28 April 2020

The Investment Association (IA) has issued updated guidance outlining shareholders expectations on how Remuneration Committees should be reflecting the impact of COVID-19 on executive pay. This guidance addresses the main areas UK listed companies have raised which are set out below.

Should a company that has suspended or cancelled a dividend in relation to FY2019 consider adjusting bonus outcomes for FY2019?

• Bonus outcomes may have been decided and, in some cases, been paid before the dividend was cancelled, however shareholders would expect Remuneration Committees to consider the use of discretion or malus provisions to reduce any deferred shares related to the 2019 annual bonus. Alternatively, shareholders would expect this to be fully reflected in the FY2020 bonus outcomes.

Would shareholders support performance conditions being adjusted to take account of COVID-19?

• Remuneration Committees are not expected to adjust performance conditions for annual bonuses or in-flight long-term incentive awards.
• Where the Remuneration Committees consider that company performance and shareholder experience is not commensurate with executive remuneration outcomes, then they should use their discretion to ensure a good link between pay and performance and engage with their shareholders and disclose the reasons for the use of such discretion.

Where companies have already granted 2020 LTIPs, what do shareholders expect from Remuneration Committees to ensure that a windfall gain will not be received by executives? 

• The majority of members have stated that for December year-end companies that have already made grants, if the share price fall is solely related to COVID-19 market movements, then they will accept that there does not need to be an adjustment to the grant size.
• Remuneration Committees should still look at the general market and share price response over the performance period to ensure that windfall gains will not be received on vesting. Shareholders will expect Remuneration Committees to use their discretion to reduce vesting outcomes where windfall gains have been received.
• Remuneration Committees should set out in their next Remuneration Report the approach they will take and factors they will consider when judging if there has been a windfall gain from the LTIP grant.
• Shareholders would expect any longer-term individual share price underperformance to be accounted for. If, for instance, the share price was down 30% in the year prior to the COVID-19 market reaction, an appropriate scaling back should be applied.

Where companies expect to make LTIP grants in the coming months, what are shareholders expectations on long-term incentive grant sizes and performance conditions? 

• There are concerns from companies and shareholders over the ability to set meaningful three-year targets at the current time and questions over the appropriate grant size given the share price reaction to COVID-19.
• In particular, Committees should be considering if it is appropriate to make LTIP grants at the current time and whether, given the current market environment, it might be more appropriate to postpone the current LTIP grant. Members believe that there are a number of options depending on the individual circumstances of the company:

1. Grant on the normal timeline setting performance conditions and grant size at the current time.
2. Grant on the normal timeline setting the grant size now but committing to set performance conditions within the next six months. 
3. Delaying the grant to allow the Committees to more fully assess the appropriate performance conditions and grant size. In such circumstances, Committees should aim to make the grant within six months of the normal grant date.

• The Committees should explain the approach they have taken to their shareholders.
• Shareholders will expect the Committees to use their discretion to reduce vesting outcomes where windfall gains have been received.
• The Committees' approach should be specific to the impacts of COVID-19 on the business and should not isolate executives from the impact of COVID-19 in a manner that is inconsistent with the approach taken to the general workforce.
• The issues on performance conditions and grant size are outlined below. 
  
  Grant size
  Remuneration Committees need to be pro-active in determining the appropriate LTIP award size in the current market environment given sustained share price falls. Making awards at maximum opportunity in cases where share prices have fallen substantially is to be discouraged. Committees should consider reducing LTIP grants to reflect the shareholder experience. 
  
  Performance conditions
  Remuneration Committees will have to consider if the performance conditions for future LTIP grants are still appropriate in the current market environment. Shareholders want performance conditions to be appropriately stretching. Committees may wish to make an LTIP grant at the usual time while delaying setting performance conditions for a reasonable period of time (up to six months) until the impact of COVID-19 on the business is clearer.
  
  If Committees decide to delay LTIP grants until further clarity is established, shareholders would still expect best practice to be a performance period of three years following grant. However, where this is not possible, Committees may shorten the performance period by up to six months, contingent on the explanation provided by the Committees and adequate post-vesting holding provisions being in place. Where the performance period is shortened, grant sizes should be similarly reduced.

What are shareholders expectations if a company seeks additional capital from shareholders or takes money from the governments such as furloughing employees?   

• Shareholders expect executive remuneration to be aligned with the experience of the company and its stakeholders.
• Where a company has sought to raise additional capital from shareholders, or has required Government support such as furloughing employees, shareholders would expect this to be reflected in the executives’ remuneration outcomes.
• Executive remuneration should be reflective of the pay and conditions in the wider workforce and Remuneration Committees and management teams should be even more mindful of the wider employee context through this period. Failure to do so may have significant reputational ramifications.
• Members have noted the number of companies who have already proposed temporary salary reductions for executives, or taken decisions to freeze variable pay. Shareholders will support those companies that do so and recognise that if they are asking employees to take temporary reductions, such an approach should be followed by the executives too.

