In the UK, the Local Authority Pension Fund Forum (LAPFF) has published recommendations on executive pay.
The recommendations are aimed at assisting the remuneration committees of FTSE 350 companies, by providing practical ways to promote alternative strategies of remuneration that are better aligned with long-term, sustainable returns and shareholder value.
The recommendations include the following:
Fixed vs Variable Pay
Ensure that base salary is the primary vehicle for remunerating executives because base salary is, in the view of the LAPFF, the up-front negotiated price for doing the job. The variable component of pay should be kept to a minimum for large cap-companies.
The LAPFF says it sees variable pay as an added reward for exceptional performance and not as an expected supplement to the annual wage.
The LAPFF recommends phasing out the use of long term incentive plans (LTIPs) in favour of company-wide, long-term profit pools that use a straight-forward formula for calculating bonuses based on base salary and seniority.
It recommends that companies endeavour to pay out bonuses over five or more years to encourage long-term strategic thinking and staff retention by allowing annual profits to accrue in the bonus pool and be paid out in future years.
Quantum of Pay
The LAPFF recommends assessing the quantum of total awards of pay packages in determining what would be considered ‘reasonable’ by shareholders and other stakeholders.
It says that the board, supported by the remuneration committee, should take all existing elements of remuneration into account including salary, benefits, bonuses, share option awards, and long term incentive schemes, discretionary awards and pension contributions in order that the actual amount granted is considered as a whole.
The LAPFF recommends setting the total pay of any new incoming executives (either internally or externally appointed) at a level below that of the outgoing executive.
It remarks that this would leave room for new executives to receive modest pay rises for exceptional performance as they grow into the role and ‘prove their worth’ to shareholders.
The LAPFF recommends ensuring that directors and officers participate in company pension arrangements on the same terms as other employees. Where directors or officers receive preferential treatment the reasons for this should be explained.|
It comments that, ideally, all employees of the company should receive fair and reasonable pensions in line with their tenure of service.
Environmental & Social Performance
The LAPFF recommends that bonuses and variable pay be clawed-back in cases where ethical standards are breached, or where poor environmental or social performance causes demonstrable harm to the company’s reputation or social license to operate.
It goes on to say that it is not prudent to award executives for making decisions to increase profits if it means the company’s ethical conduct or reputation will be severely damaged in the process.
The LAPFF discourages the use of market benchmarks for determining comparative pay levels for executives.
The LAPFF suggests the publication annually of the ratio between average employee pay and average executive pay, as well as the ratio of pay between the top and bottom 10%. A graph should be provided, charting the pay ratio trends for the current year and the preceding five years.
It believes that the publication of these ratios on a yearly basis will make the remuneration committee more accountable for making appropriate pay distributions.
The LAPFF recommends ensuring that efficient tax planning remains in line with the company’s ethical and corporate responsibility standards and suggests refraining from using creative tax planning to increase executive pay.
The LAPFF recommends publicly advertising all new executive director positions, accompanied by a job specification document, to encourage robust competition for positions and improve the diversity of candidates. All recruitment processes should be transparent and give all candidates, internal and external, an equal opportunity to be considered for the role.
It recommends discontinuing the practice of paying ‘golden hellos,’ regardless of the individual circumstances of incoming executive directors.
It recommends proactively consulting with institutional investors that hold long-term positions in the firm regarding their views on the company’s pay practices, and endeavouring to consult with both large and small shareholders, specifically with those that may take a critical view.
The views and recommendations of managers and employees should be considered and included when making remuneration decisions.
Finally the LAPFF recommends using discretion in executive remuneration only to reduce overall levels of remuneration and refraining from awarding transaction-related bonuses.