As quoted companies' remuneration committees get to grips with the decisions they need to take in 2021, there is no point in starting this alert with anything but the obvious: the COVID-19 crisis. Its continuing impact and uncertain length will undoubtedly put a brake on executive remuneration for some time.
For many companies (but certainly not all) the impact of the crisis in 2020 came too late for shareholder consultations and a more analytical approach to remuneration decisions. In other cases, there was a short-term cashflow response or companies decided to adopt a wait and see approach. Most 2021 decisions are still going to be taken in uncertain conditions but there are now far more published expectations from shareholders and investor bodies to take into account about how remuneration should be impacted.
Shareholder expectations
We have commented in the course of the year on the detail of the various pronouncements that investor bodies have made and their published expectations. Please see our May and November briefings for a discussion of these. Key points to draw from them are as follows:
Annual bonuses for 2020
There are three issues here:
- to what extent have bonuses been earned on their terms;
- if they have been earned, should they still be paid and, if so, to what extent; and
- if bonuses have not been earned on their terms but the remuneration committee feels that there should be payment, should the committee make a decision to override or amend the bonus conditions (if they have not already done so).
While decisions on quantum are not likely to be determined on legal issues, it is important for companies to remember that any decision affecting directors must fall within the scope of their approved directors' remuneration policy. Any exercise of discretion should be reported in detail and shareholders will pay close attention to the justification given in the annual report. Other available tools which may make outcomes more palatable for shareholders include deferral of the bonus, payment in shares or voluntary reinvestment. For participants who missed out on a 2019 bonus because of the timing of the crisis and their own company's financial year, an additional issue may be whether it is appropriate for them to lose remuneration for 2020 as well.
LTIP awards
For LTIP awards vesting in 2021, similar legal issues as for bonus payments arise here although 2020 will just be one year out of three in the performance period (and LTIP pay-outs tend to be larger).
For new LTIP awards, all companies will this year face the challenge of making 2021 LTIP grants with prior warning of the complexities at stake in determining both relevant performance conditions and the number of shares over which awards are granted. The investor bodies have gone into some detail on what should be taken into account here. Restricted share plans – which do not have performance conditions – remove at least one of those considerations, but the experience of companies launching these recently has been mixed. While the number of companies operating them at board level has increased, there were uncomfortable levels of shareholder opposition in several cases last year. The use of restricted share plans is still, therefore, at least at board level, far from as straightforward an answer as various share plan advisers had hoped.
Pension contributions
Investors seem particularly focused on pension contributions, expecting a road map towards meeting their demands that pension contributions for directors should not exceed the company-wide pension contribution level by the end of 2022.
Remuneration reporting
In November 2020, the Financial Reporting Council (FRC) published its review of corporate governance reporting in 2020. With regards to remuneration, areas where reporting was found to be disappointing related to the following:
- KPIs – the inclusion of non-financial KPIs in remuneration measures is a positive move but more information should be given about the selection of performance metrics and the methodology behind them. They should be clearly linked to the company's strategy and reflective of how the company is fulfilling its targets, goals and purpose;
- Pension contributions – some companies are still lagging behind in providing a rationale and timeline for the alignment of pension contributions between directors and the general workforce. Until they do so, non-compliance should be disclosed; and
- Workforce engagement – there is a detailed analysis of reporting in this area and where it falls short. The overall message is that more explanation needs to be given of the method chosen for workforce engagement, why it is effective and specifically how that engagement impacted on remuneration decisions taken.
Companies may, therefore, wish to focus on these areas when preparing the narratives for their remuneration reports this year.
Key issues
All these debates further demonstrate the importance of the following:
Discretion: the inclusion of a right for the company to amend and/or reduce payment has been recommended by investor bodies for some years. Companies should check their documentation – which may not have been updated for several years – to confirm that adequate drafting is included; that may include their directors' remuneration policy. Participants may well want some checks and balances but, now that companies are expected to prevent windfall gains arising on vesting, reasonably broad drafting is needed for new awards.
Other powers: provisions relating to malus and clawback, tighter deferral, holding periods and post-termination shareholdings are all now regularly expected by investors, as least for directors. Again, it is worth checking that the relevant drafting stands up to current expectations in all plans and arrangements, particularly in the case of annual bonus arrangements which are often not given the scrutiny afforded to LTIPs. The danger in all cases is that if, unlikely as it may seem, circumstances arise which lead to arrangements being inspected or contested, remuneration committees could be criticised for not including these terms in new awards. Investors are increasingly asking to have confirmation of relevant arrangements being put in place with some detail of how they operate. While informal arrangements may work well when a participant is in employment, once they have left contractually binding terms may be needed and perhaps companies should even consider pre-emptively putting special structures in place. For example, to enforce post-employment shareholding requirements, it may be necessary for shares to be held in an employee trust.
Smaller companies: much literature is directed at larger quoted companies and it is assumed that smaller quoted companies will follow suit. Smaller quoted companies, particularly on AIM, are able to avoid having to put in place many of the obligations mentioned above, although small size is not automatically a bar to operating these arrangements.
Below board level: even more literature is focused on executive director pay. However, below board level pay is often operated far more flexibly. For example, many companies have moved to operating restricted share plans below board level in which case they have even more flexibility on pay as they are not restricted by a remuneration policy or reporting requirements. However, while executive directors may accept that they cannot be seen to receive remuneration which is out of kilter with the times, participants below board level are not so constrained. They may push for additional remuneration or demand to retain remuneration without the deferral or other conditions which executive directors have to accept.
ESG: more than ever, environmental, social and governance components are being included in annual bonus plans and (less often) long-term remuneration plans. Companies have increasing obligations to report on their progress towards these goals and investors often think that linking some remuneration to these goals is positive.
Technical issues: aside from possible tax changes affecting capital gains benefits (which rarely affect executive director remuneration in listed companies), there are no substantive new Companies Act or other formal reporting obligations due to come into effect this year. However, on a practical level, we have found that companies have experienced some issues in offering their share plans to employees in the EU following the full implementation of Brexit, including the fact that London brokers may no longer readily be able to deal for EU employees. Also, although many were voluntary early adopters, December 2020 year end companies will for the first time be required to comply with the new requirements for reporting directors' remuneration which were implemented as part of the Shareholder Rights Directive – click here to see our earlier alert.
Caution or optimism?
Overall companies are likely to be inclined to be cautious in their 2021 remuneration decisions to avoid shareholder or public criticism. Certainly 2021 is not likely to be a year when companies propose a change in approach which requires shareholder approval unless their remuneration policy or share plan is due to expire.
Despite the climate in January 2021 being subdued, it is important to remember though that by March (or AGM time) the mood may be much more upbeat. Even so, most companies are likely to defer any decisions they can until 2022 and probably hope that awards made in 2020 and 2021 will vest at a time when the issue of windfall gains may long be forgotten about.
More information
For more information about any of the matters discussed in this briefing, please contact either of the people whose contact details are given below.
