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16 Nov 2016

The Investment Association takes a less prescriptive stance on executive pay structures

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The Investment Association (IA) has published revised principles of remuneration (the Principles) together with an open letter to the Remuneration Committee Chairmen of FTSE 350 companies which sets out issues that members will be focussing on ahead of the 2017 AGM season (Letter).

The revised Principles reflect the output from the Executive Remuneration Working Group Final Report, which was published in July and which we summarised in our update in August.

The main change to the Principles is a shift away from a "one-shoe fits all" view on executive pay structure. However, the key message remains that simplicity should be maintained. 

Summary of key changes to the Principles

  • Specific pay structures are no longer prescribed. The previous references to companies limiting their remuneration elements to one long term incentive plan and one annual bonus plan have been deleted. Now, the Principles refer to "simple and understandable remuneration structures" and those that are "most appropriate for the implementation of [a company's] business strategy". Furthermore, the part of the Principles that discusses particular types of share scheme includes a new section on restricted share plans, with guidance on the issues to consider where restricted shares are to be used as part of the incentives package.
  • There is an increased focus on levels of remuneration. A company should disclose the pay ratio between the CEO and median employee; the Board must explain why a chosen maximum level of remuneration is appropriate for the company; shareholders expect the remuneration committee to exercise discretion to avoid excessive pay outs; and the board as a whole must be mindful of pay and conditions across the workforce.
  • There is a new section on shareholder consultation. Consultation is not meant to be a validation exercise – instead consultation should focus on strategic issues with investors analysing remuneration structures from a governance and investment perspective. The Principles call on remuneration committees to engage with shareholders where more than 20% of votes are against the company's remuneration report or remuneration policy and they should publish the reasons for the dissent together with an explanation of what the board and the remuneration committee are doing to address it.
  • Remuneration committees are encouraged to consider putting in place post-employment shareholding requirements.
  • There are subtle changes to the annual bonus provisions. Previously, the Principles explained that the deferral of a portion of a bonus into shares can create greater alignment with shareholders. The revised Principles provide that deferral "is expected."
  • The disclosure requirements relating to annual bonus targets are more prescriptive. The Letter states that shareholders require retrospective disclosure of bonus targets so they can ensure there is an appropriate link between pay and performance. They also expect details of specific targets and the extent to which they have been met to be explained. Additionally, for personal or strategic objectives, a company should provide a detailed rationale for any pay out. 

What else?

Although the Principles have not changed substantively on the use of discretion, the Letter emphasises that discretion is important as a mechanism to ensure remuneration outcomes are appropriate. As with most elements of remuneration, the focus is on disclosure with the Letter setting out that where discretion has been exercised, the circumstances should be outlined and the reasons for and the outcome of the exercise of the discretion explained.

The Letter also asks issuers to justify the disparity between pension contribution rates for executives and the general workforce. Again, disclosure and transparency are taking a front seat.

What next?

The executive pay landscape has long been under scrutiny, and it's entirely possible that issuers may take the opportunity to make their remuneration structures more appropriate and understandable. However, whilst the Principles indicate an important shift in expectations, it is doubtful that things will change overnight. Companies putting their remuneration policies to a binding vote in 2017 will already have been thinking about their remuneration structures and it is possible that the publication of the Principles has come too late in the day to influence policies to be put to vote next year.

The revised Principles can be found here and the Letter can be found here.

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