19 October 2020
It’s the season when many investment managers update their guidance on executive pay, ahead of discussions with companies in preparation for the next AGM season.
Legal & General Investment Management (L&G) has published its updated UK Principles of Executive Pay (October 2020) which can be found here. As one of Europe’s largest asset managers and a major global investor, L&G’s principles are influential in executive remuneration decision-making. Their principles are similar to those produced by the Investment Association but with some differences. L&G principles have now been updated to take the coronavirus pandemic into consideration.
One key development is L&G’s position on diversity at the senior level. L&G has warned FTSE 100 companies with all-white boards that it will vote against them unless they hire an ethnic minority director in the next 15 months (by 1 January 2022). Although not specific to remuneration, it is an important development and may impact executive incentives – with diversity targets being linked to either annual bonuses or long term incentives (or both).
- Long-term incentives:
- Companies are expected to reduce the size of any new awards if they have experienced a significant fall in share price (>20%) since the last award was made and if any new award would result in a greater number of shares being granted. Where this does not happen, and no undertaking has been provided to reduce awards when they vest, L&G will vote against the remuneration report.
- In light of covid-19, some companies are choosing to exercise discretion to adjust vesting outcomes rather than reduce initial awards. L&G has voiced that this is not their preferred solution as they consider it to be more complex, however a clear explanation of this intention in the annual report until the awards have vested would ensure that this choice does not result in a negative vote in future years. At the point of vesting, L&G will also expect a detailed explanation on how discretion has been applied to ensure appropriate adjustments were made to avoid windfall gains.
- L&G clarified that they do not generally support retrospective changes to LTIP awards, therefore any proposed discretion to in-flight awards that are material (i.e. impact the outcome to the benefit of the director) should be subject to shareholder consultation and support.
- In keeping with their policy for other long-term incentive plans, L&G expects substantial share price falls over the year to be captured in the grant size of awards of restricted stock.
- Bonus: L&G does not expect a bonus to be paid in companies that have been impacted by Covid-19 to the extent that support from the government or shareholders and staff redundancies were necessary. Where this happens, L&G may vote against a remuneration policy unless there are reasons to support the payments.
- Performance metrics:
- Achieving a threshold level of financial performance should be a pre-requisite for the delivery of any bonus, including the delivery of personal / strategic performance objectives.
- L&G sees personal performance of board directors as delivering strategy. They therefore expect personal / strategic performance targets to be meaningful and quantifiable or sufficiently explained, otherwise companies risk having their remuneration policy voted against. A threshold level of financial measures must still be met before any elements of personal targets are triggered.
- L&G is understanding of companies that need to delay their target setting by 6 months in light of Covid-19, despite their general rule being that long-term incentive performance targets should be disclosed in advance and not adjusted retrospectively.
- Although L&G does not generally support setting targets below the out-turn of the previous year, where this has been done in exceptional circumstances and the remuneration committee considers it appropriate, L&G will expect an explanation of why the new targets are regarded as equally stretching or, where this is not given, a reduction in award size to reflect lower targets.
- ESG targets:
- Where a company is exposed to high levels of environmental, social or reputational risk, they should include relevant and clearly measurable targets focusing management on mitigating these risks.
- L&G expects ESG performance targets to be incorporated into the strategy of the business and believes that they are useful as a modifier to financial outcomes rather than to provide additional award - unless such targets go beyond the company’s purpose and are linked to growth opportunities e.g. green revenue.
- For oil and gas companies, remuneration should prioritise financial value over production volumes. Financial measures or other strategic metrics are therefore preferred, while volume growth targets may lead to a negative vote.
- Post-employment shareholding requirements: These should reflect a significant proportion of the standard minimum shareholding requirement (i.e. no less than 80% of the in-post requirement). L&G clarified that purchased shares do not need to be included. Where purchased shares are used to make up the in-post holding requirement, these should be replaced when shares vest from incentive arrangements.
- Salary: When a new director is appointed, L&G expects the remuneration committee to take the opportunity to reset executive pay and consider the current circumstances of the business, as well as the previous experience of the individual. They also note that salaries for new directors should be phased over time based on their level of experience.
- Pensions: L&G expects companies to ensure that pension provisions for new board directors and others whose contracts are being renegotiated are aligned with those offered to a majority of the workforce. In line with market practice, L&G has also confirmed that they expect pension provisions for incumbent directors to be aligned with those of the majority of the workforce by 2023. They will vote against a remuneration policy if no such changes have been made to address disparity in pension provisions.
- Benchmarks: L&G encourages companies to consider the appropriateness of their salary benchmarks in conjunction with comparators used across their performance pay disclosures.
- DRR disclosure: There should be an explanation in the annual report on how consistency and alignment with shareholders is achieved, along with how pay structures promote company strategy and shareholder value creation. Additional disclosures that L&G expects to find or be signposted in remuneration reports include:
- How performance criteria and targets align with the long-term strategy of the company.
- How the committee has taken into account the impact of the Covid-19 pandemic on its operations, including stakeholders when deciding pay outcomes. This aligns with L&G’s specific expectations regarding annual bonus mentioned above.
- Gender pay gap reporting. Although L&G notes that gender pay gap reporting has been suspended for the 2019/20 period due to Covid-19, they still encourage those that can report to continue to do so.
- Remuneration committee: L&G expects the chair of the remuneration committee to have a good working knowledge of the key people they are setting pay structures for and the pay and benefits being offered throughout the company.
- Other: Any gifts on departure with a material value should be fully disclosed. ‘Golden goodbyes’ are not supported.
L&G is one of the first big investors to make amendments to their principles to take the coronavirus pandemic into consideration. It is positive that they offer some flexibility to prevent companies from being unfairly penalised during these difficult times, although they will still expect reasonable explanations to be given to avoid a negative vote against a remuneration policy - ensuring that the situation will not be exploited by firms.
While L&G’s views are clear that a bonus should not be paid in companies that have relied on government funding or faced redundancies during the pandemic, they still assure that the facts of each individual case will be taken into consideration, signalling that it may be accepted in particular instances.
It is the first time that L&G has laid out their views on ESG metrics in executive remuneration. L&G have supported ESG measures for some time and have spoken at a number of conferences about this. This is a particularly prevalent topic at the moment and is one that we have reviewed in our recent 2020 FTSE 100 report. We found that one third of FTSE 100 companies now use ESG metrics in their remuneration policies, although this number will likely increase as more investor guidelines shift their attention to ESG as L&G have done.
It will be interesting to see whether companies continue to use discretion to adjust vesting outcomes following L&G’s opinion expressing preference for reducing initial awards instead. In our FTSE 100 review, we also looked at the inclusion of discretion provisions in annual and long term incentives, as well as other topics addressed in the L&G principles such as post-employment holding period requirements.
L&G’s encouragement for companies to continue to undertake their gender pay gap reporting should be noted. Many companies we know have now submitted their reports and if you haven’t, you may want to consider doing so.
We are expecting the Investment Association's updated principles in mid-November. We will send an alert at that time, and also if we see any other investors issue changes to their guidelines.
If you have any questions about this alert, or if we can help you with your incentive plan compliance, please do let us know.
Janet Cooper OBE