A significant change in approach to executive pay: Investment Association publishes letter
On Friday 23rd February, the Investment Association (“IA”), whose members collectively manage £8.8trn in assets, has published a letter to members indicating it will launch a major overhaul and simplification of its Principles of Remuneration, following feedback and public debate about the role Executive pay plays in the competitiveness of the UK.
With a number of companies already migrating (or planning to migrate) away from the London Stock Exchange, the letter acknowledges competing pressures and expectations in relation to executive remuneration amongst numerous stakeholders – including executives, asset managers, pensions funds and international investors. Some of these pressures present a real talent flight-risk, (especially where a company has significant exposure to the US), which become further exacerbated by constraints in Corporate Governance that have evolved over time in holding companies to account.
The IA letter further articulates a growing sense that some of these measures, which were originally designed with alignment in mind, are now working collectively to hamper attraction and retention of the talent calibre that the UK needs to grow and thrive, particularly when similar constraints do not exist in other jurisdictions.
Following feedback from members, whilst there is no consensus on any one single thing that will improve the competitiveness of UK remuneration, the letter outlines three themes that emerged:
- Need to increase pay opportunities through LTIP grant levels – particularly where there is a need for more flexibility to be able to offer higher LTIP rewards to attract US executives or to compete in US market (especially if there is a significant US footprint or revenue stream).
- Use of Hybrid Schemes – incorporating both performance and restricted shares – this is commonplace in the US, so there is a call for similar structures to be accepted, here in the UK.
- Requirements in the UK Corporate Governance Code reduce the perceived value of remuneration – over time the Code introduced a number of requirements which extend the long-term perspective of directors through remuneration, such as holding periods, shareholding guidelines, post-employment shareholding guidelines, and malus and clawback provisions. Individually, these measures may increase alignment between executives and shareholders, but a view is emerging that, collectively, they have a disproportionate impact on the value of remuneration received.
The publication of the Principles of Remuneration for 2024 had already been delayed, as the IA intends to consult with its members on a fundamental review. This review is being conducted with the underlying principle that in order “to support higher potential pay levels there needs to be clear alignment between pay and performance". The IA plans to simplify the guidelines to enable support of a competitive market, recognising that companies need to be able to choose remuneration structures that are most appropriate for their business strategy.
The IA emphasises that they are principles, not rules – designed to be flexible and adaptable such that companies are free to choose the best approach for their unique circumstances, which best aligns remuneration with business performance and returns for shareholders.
Our View
We welcome that the IA letter opens up a more productive conversation on remuneration, having held many discussions with our clients over recent months on the very real, and accelerating fight for talent at senior levels – not just in terms of a perceived US talent drain, but also in being able to attract US expertise.
The highly regulated nature of the UK, which has been held up as a paragon of Governance, has done little to aid growth in listed companies on a macro level, but nor has it quelled genuine concerns about growing inequity.
The Rem.n view on the IA letter and the current situation is:
- It should be acceptable to pay well – indeed very well - if the performance merits it. However, it also then needs to be accepted that in situations where performance has been poor then variable pay plans should pay at a low level or nothing at all.
- The acceptance of hybrid plans, which allow for both restricted shares and performance shares would be a very positive development. The boom-and-bust nature of many LTIPs today causes a lot of issues and often leads to different treatment for Executive Directors and the rest of the Company. Balanced incentive arrangements would reduce the need to tinker with the incentives in the future.
- Whilst we applaud and support alignment with long-term strategic aims, we recognise that sometimes the rewards are too distant, and opaque, to be valued today. Reducing the number of Governance requirements – or being able to alter them in certain circumstances, will help remove the feeling of unattainability – so for example, where there is a significant shareholding built up, we consider that there is no real need for bonus deferral or LTIP holding periods.
Not everyone will welcome the proposed change of direction – in an environment where there is still a cost-of-living crisis, continued high inflation and perceived unfairness about the growing divide between those at the top of the organisation and the wider workforce. Undoubtedly, there will be voices of dissent heard from campaigns against excessive levels of executive pay.
Finally, not everyone should be making comparisons with US companies – where these organisations are often significantly larger. However, there is still a risk of losing talent here to non-listed, UK-based, private equity, where the disclosure requirements are less onerous and the potential for very high rewards (albeit with an accompanying high risk) will remain attractive. Some of the above proposals may also act to level the playing-field to some extent in these circumstances too.