The remuneration report is now a firm part of the corporate reporting you’re required to provide by law. In response to persistent calls for greater transparency, it gives an account of the compensation package the shareholders are being asked to approve for the management. But what many people don’t realise is that different parts of your reporting can give different figures for the same compensation – and all these figures are correct.
Aremuneration report (also known as a compensation report) is an account of the compensation granted to directors, executives and advisory board members presented to shareholders for approval at the annual general meeting. The quantitative information contained in the remuneration report is subject to scrutiny by the auditors. Remuneration reports often also provide qualitative information to help recipients understand the rewards system. This information isn’t subject to audit.
Social and political background
The requirement to publish a remuneration report was born of growing discontent regarding the rewards granted to management at large companies, which culminated in the referendum on the Minder Initiative in March 2013 and the enactment of a corresponding legal framework in the form of the Ordinance against Excessive Compensation at Listed Companies (VegüV/ORAb). The idea was to make the public aware of this issue and curb excesses in management remuneration.
The VegüV/ORAb ordinance governs the procedure for compensating managers and directors at Swiss companies whose shares are listed in Switzerland or abroad. It requires disclosure in the remuneration report of the rewards granted to current and future members of the board of directors, executive management and advisory board. The report must also contain prior-year figures for comparison. The disclosure requirement applies regardless of whether the recipients of compensation are employed in Switzerland, or work in this country and live abroad. The ordinance also prohibits specific forms of compensation such as severance payments and payments in advance. Even though the remuneration report doesn’t have to be submitted to the annual general meeting (AGM) for approval, it does help shareholders make an informed decision in the vote on compensation (say-on-pay).
Ordinance against Excessive Compensation at Listed Companies (VegüV/ORAb)
In force since 1 January 2014, the VegüV/ORAb ordinance requires a remuneration report for 2014 and subsequent periods. It overrides the transparency legislation, but not all of its provisions. The remuneration report replaces only the information contained in the notes to the financial statements, pursuant to Art. 663bbis of the Swiss Code of Obligations, with severance pay no longer allowed, and certain additions (signing-on bonuses and additional amounts for members of the executive board) and redrafts made.
Swiss Code of Obligations (CO)
Art. 663c CO is still in force. It stipulates that companies whose shares are listed on a stock exchange must specify the significant shareholders and their shareholdings in the notes to the balance sheet.
Art. 958c CO describes the recognised financial reporting principles, Art. 958d 2-4 sets down the rules for prior-year figures, the currency and language of the report, and Art. 958f sets down the rules for keeping and retaining accounting records.
Art. 959c CO sets down the information to be disclosed by all entities subject to the financial reporting law. Paragraph 2 point 11 also requires non-listed entities to disclose the number and value of shares or options on shares held by management or administrative bodies and by employees.
SIX Exchange Regulation
The Directive on Information Relating to Corporate Governance published on 1 September 2014 by SIX Exchange Regulation is based on the Stock Exchange Act. Article 6 stipulates that information relating to corporate governance is to be published in a separate section of the annual report. This section may refer to other parts of the annual report (including the remuneration report) or other easily accessible sources.
Organisations had to produce a remuneration report as per the VegüV/ORAb ordinance for the first time for the 2014 financial year. This took the place of disclosure under 663bbis of the Code of Obligations. Given that there are many similarities between the two requirements, drawing up a remuneration report has been simple for companies, many of which have already achieved a high degree of transparency. Even so, in practice there are still questions when it comes to applying the rules. Particularly in the case of long-term compensation, the question arises as to how to disclose this type of reward transparently, especially given that the value of such rewards can change over time and has to be presented differently depending on the purpose. To illustrate the problem, let’s look at a simplified example.
In a prospective vote the shareholders of ABC AG grant the CEO share-based compensation in the form of a stock options plan. The CEO can acquire ten shares for free provided he works for the ABC AG group in financial years 1 and 2. Thereafter the options are subject to a lock-up period of one year. At the time of the AGM in financial year 1, the share is trading at CHF 10. At the end of financial year 2 the share price is CHF 30, and by the end of the blocking period – in other words after three years – it has reached CHF 50. The social security contribution is 10%, calculated on the basis of the value of the shares at the moment the option is exercised. The CEO exercises his option at the end of the third year. To meet the requirement, the requisite shares are acquired on the stock exchange at market price in year 3. We assume that the CEO is the most highly remunerated member of executive management and is employed by a subsidiary of ABC AG.
Truth: an amalgam of different perspectives
How much is the package awarded to the CEO in our example actually worth? To answer this question, let’s look at how this reward is presented in financial statements under IFRS and the Swiss Code of Obligations. To make things simpler we’ll leave tax out of the equation.
