10 November 2022
The Investment Association (IA) yesterday released its updated Principles of Remuneration, with the usual accompanying letter to Remuneration Committee Chairs setting out member expectations for the 2023 AGM season.
Full copies can be found here: 2023 Principles and Remco Chair letter.
Whilst the IA notes it has not made significant changes to its Principles, there are specific areas with notable updates as set out below. The IA’s previous guidance for addressing the impact of the Covid-19 pandemic has also now been withdrawn.
The guidance continues to provide that companies should scale back the quantum of awards at grant, following a substantial fall in share price, to reduce the risk of windfall gains. Further guidance has now been added, stating that shareholders expect remuneration committees to consider adjusting vesting outcomes where awards were not scaled back at grant. In the Remco Chair letter, the IA indicates that remuneration committees should clearly articulate to shareholders how they have considered the impact of potential windfall gains when determining vesting outcomes and why any reduction is appropriate. If no reduction is made, they should explain and disclose the rationale.
Companies are warned to be mindful of widening inequality and making excessive awards to executives at a time when many lower-paid employees are forced to make significant sacrifices due to cost-of-living constraints. In the Remco Chair letter, the IA points out that most companies exercised good levels of restraint in relation to executive pay through the pandemic and should continue to be mindful of this in the current economic context. In particular:
- Remuneration outcomes should be commensurate with company performance and not excessive – the guidance now states outcomes should also be commensurate with the experience of key stakeholders.
- Remuneration committees should consider the overall quantum paid to executives in the context of pay levels and conditions across the entire workforce.
- Remuneration committees should generally not increase executives’ salaries at a level greater than inflation or the increase awarded to the wider workforce. In the Remco Chair letter, the IA indicates a need to consider the impact of inflationary salary increases on overall remuneration (given that variable pay is often linked to a salary multiple) and encourages any increases to be below those given to the rest of the workforce.
The guidance on remuneration committee use of discretion remains. The changes this year add a focus on ensuring remuneration outcomes reflect the performance of the executives and their contribution to overall corporate performance – as well as the experience of shareholders, wider stakeholders and general market environment.
The Remco Chair letter states that the IA encourages remuneration committees to be clear on disclosing issues and the different drivers they have considered when judging overall performance, and to put outcomes in the context of wider stakeholder experience.
The guidance continues to suggest the inclusion of strategic or non-financial performance measures, but now clarifies that this should be in addition to financial performance measures and should promote long-term value creation.
Remuneration committees should consider the collective impact of performance targets to ensure they lead to a balanced assessment of the company’s performance and that there is ‘appropriate natural tension’ between the metrics chosen.
Where ESG measures are used, there is now express guidance to state that they should be suitably stretching. In particular, they should not provide reward for ‘business as usual’ activity or be used as essentially a ‘soft target’ to increase overall quantum. Remuneration committees should explain how progress against the targets will be measured and how performance against them will be disclosed.
The Remco Chair letter provides some potentially helpful flexibility, suggesting that given wider economic uncertainties, it may be appropriate to consider wider performance ranges and discretion may be needed to ensure appropriate outcomes are achieved.
Non-executive directors (NEDs)
Recognising the increased complexity and time commitment associated with the NED role, the guidance now states that NEDs should receive fees commensurate with their duties, but that any increases in fees should be properly explained. Guidance on encouraging ownership by NEDs of shares in the company is retained, with a new acknowledgement that the number of companies introducing a minimum shareholding guideline for NEDs is increasing.
The Remco Chair letter includes a statement that IVIS will red top any remuneration policy or report where executive pension contributions are not aligned to the majority of the workforce, reflecting the previous guidance that such alignment should be achieved by the end of 2022.
The annual update to the IA Principles provides a useful barometer of investor views and key focus areas in relation to executive pay, and the changes are unsurprising given the wider economic outlook. These focus areas will be an important factor for companies in considering their executive pay structures for the year ahead. Whilst much of the guidance remains unchanged, the changes made will potentially be significant for those companies impacted, in a year where many will be renewing remuneration policies, managing the vesting of “Covid grants” under their LTIPs, and considering pay in the context of the current economic climate.
In addition to the IA’s update, LGIM has also published remuneration guidance, and the ISS has published its 2023 benchmark policy consultation. The FRC’s annual review of corporate governance reporting also contains some useful observations. We will be considering all of the updates in our Q1 webinar on Investor Expectations – look out for details to follow!
As always, if you have questions about any of the content of this alert, or there is any assistance you need in relation to your incentive plans, do not hesitate to contact us.
Hannah Needle, Suzannah Crookes and Sally Blanchflower