A working group of the Investment Association has published an interim report on its review of executive pay in UK listed companies. The group was tasked with assessing whether remuneration structures (particularly their complexity) are inhibiting management from acting in the best interests of companies and their investors.
The main message is that a move towards a company specific approach when designing remuneration is encouraged. Companies (through their remuneration committees) should be empowered to put in place more appropriate structures. Simplifying pay structures is still high on the agenda and must be factored in as a key consideration at the design stage. Changes in this area are expected to drive up shareholder value and restore confidence in remuneration design and the size of resulting pay-outs.
The report acknowledges that the typical three to five year vesting LTIP (used by most companies whose shares are listed on the London Stock Exchange) is not necessarily appropriate for all companies. It also identifies that the perceived value of the incentive to executives is diminished where LTIPs:
- use performance measures involving comparator groups;
- include malus and clawback provisions, as required under the Corporate Governance Code; and
- impose holding periods on any equity acquired.
These factors have resulted in award sizes being ratcheted upwards to keep key people within organisations incentivised. This is not to say that LTIPs are no longer seen as appropriate at all - for many companies, LTIPs may well still be a good fit. Ultimately, careful thought must be given to ensure each company is putting in place the most effective and appropriate remuneration structure.
The working group identifies four specific areas of focus:
Transparency – retrospective reporting of performance targets and disclosure of the areas where remuneration committees have exercised discretion is encouraged. This, the working group believes, will re-establish trust between companies and shareholders.
Shareholder engagement – Shareholders should no longer rely on corporate governance specialists and instead should engage to analyse proposed remuneration structures and pay-outs.
Accountability – Remuneration committees need to be more accountable to ensure pay outcomes align with business strategy and performance.
Flexibility – remuneration structures should be tailored to the needs of the company and its business strategy. This involves a move away from using benchmarking tools in favour of remuneration committees using their judgement to structure pay (and its various components) and determine pay-outs appropriately.
The report also considers structures other than LTIPs that could be used, including:
- A deferral of bonuses into shares which vest over time – these may be suitable for companies with short business cycles or where setting meaningful long-term performance targets is difficult;
- An award of shares based on past performance over a specified period, say three years. Shares received would be subject to vesting over a three to five year period after grant. The working group's view is that, because the performance element of the award will already have been determined, the award will have more "value" to the participant; and
- Annual awards of restricted shares which vest over time.
What happens next?
The working group is seeking feedback on its proposals for the simplification of executive pay through a series of roundtable discussions with stakeholders. It anticipates that it will publish its final findings in the early part of this summer. Depending on the outcome of the final report, this could result in a complete revamp of the existing guidelines that are published by the Investment Association annually (the Investment Association Principles of Remuneration) to reflect the findings of the working group.
Although any radical overhaul of remuneration and pay structures may be some way into the future, the interim report has come at a good time for those companies that first put their remuneration policy to a shareholder vote in 2014. Those companies will already be thinking about their remuneration policy given that it will need to be put to shareholders again in 2017 and the working group's findings may influence the shape of such policies.
Whatever the findings of the working group, it is apparent that whether it is quantum or design, shareholders have remuneration high up on their list of priorities. As companies enter the main AGM season we've already seen shareholder dissent on executive pay matters at Ladbrokes, BP and Anglo American, to name a few. It is inevitable that some changes are still needed to better align pay with business strategies.
The interim report can be found here and the latest version of the Investment Association Principles of Remuneration can be found here.