In the remuneration report covering financial year 1, the total allocation of ten options at a value of CHF 10 each, including the 10% in social security contributions likely to be deducted, is disclosed, giving a total figure of CHF 110. This also corresponds to the total figure voted on by the shareholders. Since the remuneration report constitutes a statement in relation to the say-on-pay, according to recognised practice no further disclosure seems to be required in the subsequent years.
In terms of the IFRS (group) financial statements, the value of the option on the grant date, CHF 10, is the determinant for the whole vesting period. Since the CEO acquires the entitlement over financial years 1 and 2, the total expense for this share-based compensation is spread over these two years, in other words CHF 50 per year. Taking account of probable social security contributions, this leads to the recognition of CHF 55 in expense in year 1, and CHF 75 in year 2. The expense in financial year 2 is calculated on the basis of the total benefit including social security contributions of CHF 130 (CHF 100 for ten shares worth CHF 10 plus 10% of ten shares worth CHF 30 the second year) minus the expense already recognised in the first year. The additional social security contributions of CHF 20 due in year 3 (10% of ten shares worth CHF 50 in the third year minus social security contributions of CHF 30 already recognised) have to be recognised as an expense at the time the option is exercised. Taken over three years, the expense under IFRS comes to CHF 150. Under the terms of IFRS, compensation paid to the CEO does not have to be disclosed separately. Instead, the key management personnel compensation for a period has to be disclosed in total and for various individual categories (short and long-term benefits, post-employment benefits, termination benefits and share-based payment benefits).
Since there is no employment contract between ABC AG and the CEO, this share-based compensation does not have to be recognised in the financial statements of ABC AG under the Swiss Code of Obligations, nor does it have to be disclosed there under the terms of Art. 959c para 2 point 11 CO. Instead, under the Swiss Code of Obligations the compensation is recognised in the financial statements of the subsidiary of ABC AG (which in legal terms is the CEO’s employer). The subsidiary has a liability to amounting the pro rata market value of the shares and the social security contributions due on them (ultimately ten shares worth CHF 50 each plus 10% social security contributions). Accordingly the subsidiary recognises an expense of CHF 55 in the first year, CHF 275 in the second year (ten shares worth CHF 30 each plus 10% social security contributions minus the first year’s expense) and CHF 220 in the third year (ten shares worth CHF 50 each plus 10% social security contributions minus the first two years’ expense).
If you now look at the reports published by ABC AG and the financial statements for the subsidiary under the Swiss Code of Obligations for the three years, you will see the following figures for the transaction described above:
|Year 1||Year 2||Year 3|
|Published remuneration report (as part of the total compensation of the CEO)
|Published consolidated financial statements under IFRS (as part of the share-based compensation of key persons)||55||75||20|
|Published individual financial statement under the Swiss Code of Obligations for ABC AG
|Unpublished financial statement for the individual subsidiary
In other words there are different messages and figures for the same thing, and the information published in the remuneration report can deviate from the information in the financial statements for the group and individual entities. Nevertheless, the different figures for the same compensation are all correct under the terms of the rules applicable in each case, and are attested by the auditor accordingly. This means that comparing compensation in different reports can open up expectation gaps.
Here too, time is often money
Time is a key factor, especially for long-term incentive plans (LTIPs) involving share-based compensation. In terms of measuring compensation of this type, the year of allocation or grant date (often the day of the AGM) is relevant. The figures stated in the remuneration report and financial reports may differ as a result of fluctuating prices or differences in cut-off dates. For this reason the value used and the measurement date should be specified and explained in each report. While the remuneration report focuses on the amounts of compensation granted, in IFRS financial statements the focus is on recognising the expense resulting from the granting of this compensation in the relevant periods. Finally, financial reports under the Code of Obligations are geared to the settlement of the transaction.
Glossary of compensation/remuneration
Accrual principle: A key principle of financial reporting. The accrual principle is the notion that payments should be taken account of in the periods in which they have an economic impact, and not recognised as profit or loss (i.e. not on an event-oriented basis) on the date the cash is actually paid and collected (see for example International Accounting Standard IAS 1.25, Swiss GAAP FER Framework 11 and 12, and Art. 958b CO).
Bonus: Variable compensation, therefore the term is not clearly defined in employment law. Variable compensation can be paid as a component of salary or as a discretionary bonus. A bonus may be paid in cash and/or in the form of shares and options. Bonuses are disclosed in accordance with the accrual principle.
Grant date: The date compensation is awarded, used as the basis for determining the market value of a share or option granted as compensation. In a retrospective vote on a share-based compensation plan, the grant-date value is determined retrospectively on the day of the AGM.
Long-term incentives (LTIs): Long-term compensation designed to encourage loyalty and motivate employees, in particular executives and talented and important staff. LTIs for future contributions are disclosed in the remuneration report in the year they were allocated.
