The Executive Remuneration Working Group published its final report (the “Report”) last week proposing ten recommendations to rebuild trust in executive pay structures in the UK. Developed by five leading representatives of listed companies, investment management and asset owners, the Report represents a far-reaching plan to simplify pay structures for company executives by allowing companies to be given the flexibility to select the right pay structure that works for them and their shareholders, rather than focusing solely on the currently dominant ‘one-size-fits-all’ Long-Term Incentive Plan (LTIP) pay structure.
The Executive Remuneration Working Group was established by the Investment Association in 2015 as an independent panel to address the concern that executive remuneration has become too complex and is not fulfilling its purpose.
According to the Working Group, there is growing concern from both companies and investors with the current levels of executive pay and its complexity and the latter is considered to have contributed to poor alignment between executives, shareholders and the company, sometimes leading to levels of remuneration which are very difficult to justify.
While intended to link long term performance with shareholder experience, the LTIP does not always reflect how a business works or allow for the fact that it may not be possible to set meaningful long-term targets in all businesses.
The Working Group published its interim report in April 2016 and consulted widely in May and June this year in order to form its final recommendations in the Report. The Report aims to rebuild trust by strengthening remuneration committees and their accountability, boosting shareholder engagement, making target-setting more transparent and giving companies discretion to explore how differing pay structures may gain market trust.
The Report contains a framework of possible structures to illustrate what this flexibility might mean in practice. The framework is intended to be used to explore the practicalities of a more flexible system and help committees to consider the options that are right for their business. The Report contains a set of 10 recommendations which propose changes to improve flexibility in five specific areas:
- Strengthening remuneration committees and their accountability
- Improving shareholder engagement
- Increasing transparency around target setting and use of discretion
- Addressing the levels of executive pay
- Setting parameters on how alternative structures might operate to gain market trust
The 10 recommendations are as follows:
Strengthening remuneration committees and their accountability
- There should be more flexibility afforded to remuneration committees to choose a remuneration structure which is most appropriate for the company’s strategy and business needs.
- Non-executive directors should serve on the remuneration committee for at least a year before taking over the chairmanship of the committee. The Financial Reporting Council should consider reflecting this best practice in the UK Corporate Governance Code.
- Boards should ensure that the company chairman and whole board are appropriately engaged in the remuneration setting process. This will ensure that the decisions of the remuneration committee are agreed by the board as a whole.
- Remuneration committees need to exercise independent judgement and not be over-reliant on their remuneration consultants, particularly during engagements with shareholders. To ensure independent advice is maintained, the remuneration committee should regularly put their remuneration advice out to tender.
Improving shareholder engagement
- Shareholder engagement should focus on the strategic rationale for remuneration structures and involve both investment and governance perspectives. Shareholders should be clear with companies on their views on and level of support for the proposals.
- Companies should focus their engagement on the material issues for consultation. The consultation process should be aimed at understanding investors’ views. Undertaking a process of consultation should not lead to the expectation of investor support.
Increasing transparency around target setting and use of discretion
- Remuneration committees should disclose the process for setting bonus targets and retrospectively disclose the performance range.
- The use of discretion should be clearly disclosed to investors with the remuneration committee articulating the impact the discretion has had on remuneration outcomes. Shareholders will expect remuneration committees to take a balanced view on the use of discretion.
Addressing the levels of executive pay
- The board should explain why the chosen maximum remuneration level as required under the remuneration policy is appropriate for the company using both external and internal relativities.
- Remuneration committees and consultants should guard against the potential inflationary impact of market data on their remuneration decisions.
Chair of the Executive Remuneration Working Group, Nigel Wilson, believes that the 10 recommendations outlined in the Report “will help to simplify, provide greater transparency, and deliver better shareholder, company and executive alignment on pay. We need to restore public confidence in executive pay. Our report shows shareholders, boards and executives agree the current approach is not working, and want constructive collaboration to get it right”.
The Investment Association has informed the Working Group of its intention to review its Principles of Remuneration to consider the recommendations.