Updated 2020 Investment Association Principles of Remuneration
The Investment Association (‘IA’) has published a formal update on its Principles of Remuneration. On the whole, there are few material changes from last year, as the IA focusses more on confirming its position on investor hot topics such as executive pensions, post-exit shareholding, and Committee discretion. The update comes with an open letter to the Chairs of Remuneration Committees of FTSE350 companies, which highlights a few areas of focus, as follows: Alternative remuneration structures
The IA highlights members’ concerns around the effectiveness of traditional LTIPs, and encourages Remuneration Committees to evaluate their remuneration structures to ensure appropriate alignment with company strategy and long-term value creation.
The IA continues not to prescribe any particular incentive structure, and members commit to working with stakeholders to look at the circumstances in which alternative incentive structures may be more widely implemented in the UK market.
Mercer commentary: next year, we expect to see a higher number of remuneration proposals that include restricted stock as an alternative to the traditional LTIP, to help mitigate volatility in incentive outcomes, reduce the headline single figure, and reduce the sensitivity of the pay package to uncontrollable factors. Companies currently considering unusual incentives will likely be encouraged by the IA’s continued openness to supporting alternative structures, and commitment to coordinate greater acceptance of them.
The IA recommends that Remuneration Committees consider introducing discretion into incentive plans to cap vesting outcomes if a specific monetary value is exceeded, in order to limit the reputational impact on the company, their Directors and shareholders. It is for individual Remuneration Committees to decide on the absolute monetary level and how it would be implemented.
Mercer commentary: the concept of a vesting cap is not new (e.g. Hermes Investment Management recommended a cap on total pay opportunity in 2016), though to date it has not received mainstream acceptance, with the principal argument being that it creates a misalignment between executive and shareholder interests above a certain level of performance. Vesting caps are also optically problematic, as they immediately draw attention to a headline number that is considered ‘acceptable’ to the Committee. A perhaps more workable alternative is to defer payment of amounts earned above a certain threshold. Companies in highly-cyclical industries may in future years come under particular pressure to consider this issue as a way to mitigate windfall gains.
The IA refers to its position paper from September 2019, and confirms that pension contribution rates for Executive Directors should be aligned with those available to the majority of the company’s workforce. The IA continues to expect companies to set out a ‘credible action plan’ to reduce the pension contributions of incumbent Directors to the majority of the workforce level by the end of 2022. Note, capping the monetary value is not seen as a credible plan. Shareholders do not expect compensation to be awarded for a reduction to pensions.
Mercer commentary: in addressing the updated UK Corporate Governance Code, the IA has been particularly vocal and specific on the actions they expect from companies on closing the pensions gap, and the timeframe in which changes are to be implemented. Notwithstanding the challenges of contractual commitments, we expect there to be significant movement in the FTSE during 2020 in reducing incumbent pensions. 27% of FTSE100 companies have already fully aligned executive and workforce pensions; a further 12% are planning either immediate or phased reductions to the workforce level.
The IA reiterates its preferred approach to post-employment shareholding, i.e. a requirement to hold the lower of the in-post level and actual shareholding on departure, for a minimum of two years following departure. Shareholders expect requirements to be established as soon as possible, and at a minimum, by the company’s next Policy vote.
Mercer commentary: the IA remains silent on the specifics, e.g. whether purchased shares may be ring-fenced from the requirement (as permitted by LGIM), and whether unvested or held shares could or should be included in the calculation. Given this is an evolving area, both shareholder expectations and companies’ policies will likely remain flexible, and be further shaped by the 2020 AGM season as practice continues to evolve.
Pay for performance
IA members continue to expect transparent disclosure of incentive targets, so that the link between pay and performance may be clearly seen. The IA expects separate disclosure of personal and strategic objectives in the annual bonus.
Mercer commentary: the requirement to disclose personal and strategic objectives separately likely came from LGIM, who stated this expectation in their recently updated guidelines.
This briefing is for general guidance and does not necessarily cover all areas of the topics included in this briefing. It is not designed to give legal or other professional advice.