Many companies will have their three-year Remuneration Policy up for a shareholder vote at the forthcoming AGM. How will shareholders consider proposals to change remuneration structures, including increases to variable pay opportunity? 

• Shareholders do not believe that these companies should be rewriting their remuneration policies at this time, but if companies are seeking to propose variable pay increases in the current year, then Remuneration Committees should carefully consider if such an increase is appropriate in 2020.
• For those companies that are yet to consult on a new remuneration policy, it may not be appropriate to bring forward remuneration policies with substantial changes if the company is significantly impacted by COVID-19. For these companies, it may be more appropriate to wait until there is greater clarity on the future market environment before proposing significant changes to their policies.
• Remuneration Committees will need to sensitively balance the need to continue to incentivise executive performance at a time where management teams are being asked to demonstrate significant leadership and resilience and ensure the executive experience is commensurate with that of shareholders, employees and other stakeholders.

Tapestry Comment
It is helpful that the IA has set out its current thinking and guidance for Remuneration Committees. One principle that features prominently in the IA’s guidance is Remuneration Committees' use of discretion. We know from the work we are doing with many of our clients that many are making sure they understand the scope of the discretions to change vesting outcomes in their executive plans to ensure that outcomes will reflect company and executive performance as well as the experience of shareholders, employees and other stakeholders.

Many of our clients have been reviewing the terms of the discretions in their executive incentive plans, some have wanted to clarify or extend the circumstances in which they may use them and also made clear reference to them in the communications going to participants. It is likely that institutional investors will want good disclosure on the use of discretions going forward.

If you would like to discuss the implications of this guidance, or of COVID-19 on your incentives more generally, please do let us know.
 
Janet Cooper OBE

28 April 2020

The International Corporate Governance Network (ICGN), who provide guidance to investor groups on executive pay and governance, have shared their most recent views in light of Covid-19 and beyond.
 
The open letter (which can be found here) addressed to “corporate leaders” from the ICGN includes the following key points relevant to remuneration for companies:

• Executive remuneration: executive pay should reflect the experience of the whole workforce giving consideration to wider decisions on redundancies, furlough, salaries and bonuses. Management should give priority to preserving the long-term financial health of the company over bonus decisions. Financial sacrifice should be appropriately shared between ordinary staff and senior executive management.
• Annual General Meetings: companies should engage with investors to address any questions as needed, and companies should plan other ways to facilitate these questions given that AGMS are mostly taking place virtually this year.
• Reporting: companies are encouraged to disclose how they are dealing with the pandemic, preferably in the annual report. Companies will need to demonstrate the steps they have taken to achieve resilience.

The letter also covers other governance priorities for companies including:

• Dividends: companies severely affected will need to consider  a substantial reduction or complete suspension in dividends. However, if companies can pay dividends without compromising financial stability, they should continue to do so to support the livelihoods of ordinary pensioners and long-term savers.
• Social responsibility: Companies should treat the workforce (employees and contractors) equally to ensure the health and well-being of all staff. Redundancies should be avoided and paid sick leave should be offered.
• Capital raising: the ICGN supports the suggestion that investors should allow share issuers that could be up to 20% dilutive, rather than the current pre-emption 10% limit.

The letter also includes governance considerations for investors - the key point made to investors is to ensure they have regard to the long-term approach. Investors may need to accept short term pain with reductions in dividend payments and investment returns to enable companies to survive this financial crisis. The letter also includes other considerations to investors including climate change, capital allocation and monitoring.

Tapestry Comment 
The ICGN is very influential in thought leadership, with many who are influential in corporate governance initiatives involved in the organisation.
 
Companies need to ensure they are considering the bigger picture across their whole business - not individual decisions in silos. Companies need to ensure that decision making on executive pay is aligned with decision making for the wider workforce. Journalists are very keen to report on mismatches between executive and employee pay decisions and the reputational damage of that could last for a long time.
 
The letter from the ICGN adds another example of guidance and investor pressure to act responsibly in governance and remuneration decision making at this time and in the coming months and years. Companies will need to be mindful in their decision making, both now and in future remuneration policy setting.
 
Companies that have received support from government funds are under particular pressure to be seen to be making the “right” decisions. Remuneration has historically been a private matter between a company and its shareholders. We have seen regulation on executive pay in recent years, but with public funds being used to support companies - will pay of employees in private companies become even more of a public concern?

If there is anything you would like to discuss, we are here to help so please do contact us.

Carla Walsham

14 April 2020

Institutional Shareholder Services (ISS), the proxy advisory firm, has issued policy guidance clarifying how they will apply the ISS Benchmark and Specialty Proxy policies during the main 2020 AGM seasons. The guidance gives increased flexibility to companies in relation to certain topics and applies globally, but should be read in combination with the relevant market and region-specific voting guidelines and FAQs, which can be found here.

