The Investment Association's latest views on executive pay and shareholder expectations in the current pandemic

Pensions, proper mechanisms for enforcing post-employment shareholdings, ESG performance conditions and how bonuses and long-term incentives are affected by COVID-19 are the main subjects addressed by the Investment Association (IA) in its usual November update of its Principles of Remuneration and other remuneration guidance.

The updates to the remuneration principles are not changes of substance but more in the nature of clarification or emphasis. Similarly, the approach to pension contributions is largely a restatement of the IA's previous position, apart from one strengthening of its views flagged below. The main changes are in relation to expectations on executive pay during the pandemic where things have moved on since the guidance was first published in April. 

We summarise the key points below.

1.  Principles of Remuneration

This year's changes focus on three areas:

• Post-employment shareholdings: greater emphasis has been placed on the need for remuneration committees to say how they will enforce the obligations on directors to retain shares after they have ceased employment. The best way to achieve this is usually for the shares to be held in the company's employee trust, or by another nominee, combined with a contractual requirement for the company's consent to be obtained for the disposal of the shares. If you need assistance with putting appropriate arrangements in place, please get in touch.
• Performance conditions: in setting the performance conditions for annual bonuses, remuneration committees should consider including the management of material Environmental, Social and Governance (ESG) risks, provided any such conditions are clearly linked to the implementation of the company's long-term strategy. The IA notes that its members have seen the increasing use of strategic targets and/or personal objectives in annual bonuses but expect financial metrics to comprise the significant majority of the overall bonus. Where personal objectives are used, companies need to demonstrate how they link to long-term value creation and are not simply for "doing the day job".
• Annual bonus deferral: Where the annual bonus opportunity is greater than 100 per cent of salary, a proportion of the entire bonus - with the word "entire" being new - should be deferred into shares.

2.  Approach to pensions

The IA identified some time ago the discrepancy between the level of pension contributions for directors and the majority of the workforce as an issue it would like to see remedied. This year's open letter to remuneration committee chairs updates them on the IA's expectations with regard to the alignment of  pension contributions. 

As regards incumbent directors, the IA has already indicated that a credible action plan should be in place for alignment to be achieved by the end of 2022. For year-ends starting on or after 31 December 2020, IVIS will "red-top" (i.e. identify as a major area of concern) any remuneration report where no such plan has been disclosed and an executive director receives a pension contribution of 15 per cent of salary or more. This replaces the previous cap of 25 per cent of salary and is therefore a hardening of the IA's position. Fixing the monetary value of pension contributions over time is not generally considered to be a credible action plan for alignment.

As regards new directors, in 2021 a remuneration policy will be red-topped if it does not explicitly state that any new executive director will have their pension contribution set in line with the majority of the workforce. The remuneration report will be red-topped if the pension contributions of any new executive director or director changing role are not so aligned.

3.  Shareholder expectations during the COVID-19 pandemic

The IA's original guidance on its members' expectations with regard to COVID-19 and executive pay was published in April and is discussed in our briefing here. We were only at the start of the pandemic then and the IA has now had more time to evaluate the position. Its updated guidance reiterates most of the messages from its original statement with the core point being that executives should not be isolated from the impact of COVID-19 in a manner that is inconsistent with the approach taken to the general workforce. Additional expectations are as follows:

• Government/shareholder support: where companies have received direct government support or have raised additional capital from shareholders, IA members would not expect the payment of any annual bonuses for FY 2020 or FY 2020/21 unless there are truly exceptional circumstances. Where companies have received indirect government support such as the business rate relief, remuneration committees should disclose how they have taken into account the impact of this on remuneration outcomes.
• Performance conditions: Companies are asked to confirm in the remuneration committee chair's statement that they have not adjusted performance targets during the year to account for the impact of COVID-19.
• Salary: restraint is expected and any increase in executive salaries should be in line with changes for the wider workforce.
• Bonuses: increased disclosure is expected around the use of discretion and its rationale, such as how financial targets have been determined, why pay-outs may have been allowed under non-financial elements only and how performance measures may have been adjusted as a result of exceptional circumstances such as rent concessions or waivers. Companies are also asked to consider whether a higher portion of the bonus should be deferred into shares.
• LTIP awards: such awards should not be cancelled and replaced with new awards and executives should not receive a higher variable remuneration opportunity in 2021 to compensate for lower remuneration received in 2020 due to the pandemic.
  
  Remuneration committees should set out in the remuneration report what approach they will take to judging if there has been a windfall gain from LTIP grants made in 2020 and also state if the size of the award was reduced. Committees need to be pro-active in determining what the appropriate LTIP award size is in the current market environment and granting awards at the maximum level where share prices have fallen substantially is discouraged.
  
  Performance targets for future LTIP grants also need to be reviewed to ensure they are sufficiently stretching. A reduction in the performance target range or a wider performance range may be appropriate. Committees should use their discretion to reduce vesting outcomes where performance outcomes are not consistent with overall company performance or windfall gains have been received.
• Restricted share plans: the difficulty in setting long-term performance conditions in the current environment is not a reason in itself for moving to a restricted share model. If a restricted share plan is introduced, remuneration committees should consider share price factors in addition to the usual discount rate of at least 50 per cent from the equivalent LTIP grant.
• New policies: it may be advisable for companies significantly impacted by COVID-19 to wait until there is greater clarity on the future market environment before proposing significant changes to their remuneration policies.

More information

The IA's guidelines represent the views of a committee and so individual fund managers may have different views. Other voting agencies are also emerging with similar but, in some cases, slightly different approaches. If you would like to discuss any of the issues raised in this briefing, please contact either of the people whose details are given below.