16 November 2020
As the season of updating voting guidance continues - today, the Investment Association ("IA") published its eagerly awaited Principles of Remuneration for 2021 (“Principles”), with an accompanying letter to Remuneration Committee Chairs setting out member expectations for the 2021 AGM season. Perhaps more notably, the IA has also provided updated shareholder expectations (“Guidance”) on how members expect Remuneration Committees to be reflecting the impact of COVID-19 on executive pay.
The IA Principles of Remuneration for 2021
The key updates to the Principles from last year are:
Post-employment shareholding requirements: Remuneration Committees should state the structures or processes they have in place to ensure the continued enforcement of the post-employment shareholding requirement, particularly after a Director has left the Company.
Pensions: Minor clarification and reminder that the contribution rates for incumbent executive directors should be aligned over time to the contribution rate available to the majority of the workforce. Members expect this to be achieved as soon as possible / by the end of 2022 at the latest and IVIS will Red Top the remuneration report where such a plan is not in place and any pension contribution is set at 15% or more.
- IA members have noted the increasing use of strategic targets and/or personal objectives in annual bonuses. Shareholders continue to expect that financial metrics will comprise the significant majority of the overall bonus. Where personal objectives are used, companies should demonstrate how they link to long-term value creation and should not be for actions which could be classed as “doing the day job”.
- Following the payment of a bonus, in relation to personal or strategic objectives, investors expect a detailed rationale and disclosure of achievements which have led to the payment of these elements. The weightings, achievement and outcomes of personal and strategic objectives should be disclosed separately.
- Deferring a portion of the entire bonus into shares is expected for bonus opportunity of greater than 100% of salary.
- Shareholders expect that bad leavers will not receive annual bonus payments.
- The IA accepts that the impact of material Environmental, Social and Governance (“ESG”) risks on the long-term value of companies is becoming increasingly apparent.
- Where companies are incorporating the management of material ESG risks and opportunities into their long-term strategy, it is appropriate that Remuneration Committees consider the same as performance conditions in variable remuneration (included in the annual bonus section).
- It is imperative that ESG performance conditions are however clearly linked to the implementation of the company’s long-term strategy, especially when including such metrics in annual bonus awards.
Updated Shareholder Expectations during the COVID-19 Pandemic
The key changes to the Guidance since April 2020 (many of the main points remain the same) are:
Government support / additional capital:
- If a company has raised additional capital from shareholders, required Government support through the furlough or job retention schemes or, taken Government loans, the payment of any annual bonuses for FY2020 or FY 2020/21 will not be expected, unless there are truly exceptional circumstances.
- Companies should disclose how they have taken any positive impact of the Business rate relief on the company’s financial performance into account in terms of remuneration outcomes.
- Remuneration Committee Chair statements should confirm that performance targets for in-flight LTIP and annual bonus awards have not been adjusted during the year.
- LTIP performance targets for future awards should not be adjusted to compensate executives for reduced remuneration outcomes as a result of the COVID-19 downturn and Remuneration Committees should disclose the determination process including the use of internal budgets and consensus estimates.
Annual bonuses and disclosure:
- The increased use of discretionary powers with regards to variable pay must be matched with increased disclosures concerning the rationale and outcomes for such discretion, including a higher level of disclosure on how financial targets have been determined (especially if lower than before), and why pay-outs under non-financial elements only may have been allowed.
- Enhanced disclosure expectations will also apply when companies have made adjustments to variable pay performance measures as a result of exceptional circumstances such as rent concessions or waivers, and disclosure is expected on what has been included/excluded and the rationale, especially since such items may be material to pay-out/vesting.
- Companies may consider whether a higher portion of the bonus should be deferred into shares.
LTIPs and restricted shares:
- LTIP grants are not expected to be cancelled and replaced with another long-term incentive grant and Remuneration Committees are not expected to compensate executives with higher variable remuneration opportunity in 2021 for lower remuneration received in 2020 due to the pandemic.
- Many companies are considering the move to restricted shares, but the difficulty of setting meaningful long-term performance conditions at the moment should not be the key driver to do this. Shareholders will continue to review the strategic rationale for implementation before approving such a move. Consideration of share price factors and the usual discount rate of at least 50% from the LTIP grant level remains expected.
Other notable points:
- Continued restraint to salary increases is expected and must be in line with the wider workforce.
The changes to the Principles themselves are minimal but are in line with the focus of other investor guidelines on the topics of the use of ESG targets, the choice and disclosure of non-financial performance metrics, the alignment of pension contributions and post-employment shareholding requirements.
The IA acknowledges that ESG remains hot on the Remuneration Committee agenda and that it is therefore appropriate to include ESG performance conditions for variable remuneration, but stands firm that companies should only be doing so where ESG is firmly part of the long-term strategy of the wider business. This fits in with their observation that personal and strategic objectives for the annual bonus are generally on the rise, and their reminder that such objectives must be clearly linked to long-term value creation and must not overtake financial metrics as the dominant conditions for bonus awards. The IA is clearly calling out for the continued evaluation by each company of only using performance conditions that genuinely fit with their longer-term strategy.
The focus on the enforcement mechanism for the post-employment shareholding requirement is also not surprising, given that the IA had previously required disclosure of how the requirement would be met post-employment, but our review of the FTSE 100’s 2020 annual reports showed that companies were mostly not disclosing the actual detail on how they were doing this. It is clear shareholders are now expecting to see in the 2021 AGM season exactly what companies are doing in practice to actually enforce the requirement, now that the process behind this requirement should be embedded in.
Whilst the Principles themselves remain broadly unchanged, the updated COVID-19 Guidance is helpful to give further clarity on the IA’s expectations on how executive pay should be structured in 2021. The IA has kept its stance that existing performance conditions should not be changed, and that structural changes to future awards should not be made to compensate for loss of payout or value as a result of the downturn from COVID-19. What also remains clear, is the IA’s view that actions taken in relation to executive pay as a result of continuing COVID-19 need to be taken in the round, as the balance between the need to reward and incentivise management whilst reflecting the experiences and expectations of all employees, suppliers, shareholders and wider society is of primary importance. The IA warns that the pandemic will serve to bring executive pay and inequalities even further into the spotlight. Disclosure in the 2020 AGM season of the reasoning behind why actions have been taken (or not taken) is therefore the key message across all topics, so that shareholders can assess whether each company has responded appropriately to the current and continuing situation in its executive remuneration strategy.
If you have any questions around any of the updated investors’ guidelines ahead of the 2021 AGM season, please do let us know.