, one year rolling contracts, part-payment in shares and regular contractual reviews. They also outline ways of handling the different elements of severance packages – basic pay, earned bonus and pensions.
The response is intended to provide a flexible and transparent framework primarily for FTSE 100 companies. It includes six key principles which could be used by companies as a benchmark for all executive director contracts.
Best Practice Guidelines
- Key contractual terms should be announced to shareholders immediately after the parties are committed to each other and severance details should also be announced after agreement between the company and the individual.
Details of directors’ contracts are often made public in company annual reports which may not be published for some months after an appointment has been made. The CBI recommends that key details of directors’ contracts are made available at the earliest opportunity, so shareholders know speedily exactly what commitments have been made. Severance terms should be similarly announced.
- The terminology of each clause in the contract must be clear to ensure the reader can determine the precise nature of the agreed terms and conditions, and confusing terms like ‘guaranteed bonus’ should be avoided.
- Severance entitlements should be restricted to basic pay, earned bonus and pensions accrual only in line with pay. They should take account of the individual’s circumstances and opportunity to mitigate loss by finding another job.
Contracts should provide for the usual payment of severance, unless there are special circumstances which are clearly explained to shareholders, to be by monthly payments until the end of an agreed period or until another job is obtained, whichever is earlier.
Payments under share or other equity based incentive plans should be made under normal scheme rules and not special departure conditions. Any attempt to enhance pension payments outside contracted entitlement should require specific shareholder approval.
- In normal circumstances, directors should have contracts no longer than one year to help minimise the cost of severance. It is, however, recognised that circumstances do sometimes exist which dictate a longer initial contract.
- Within two years newly appointed directors should have terms and conditions which are in line with those of incumbent Board directors.
New directors may need to be tempted away from existing secure positions so an additional amount of initial contractual security may be needed but the CBI recommends that those contracts are brought into line within two years of recruitment.
- To strengthen the alignment between shareholders and company directors the CBI recommends that a proportion of remuneration should be directed into shares bought on the open market which should be held for three years.
CBI Director-General Digby Jones said: “The CBI is unequivocally against rewards for failure. There have been a small number of well publicised cases where severance arrangements have given the wrong signals. The standing of business is at stake and must be tackled but in a way that ensures world-class companies can attract top international business people and retain and nurture home grown talent.”
He added: “If a company has explained a specific set of circumstances and secured agreement, when the issue then becomes public, shareholders should weigh in with public support of the board. Perhaps now is also the time to see greater transparency in the way that fund managers are rewarded and how investment decisions are taken.”
Commenting on the guidelines, George Cox, Director General of the Institute of Directors said: “We are very much in accord with the thinking behind the proposals since, all too often, high severance payments are not so much a matter of misplaced generosity but the outcome of contracts which were poorly structured at the outset.”