Remuneration impacts 

• Change in performance metrics for short-term compensation - where boards look to change performance metrics for short-term compensation in response to the drop in the markets and the possible recession in the wake of the crisis, the ISS encourages contemporaneous disclosure to shareholders of the rationale for such changes.
• Change in performance metrics for long-term compensation - the ISS is not generally supportive of changes for ‘in-flight’ awards as they cover multi-year periods, so will look at such changes on a case-by-case basis to see if directors exercised appropriate discretion and provided adequate explanation to shareholders of the rationale for changes. The ISS will assess any structural changes to long-term plans, which seek to account for the new economic environment, under the existing benchmark policy framework.
• Option repricing - given the fall in stock price, companies may seek to reprice, replace, exchange or cancel and re-grant “out-of-the-money” or “underwater” options. If boards seek to do this without asking shareholders to approve or ratify this in a timely fashion, directors will be scrutinised under the relevant ISS benchmark policy board accountability provisions. If boards seek shareholder approval or ratification of repricing at the 2020 meetings, the ISS will apply the relevant existing case-by-case policy approach. For example, in the U.S., the ISS will generally recommend any opposing repricing that occurs within one year of a precipitous drop in the company's stock price, but will take a range of factors into account before making a decision.

Selected other points

• AGMs - ISS supports a focus on health and safety and recognises that physical meetings may not be possible. Companies should use standard disclosure documents (e.g. proxies; accounts), press releases and websites to notify stakeholders of material developments, and electronic engagement with shareholders (e.g. via conference calls) is welcomed. The ISS will also not discourage or make adverse voting recommendations against companies holding “virtual-only” meetings until it is safe to hold in-person meetings, but if a “virtual-only” meeting is used, the ISS encourages disclosure of the rationale (e.g. due to COVID-19) and for shareholders to have a meaningful opportunity to participate.
• Changes to the Board or Senior Management - if vacancies need to be filled due to the disability or incapacity of a director or senior manager, or there is a need to urgently add critical expertise, the ISS will consider this on a case-by-case basis and will assess the company’s explanation. The ISS believes  boards should have broad discretion during the crisis to ensure the right team is in place and will adjust the application of their policies as appropriate for the current exceptional circumstances.
• Dividends - the ISS recognises the ongoing market downturn and the need to manage cash has caused some boards to consider whether to continue to pay dividends, and further recognises that some government assistance programs prohibit (or may prohibit) dividend payments for companies benefitting from assistance. The ISS supports broad discretion for boards to set dividend pay-out ratios below historic levels or customary market practice but, when reviewing such proposals, will consider if the board discloses plans to use preserved cash from dividend reductions to support and protect the business and workforce.
• Share repurchases - boards may open themselves and their companies up to intense criticism and reputational damage by undertaking repurchases at this time, especially if the company’s workforce has suffered cutbacks. The ISS asks directors to consider the reputational, regulatory and business risks that exercising any existing authority to undertake a share buyback might create, even if shareholders approved that authority. That said, the ISS notes that, absent any barring regulation or serious concerns, they will generally continue to recommend in favour of repurchase authorities within customary limits for each market, but states that any repurchases in 2020 will be reviewed in advance of the next AGM to consider if directors managed risks responsibly for any share repurchases undertaken.
• Share issuances - the ISS generally provides for case-by-case recommendations on proposals to increase the number of shares of common or preferred stock authorised for issuance. The existing policy will be applied to general authorisation and share issuance requests but will be adapted to account for appropriate local market regulatory relaxations or new guidance as a result of the crisis.

Tapestry comment
The ISS understands the difficult position that boards and companies are currently in and the new policy guidance seeks to reduce the pressure by providing useful flexibility in a number of areas where the ISS would have normally challenged companies which failed to comply with the voting guidelines. Companies that have a shareholder-base influenced by the ISS should read the policy guidance in detail, alongside the existing applicable market and country specific voting guidelines.

It is notable, however, that there is not much additional flexibility with regard to remuneration. The ISS appears to be cautiously open to changes for short-term compensation but is clearly less open for changes to long-term compensation structures and to option repricing. If a company wishes to make changes to long-term compensation, or if they wish to reprice or exchange underwater options in any way, this should be approached with care. It is not guaranteed that the ISS will show any flexibility to these proposals.

Some of the other changes, such as in relation to AGM and board / senior management positions will help to reduce the operational burden for companies. It is important for companies that rely on this flexibility to note where the flexibility ends and take note of any expected enhanced disclosure and the prospect of enhanced scrutiny afterwards.

The ISS has noted that, as the situation develops, laws change, and issues are identified by investors or companies, the guidance will be updated as needed during the 2020 main proxy seasons. The ISS has also noted that, looking beyond the current short-term crisis, and in advance of the 2021 main proxy seasons, the ISS will consult with stakeholders to address whether further near- or long-term adjustments to their policies will be appropriate for 2021. We will keep you updated if we hear of any further changes.

If you would like to discuss the implications of this new guidance, or of COVID-19 on your incentives more generally, please do let us know.

Matthew Hunter