UK: Investment Association publishes Interim Report on Executive Pay

The Investment Association's Executive Remuneration Working Group, which was established in Autumn 2015, has recently published its Interim Report on whether current remuneration structures effectively incentivise management teams. The Working Group is now seeking views on its findings, with publication of a Final Report expected this summer. The Investment Association will then consider whether to adopt the Working Group's recommendations in its Principles of Remuneration.

Focus of the Interim Report

The initial view of the Working Group is that current remuneration arrangements often give rise to poor alignment of interests between executives, the company and its shareholders, and that executive reward schemes of UK listed companies should be modified, and simplified, to ensure that they more effectively motivate executives and reflect the needs of individual businesses.

The working group has identified four areas of concern on which they are now seeking further views:

Transparency: There is a current concern over the lack of transparency in reward outcomes which the Working Group considers could be tackled through the retrospective reporting of both performance targets and outcomes, and also of the circumstances in which the Remuneration Committee has used its discretion.

Shareholder engagement: Mainstream fund managers and sell side analysists, rather than just corporate governance specialists, should be encouraged to become more engaged in proposed reward arrangements and payments, which could be achieved through greater disclosure of retrospective (and prospective) targets.

Accountability: Whilst remuneration committees should be given more flexibility to determine reward outcomes, including the ability to exercise discretion both upwards and downwards rather than relying on formulaic outcomes, greater disclosure of the rationale for the approach taken would be required. Shareholders should be encouraged to hold remuneration committees to account through votes on the remuneration report, or on individual re-election.

Flexibility: Remuneration packages should be tailored to reflect and promote the aspirations and strategy of individual companies rather than there being a "one-size fits all" approach which leads to the use of median comparators.

The use of long term incentives

The Interim Report, in the main, focuses on the use of long term incentive arrangements to reward executives. The Working Group highlights that the typical three-year long term incentive plan (LTIP), which is widely used by FTSE companies, may not be the most appropriate arrangement to align executives interests to the company's business model and strategy. Indeed, other arrangements (which may include the deferral of bonus into shares, awards granted by reference to pre-grant performance conditions, or the use of restricted shares) may, for some companies, be more appropriate.  Remuneration committees should not feel constrained in proposing such alternatives to shareholders.

The Working Group believes that LTIPs (with three- to five-year performance conditions, or with an additional holding period), alongside shareholding guidelines, may for many companies continue to remain the most appropriate reward arrangement. However, views are sought on whether further changes to LTIPs (such as even longer holding periods, or vesting in tranches) should be proposed.

In relation to the LTIP alternatives, the Working Group is also seeking views on whether the greater certainty in relation to the delivery of the reward is likely to provide a more effective incentive and alignment of interests. There is also a suggestion that the balance for shareholders might be lower (discounted) award levels, or the ability for the remuneration committee to restrict payments to avoid pay-outs in situations where a minimum performance threshold has not been met.

Finally, the Working Group is also seeking feedback on the appropriate levels for shareholding guidelines, and the length of time that executives should be given to achieve compliance.

Feedback

The Investment Association is now arranging a number of roundtable discussions with stakeholder groups to seek views on the Interim Report and the specific discussion points which are raised. Interested parties can also send views by email to remuneration.panel@theia.org.