Corporate shareholder guidelines get tougher on executive pay

The Investment Association (IA) Principles of Remuneration for 2019 (20-page / 812KB PDF) call on companies to adopt new pay ratio reporting requirements early, and to broaden the grounds on which they can use 'malus' and 'clawback' provisions to recover bonuses. These principles are annually reviewed and updated.

The principles also recommend that director pension contributions should be limited to the rate given to the majority of the rest of the workforce, rather than making higher contributions to push up the total pay package. Directors should also be required to hold onto a proportion of their shares in the company for a minimum of two years after their departure, giving them a stake in the long-term value of the company after they move on. This will be the lower of the recommended holding under the company's guidelines for that director, or the number of shares actually held at the time of departure.

Publication of the updated principles was timed to coincide with the IA's 2018 'stewardship and governance' conference, at which Alex Chisholm, permanent secretary at the government's Department of Business, Innovation and Skills (BEIS), gave a speech on the latest developments in corporate governance and stewardship from a government perspective.

As usual, the latest version is accompanied by a covering letter (3-page / 213KB PDF) from the IA to FTSE remuneration committee chairs that helpfully outlines the key changes to the principles and also highlights the "items of focus" for IA members when considering their remuneration-related voting decisions during the 2019 AGM season. These items are likely to be amongst the factors guiding the IA's subsidiary IVIS in preparing its 'red', 'amber' and 'blue top' reports for IA members and subscribers on FTSE AGM proposals during the 2019 AGM season.

Share plans and incentives expert Lynette Jacobs of Pinsent Masons, the law firm behind Out-Law.com, said that "the time has passed when shareholder views can be ignored".

"The tone and themes of the updated IA Principles reflect - and influence - shareholder, Financial Reporting Council (FRC) and government views that significant controls are now required on executive remuneration," she said.

"Shareholders have shown increasing dissent on remuneration resolutions in the FTSE 100 and there have been significant votes against remuneration resolutions more widely. Since last December, companies which have received less than 80% of votes in favour of a remuneration resolution are included in the IA's Public Register. An amendment to the principles - which reflects the revised Corporate Governance Code issued in July - notes that companies should respond to such a significant vote against, seeking to 'understand the reasons for the dissent and issue an update statement in response to the dissent, including the views received from shareholders and what the company has done, or proposes to do, in response'," she said.

"Reflecting stakeholder and public concern about executive remuneration following recent high-profile company failures, the principles now provide that 'undeserved and excessive remuneration sends a negative message to all stakeholders, including the company's workforce, and causes long term damage to the company'. Investors will therefore 'expect the remuneration committee to ensure that the remuneration structure is appropriate and to exercise relevant discretion to avoid these situations'," she said.

The IA is the trade body which represents the interests of the £7.7 trillion UK asset management industry, including both retail and institutional assets. Its Principles of Remuneration set out investor expectations and best practice on how FTSE companies should pay their top executives in line with the revised Corporate Governance Code and other legal requirements, and are updated annually to take account of any trends and issues emerging from the previous AGM season.

The latest version of the principles have been published against a backdrop of shareholder rebellions and growing concern among IA members that the companies in which they invest are not listening to investor views. The IA had added 61 companies to its public register of shareholder votes of at least 20% against pay resolutions as of 31 October: 15 FTSE 100 companies; 23 FTSE 250 companies and 23 FTSE small cap companies.

The government's package of corporate governance reform measures have also moved further forward since last year's principles were published, including with the publication by the Financial Reporting Council (FRC) of its "shorter, sharper" updated Corporate Governance Code. From next year, listed companies will also be subject to a new requirement to disclose and explain the ratio of their chief executive's total pay to the median and 25% and 75% interquartile threshold total pay of the company's UK employees.

The IA principles call for companies to adopt the new pay ratio reporting requirements early, "to maximise transparency over pay and ensure that there is accountability for high levels of pay internally". The IA called for companies to begin disclosing pay ratios on a voluntary basis as part of its 2017 principles.

The principles also seek to encourage remuneration committees to think more about the circumstances in which companies will be able to refuse to pay performance-based bonuses, or to 'claw back' bonuses that have already been paid. Companies will be encouraged to adopt a broader range of malus and clawback triggers, beyond the current "market standard" triggers of 'gross misconduct' and 'misstatement of results'; and to set out the process by which malus and clawback provisions will be implemented, not simply the triggers.

"The principles note that the current market standard triggers are 'likely to be rare' and that 'when they do occur, it may be challenging to prove the individual culpability of directors'," Jacobs said. "Remuneration committees should therefore 'establish a more substantial list of specific circumstances in which the malus and clawback provisions could be used' with the relevant circumstances being 'clearly disclosure to shareholders'."

"Practical steps to the enforcement of malus and clawback are included in the principles, requiring executives to sign forms of acceptance at the time of grant in order to set the expectations for malus and clawback applying to that award, and setting out how and when it may be applied. The documentation for the long-term incentive plan (LTIP) and bonus rules, and communication around the payment of bonuses or LTIPs, the remuneration policy and employee contracts must all be consistent," she said.

"Innovative, company-specific and context-responsive actions and approaches are much favoured by the market, and such an approach to executive remuneration, which is highly standardised across the market, aligned with the principles and relevant guidelines such as the Corporate Governance Code, would be widely welcomed," she said.