Employee option: A form of employee participation. The option entitles the employee to acquire a defined number of shares over an agreed period of time at a predetermined price. Employee participation plans often involve non-tradeable and non-transferable options.
Performance share units (PSUs): Free shares awarded to employees subject to the fulfilment of performance targets.
Restricted share units (RSU): Shares subject to a lock-up. By contrast with an employee option, the share is granted free of charge; in other words, the employee does not have to pay an exercise price. The employee has no influence on the date the shares are allocated and the corresponding shareholder rights are transferred.
Say on pay: The AGM’s say in retrospectively or prospectively determining the compensation of non-executive directors and executives.
Short-term incentives (STIs): Short-term components of compensation; usually refers to bonuses.
Vesting period: The period over which an employee accrues a benefit.
Heads and tails
The say-on-pay principle enshrined in the VegüV/ORAb ordinance works on the basis of monetary amounts rather than the number of stocks or options granted. In the case of simple compensation systems this principle makes a lot of sense; after all, the shareholders want to have a say in the amounts of salary paid to their management. But if you take a prospective approach to share-based compensation it can get complex, because this can’t take account of future price developments. An estimated, promised value can fluctuate over the years. If the share price develops positively, shareholders will be delighted with their capital gains, but at the same time they might also find that the value of the share-based compensation granted to management has increased dramatically since the date on which they voted on the compensation – when the share price was relatively low. Deviations from the figures stated in the financial statements can also emerge in the event of bonuses approved retrospectively, as the books will already have been closed by the time of the AGM.
Watch out when social security contributions are involved
In a narrow sense, social security contributions constitute a pension promise to employees. The VegüV/ORAb ordinance requires companies to state as compensation any expenses that establish or increase entitlements to employee benefits. This means employers must disclose expenses for social security contributions. Basically you have two choices when it comes to the timing of disclosure. Contributions are either
a) added to the stated compensation and disclosed together with the compensation on the date of allocation, or
b) disclosed separately from the stated compensation, and only stated in the year of the actual payment.
As the example described above shows, social security contributions can diverge considerably over time, especially since other facts besides the base value can change, for example contribution rates or the social security system applicable if the employee changes place of residence. To maximise transparency it would also be conceivable to combine the two options in the remuneration report by disclosing both the estimated social security contributions on granting of the compensation and the contributions actually paid on the compensation.
Not always the last word
While the say-on-pay rules give the AGM a say in the compensation of management, they don’t necessarily mean the shareholders always have the last word. This is because the content of this kind of vote is also influenced by other binding requirements, such as employment law or the social security rules. For example if a key employee who has been granted a long-term incentive plan in a say-on-pay vote subsequently quits, this person is entitled to the compensation for the entire duration of their period of notice (generally a year for top management) even if they are relieved of their operational duties on the day they hand in their notice.
The remuneration report is subject to scrutiny by the auditors, although they only have to verify the information stipulated in
Art. 12 to 14 of the VegüV/ORAb ordinance. This includes quantitative information on compensation, credits and loans. Qualitative aspects, such as the description of the company’s philosophy on compensation, compensation mechanisms and the processes for determining compensation, are not audited. Neither do the auditors have to give an opinion on the fitness of the compensation system in terms of its strategic relevance, or the appropriateness of the compensation paid. When conducting the audit, the auditors have to be aware that what are supposedly the same facts can be presented according to a variety of different rules. They have to make sure that in each presentation, the rules governing that particular approach have been complied with and implemented correctly. The auditors check whether the components of compensation covered in the remuneration report correspond to those laid down in the VegüV/ORAb ordinance, and whether they’re stated properly. For example, they verify whether the right people have been named in the right functions, or whether the number of people sitting on the executive board is correct.
Little to criticise, plenty to explain
Swiss companies limited by shares that have to comply with the VegüV/ORAb ordinance generally handle their compensation duties in compliance with the law. This seldom poses problems in terms of the audit. Typically for a first-time adopter situation, compensation is the subject of a great deal of public interest. Despite this, transparency remains a challenge, especially when it comes to presenting compensation systems with long-term components in a comprehensible form. On the basis of initial experience over the last two years we will see the emergence of recognised practice with easily representable models.
Looking for answers
As described above, challenges emerge when you start looking at other questions relating to compensation, for example the disclosure of fees received by a non-executive director or executive on the basis of a consulting agreement. If the director or executive in question has entered into the consulting contract as a natural person and receives the fee directly or indirectly, it has to be disclosed as compensation paid to the director or executive in the remuneration report. If the consulting agreement is with a third party (an incorporated company or partnership), the disclosure requirement depends in the first instance on whether the third party counts as a related party. The EXPERTsuisse publication Ausgewählte Fragen und Antworten bei der Prüfung von Vergütungsberichten in Übereinstimmung mit der VegüV (revised edition of 18 August 2015) provides information on this and similar questions.