November 2017: Tapestry Alert: UK: Executive Remuneration Investment Association announces latest update to the Principles of Remuneration

The Investment Association (IA) has published the key changes to the IA Principles of Remuneration for 2018. A copy of the updated Principles can be downloaded here.

What are the IA Principles of Remuneration?

The IA represents investment managers and clients and provides advice on a broad range of investment issues. To assist its members in their corporate governance work, the IA maintains the Principles of Remuneration which set out members’ views on the role of shareholders and directors in relation to remuneration and the manner in which remuneration should be determined and structured. The Principles are structured as a set of over-arching Principles plus general Guidance.

The Principles are not legally binding but they do have persuasive influence. If a company wants to develop a remuneration plan outside the Principles, the IA may recommend that shareholders vote against the proposed plan.

What changes have been made for 2018?

The Principles are updated annually and in 2016 underwent a substantial rewrite. The latest updates for 2018 are described by the IA as incremental changes.

The Principles have been updated to reflect best practice on executive pay and the government’s Corporate Governance reform initiatives.

The main changes are:

  • Relocation benefits: IA members expect relocation benefits will be (a) disclosed at the time of appointment; (b) in place for a limited time; and (c) fully detailed in the Remuneration Report.
  • Annual bonus: the Principles have been updated to provide that bonus targets are disclosed within twelve months of the bonus payment and that deferral is expected for any bonus opportunity greater than 100% of salary.
  • Long term incentive schemes: the Principles have been reorganised to give a clearer picture of IA members’ attitudes to long-term incentive structures, including LTIPs and Restrictive Share Awards.

What issues are likely to be focussed on at 2018 AGMs?

In the Letter of Introduction to the updated Principles, the IA also highlighted issues which its members will be focussing on ahead of the 2018 AGM season. Of particular importance to IA members are:

  • Levels of Remuneration: IA members welcomed actions by those (mostly) large companies which have reduced potential variable remuneration awards and limiting overall pay. IA members expect all companies to follow this lead and to show restraint on any variable remuneration increases. Members consider that levels of remuneration paid to executives must be able to be justified in the wider social context of executive pay and will be looking closely at how any increases are justified.

Other ongoing issues are:

  • Pay ratios: companies are expected to disclose the pay ratios between the CEO and median or average employee, as well as the CEO and the executive team.
  • Pensions: executive directors should have pension contribution rates at the same level as the general workforce.
  • Remuneration Structures: last year, the Principles were amended to include a specific statement that IA members do not seek to prescribe or recommend any particular remuneration structure and to acknowledge the need for increased flexibility in the choice of remuneration structures. However, an increase in the number of companies adopting restricted shares raises concerns for some IA members. The IA notes that its members encourage remuneration committees to adopt the remuneration structure which is most appropriate for the company and the implementation of its business strategy.

Shareholder Consultation: the IA stresses that consultation with shareholders on executive remuneration must be meaningful and treated as a two-way process. The IA guidance letter points out that failure properly to understand the views of shareholders has led a number of companies to withdraw their resolutions prior to the AGM, and stresses that where this has happened, the company should consult with shareholders before re-submitting its Remuneration Policy.

Pay for Performance: to assist with making an appropriate voting decision, IA members expect remuneration packages to include robust transparency on targets and structures so that the link can clearly be seen between remuneration and company performance. In particular, there is a focus on:

  • Financial Targets: full disclosure of threshold, target and maximum performance targets, usually disclosed at the time of payment of the award. If the metrics have been adjusted from the figures shareholders can see as headline KPIs or reported numbers, members expect an explanation of the adjustments and their impact.
  • Disclosure of Personal and Strategic Performance Targets: members expect to see a thorough explanation as to why personal or strategic targets have paid out, not just a description of non-financial performance indicators. Payouts on non-financial targets will be particularly scrutinised if the financial bonus targets were not met.
  • Accountability of Remuneration Committee Chairs: the chance of individual directors being re-elected is increasingly affected by their voting record at the Remuneration Committee.
  • Dilution: the previous provision permitting the usual 5% in ten years dilution limit to be exceeded where vesting was dependent on significantly more stretching performance criteria has been removed. The minority of companies affected will need to consider how they should respond.

Tapestry Comment
There are no big surprises here. More a continuation of the direction of travel we have been seeing over recent years. Shareholders expect executive remuneration to be well designed, explained and justified in the context of the company, its business, its performance and, increasingly, its wider workforce. The fundamentals are clear. Remuneration policies should be set to promote long-term value creation through transparent alignment with agreed corporate strategy.

The IA has not changed its view that equity based long-term incentive schemes are the most effective way to align the interests of participants and shareholders. There is increased pressure for earlier and better explanation of targets and outcomes. In many ways the IA’s updated Principles encourage companies to engage early with remuneration and disclosure requirements that may well become more than just best practice as the Government brings into effect its proposed changes to executive remuneration and corporate governance. Click here for our August 2017 update on proposed new corporate governance reforms.

If we can help you with your DRRs or your executive incentive arrangements, please do let us know.

Sarah and Sharon

Sarah Ferguson

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