Legal & General Investment Management (LGIM) recently published its Corporate Governance & Responsible Investment Policy – UK and backed it up with a letter to the chairs of the FTSE350. Looking at the section on remuneration (the largest part), there is a strong sense of déjà vu. Not surprising really, since LGIM is a member of the Investment Association (IA), contributing to the development of the IA’s principles of executive remuneration and it sent a letter to remuneration committees in 2013 confirming its support of the GC100 and Investor Group guidance on directors’ remuneration reporting. So you might expect them all to be singing from the same song-sheet.

However, it contains three little words which very much break new ground ….

Time for a small diversion into the history of the limits on the use of shares for incentives. The old Association of British Insurers (ABI) guidelines on executive remuneration always had two limits on the new issue of shares for this purpose, which are still there in the current IA principles. Essentially in any rolling ten-year period:

  • no more than 10% of a company’s share capital can be the subject of incentive awards (outstanding and paid out) under all its share plans; and
  • no more than 5% can be used for executive (discretionary, as opposed to “all-employee”) plans.

These were/are under the heading of “dilution limits”, suggesting that shareholders were prepared to allow their holdings to be diluted by up to 10% (that is, have a slightly smaller slice) against the expectation that the incentives would encourage the employees to grow the size of the cake. Already-issued shares – such as shares bought in the market – didn’t count for the purposes of these limits, which seemed logical, as they were non-dilutive. Then along came treasury shares in 2003. The ABI felt sufficiently sure of its clout to say that these shares should be counted under the dilution limits if they were used to satisfy awards under share plans (although many thought that treasury shares should fall into the “already-issued” category). Prior to 2004, companies had to provide in their accounts for the cost of buying shares in the market, but not for the shares issued on the exercise of options. Then the accounting standards for share-based payments were changed, so that the P and L account was hit by the cost of both market-purchase shares and newly-issued shares. Cue the growth of LTIPs, usually consisting of nil-cost options. To avoid offending against the company law prohibition on issuing shares at less than nominal value, shares to satisfy these awards had to be transferred from an employee benefit trust (EBT) rather than newly-issued. Although the guidelines said/principles say that no more than 5% of a company’s shares can be held in an EBT without shareholder approval, for many years it has been possible to use the market purchase route to circumvent the limits and create more headroom for share plans.

Now back to the three little words. The LGIM policy says that these “restrictions should apply to all shares whether market purchased or newly-issued”. So, the gloves are off – despite this wording being under the heading of “equity dilution”, it’s clearly no longer only about that.

LGIM are focusing on headroom not only for share plans in the ordinary course, but also for share-based payments to a newly-appointed director. The Listing Rules (LR 9.4.2 for those who are interested) allow a share award to be made to a single director without shareholder approval in order to recruit or retain that individual. LGIM has made it clear that it will “not support the use of Listing Rule 9.4.2 … if there is sufficient headroom in existing arrangements”. By “not support” it means voting against both the remuneration report and the re-appointment of the chairman of the remuneration committee.

So why this new approach? The introduction to the remuneration section notes the “significant increase to [sic] executive remuneration which has not necessarily been linked to the growth in shareholder value”. Witness the shareholder revolts expressed through voting against executive remuneration policy and implementation over the 2016 AGM season, covered in our previous post. It looks like LGIM considers that, in the current climate, with so much high-profile bad press about “excessive” payments to directors of big companies, it is time for it to be bold enough to plug this back-door route of using shares purchased in the market to deliver value to executives.

All in all, LGIM’s policy seems to be marking companies’ cards at the time when they will be considering the contents of their remuneration policy, which in many cases will need to be put anew to a binding shareholder vote in 2017. It will be interesting to see whether the IA follows suit in a few weeks, the usual time for it to update its principles of remuneration. Presumably it will also harden its stance on this issue.

Coming in the same week as the launch of the enquiry by the Business, Innovations and Skills Committee into corporate governance, including hard-hitting questions on executive pay, it is clear that there is pressure on all sides to limit what is seen as excessive growth in executive remuneration.