Companies can be criticised for paying excessive levels of executive pay and many have seen a shareholder revolt over unwarranted remuneration. Earlier this year, the Investment Association introduced a public register which names listed companies where more than 20% of shareholders have voted against resolutions, which include resolutions on executive pay.
Cineworld and Unilever are two companies which find themselves on this register following the most recent AGM season.
Investors appreciate the importance of maintaining reasonable levels of pay that mirror the performance of the company. The Investment Association (IA) and Institutional Shareholder Services (ISS) have both published updated principles relating to executive remuneration for 2019.
The IA’s Principles of Remuneration for 2019 and the ISS 2019 Proxy Voting Guidelines are not mandatory requirements but listed companies need to follow them in order to attract and retain large institutional investors and to maintain good relationships with those investors. These larger institutions are likely to vote against resolutions, such as those relating to a company’s remuneration policy, where the company does not follow their requirements.
IA Principles of Remuneration
On 22 November 2018, the IA wrote to the remuneration committees of FTSE 350 companies outlining the changes to its Principles for the upcoming year. A company’s remuneration committee is a committee of the board responsible for, amongst other things: setting the remuneration policy of senior management; determining targets for performance related pay; and determining the total remuneration package of each individual director.
This year’s review by the IA is based predominantly on the new UK Corporate Governance Code (the Code) and the new remuneration requirements contained within it. The IA’s letter highlighted some of the issues shareholders are likely to focus on in the AGM season over the next year, including: companies treating shareholder consultation merely as a validation exercise and not genuinely seeking the views of shareholders; and remuneration committees being ‘overly considerate’ of the views of the management, at the expense of shareholder views.
Post-employment shareholding requirements: The IA recommends that the post-termination shareholding requirement should be set at a period of at least two years and at a level equal to the lower of the shareholding requirement in force immediately before leaving or the executive’s actual shareholding on leaving the company. This new requirement should be introduced at the earliest opportunity to all new and existing directors, and by the next remuneration policy at the latest.
Malus and clawback: The Code also requires share plans to allow the company to recover, or withhold, sums in certain circumstances. Currently, trigger events are gross misconduct or a misstatement of results, but these are very rare in practice and when they do occur it can be difficult to prove that they are linked to a particular director. Companies should establish a more substantial list of circumstances in which sums can be recovered and the director, when accepting a share award, should sign a form which clearly outlines the clawback rules.
Restricted share plans: There is also new guidance on restricted share plans. Investors appreciate that these may be appropriate in certain businesses and so these will be assessed on a case by case basis. The vesting period for restricted share awards should be set at five years.
Pensions: The pension contribution rates of directors should be reduced over time to comply with the new requirements in the Code.
ISS 2019 Proxy Voting Guidelines
The Guidelines consider remuneration in terms of both a company’s remuneration policy and its remuneration report.
Annual bonus: This component of a company’s remuneration policy seeks to reward contribution to the business during the year above the level expected to be received as a salary. The updated Guidelines state that good market practice is for the target bonus to be no more than 50% of the maximum bonus potential and any pay out above this level should be supported by a detailed explanation. Investors have recently increased their focus on the level of bonuses paid to directors based on mediocre or poor corporate performance and this has resulted in an increase in votes against company remuneration proposals.
LTIPs: The requirements in relation to long term incentive plans, or LTIPS, mirror those in the Code: performance periods of longer than three years are encouraged and any share awards should be subject to a total vesting and holding period of five years or more. As mentioned above in the context of the IA Principles of Remuneration, post-employment shareholding requirements are becoming increasingly common and the remuneration committee should develop a formal policy to deal with these.
In terms of the remuneration report, the Guidelines state that remuneration committees should look to reduce the size of LTIP awards where there has been a significant decline in the company’s share price. Award sizes should be considered annually, particularly where there has been a degree of volatility in the share price. Also, the fees payable to non-executive directors should not be excessive relative to similarly sized companies in the same sector.
Corporate governance continues to evolve
Corporate governance has been a hot topic throughout 2018 and, following the updates to the new Code and these changes to investor guidance, it looks like it will continue to be a focus for regulators and investors alike in the New Year. Executive remuneration, in particular, is under scrutiny. We will soon see the implementation of new remuneration reporting requirements and BEIS is currently carrying out a review into fair pay.