A working group of the Investment Association (IA) (which has incorporated the executive pay review service which was for many years run by the Association of British Insurers) has produced interim proposals on the simplification of long-term incentive pay in quoted companies. 

Most significantly, the paper appears to provide a licence for companies, with appropriate caveats, to move away from the standard 3-year LTIP for their executive awards. Quoted companies traditionally shape their incentive plans to comply with investor expectations. If these interim proposals are followed in the final recommendations, significant changes to UK quoted company practice may therefore follow.

Background

Although investor dissatisfaction with the structure and quantum of executive director pay in quoted companies is nothing new, the IA announced in September 2015 that it was setting up a special working group to look at a radical simplification of executive pay. This would be more than the traditional minor changes made each year to the IA Remuneration Guidelines. 

The working group have now released interim proposals. It remains concerned that executive pay has steadily increased while share price performance over the long-term has been static, there is disparity between executive and all-employee pay and reward for failure still persists.

Key areas for discussion

Areas where the working group believes that changes can be made to address these problems are: 

Transparency – retrospective reporting of targets (and performance against them) needs to be encouraged more, as should any use of Remuneration Committee discretion 

Engagement – shareholders need to become more engaged in pay rather than leaving this to consultants (or proxy houses) on whom they rely. Greater transparency might lead to greater interest from shareholders 

Accountability – Remuneration Committees should be more accountable for outturns (and the total annual fee income of a remuneration consultant should be disclosed, not just the annual fee income from remuneration) 

Flexibility – moving away from a default tendency to benchmark against median and follow market practice to liberate Remuneration Committees to award what they think is appropriate in a way that they think appropriate, provided this can be justified on a case by case basis and provides better alignment between executives, company performance and shareholders. 

It is in this final area that the working group is particularly interested in working out how practice can be changed. It wants to move away from a near-universal usage of a 3-year LTIP, though recognises that a longer period can have the detrimental effect of constituting too remote a target for executives and a shorter period can also have undesirable consequences. Quantum is also an issue. As part of this, the report recognises that the new complexities that have in recent years become associated with pay, eg holding periods, clawback etc have possibly led to executives being able to negotiate higher award levels. 

The paper then discusses the pros and cons of a 3-year LTIP, bonus deferral, pre-grant only performance conditions and the straightforward vesting of shares simply based on continued employment for a set period (and no performance conditions). The consultation seeks views on their relative simplicity and suitability. 

Particular points made are:

  • removal of performance conditions should lead to lower quantum (and the paper questions what that discount rate should be – a discount rate of up to 50% is suggested)
  • whether the current prohibition on directors selling shares until 5 years after award needs to be moderated so that there is phased vesting between years 3 and 5
  • whether holding shares worth 500% of salary is a reasonable shareholding target, and
  • finally, whether a genuine financial performance underpin is needed before any variable remuneration payment can be made. The paper recognises that this may involve Remuneration Committees having to exercise more discretion, and indeed that there is a general point here in that, if there are to be more company-specific arrangements and more discretion in operating them, Remuneration Committees will need to be braver and shareholders will also have to trust them.

Next steps

Next steps are various roundtables to be followed by a publication in early summer 2016 of the final proposals, which are expected to be reflected in revised Remuneration Guidelines later this year. The undoubted aim is then to try to start influencing the shape of executive remuneration and particularly remuneration proposals put to shareholders from 2017 onwards. No changes to legislation are suggested to implement any of the proposals. 

Simplification is a goal of many projects, and it would not be the first time that competing objectives and investors’ and companies’ own behaviours delay or scupper changes to implement what is on any basis a sensible objective. The simplification project started last year ahead of the series of investor protest votes on remuneration which have been seen over recent months, but the tension this year can only give the project greater impetus. If any change occurs, however, it is likely that it will take many years for companies and their shareholders to feel confident about using new freedoms. 

Click here to read the interim report.