In a paper entitled "Rewards for Failure", the government weighs up alternative strategies for tying directors' pay more closely to performance.

They include shortening directors' notice periods to one year or less, and encouraging firms to insert clauses limiting severance pay into their employment contracts.

The government has asked shareholder groups, trade unions, and business lobbies to comment on the document, and may come forward with concrete proposals later this year.

Shareholders are rightly concerned when directors leave failing companies and walk away with excessive payouts Trade Secretary Patricia Hewitt How the controversy is upsetting Labour's friendship with business

Business groups have urged the government not to legislate against 'fat cat' pay, saying that new regulations would create unnecessary legal complexities for big companies.

"Transparency and shareholder activism are the wasy to police directors' pay, not legislation," said Digby Jones, director general of the Confederation of British Industry.

However, the paper makes clear that the government has not ruled out changing the law to stop hefty pay-offs for directors who preside over share price collapses or large-scale job losses.

Chorus of protest

"Britain has some of the best and most successful businesses in the world. But the good reputation of the majority is being tarnished by the bad practice of the minority," Ms Hewitt said.

"We have no problems with big rewards for big success, but shareholders are rightly concerned when directors leave failing companies and walk away with excessive payouts."

The government's move comes in response to a growing tide of resentment over 'fat cat' pay over the past year.

Warning shot

Protests came to head last month when shareholders in drugs giant GlaxoSmithKline (GSK) sensationally voted down a pay package that entitled chief executive Jean-Pierre Garnier to up to $35m (�22m) if he left the job early.

'FAT CATS' IN THE SPOTLIGHT Glaxo's Jean-Pierre Garnier over �22m pay-off entitlement HSBC's �25m pay deal for director William Aldinger Tesco under fire for rolling two-year contracts for directors At a glance: Key government pay proposals

Their opposition was fuelled partly by a slump in GSK's share price in the two-and-a-half years since Mr Garnier took over.

It was the first time that shareholders in a British company had voted down directors' pay proposals, and sent out a powerful signal that investors' patience with underperforming company bosses had reached breaking point.

Several other blue-chip companies, including HSBC, Barclays, Reuters, and Shell, are also facing shareholder dissent over directors' pay.

Trade union groups said the government's move on fat cat pay sent out a warning shot to big companies.

"UK business leaders are now gambling at the last chance casino. Unless they stop rewards for failure, and curb corporate greed they will inevitably face tough legal changes," said TUC leader Brendan Barber.