The UK Investment Association’s Working Group on Executive Remuneration released its final report on 26 July 2016. When the Working Group released its interim report in late April, Guerdon Associates summarised its interesting views on LTI alternatives see HERE.

The UKIA has a very important role in governance, in that they are the UK’s default standard setters. Their standards tend to trickle their way not only into UK proxy adviser and investor guidelines, but also to Australian standards.

The timing is apt as new Prime Minister, Theresa May, has signified her determination to tackle perceived excesses in executive pay with:

• an annual binding shareholder vote on both pay and its implementation (rather than the current arrangement of a binding for remuneration policy every three years);
• more transparency including full disclosure of bonus targets and publication of pay multiple of CEO and median worker ; and
• simplification of the way bonuses are paid (see HERE insert URL of other UK article).

The Working Group believes there are five areas to help restore trust in the system, namely:

• Strengthening remuneration committees and their accountability.
• Improving shareholder engagement.
• Increasing transparency in target setting and use of discretion.
• Addressing the level of executive pay; and
• Setting parameters to illustrate how different structures may operate to gain market trust.

To help assist this, the Working Group made ten recommendations, some of which fit with Theresa May’s pronouncements, such as more disclosure for incentive targets and a call for Boards to explain why their company’s maximum remuneration level is appropriate having regard for the pay ratio between the CEO and median employees.

Methods to simplify remuneration, as noted in our prior article, endorses consideration of:

• Restricted share awards rather than performance contingent grants
• Retaining a 3 year employment contingency
• Releasing shares in one-third tranches on each of the third, fourth and fifth anniversaries of grant
• Taking a 50p in the £ exchange rate as the starting point for any exchange from a traditional LTIP into restricted shares.

Guerdon Associates senses that the UKIA has received a muted reaction to the report. The reaction includes, interestingly, comments from one proxy adviser (ISS) that some of the Working Group’s alternatives would not be acceptable to it because they are not market practice. On this basis good governance is, apparently, what everyone else is doing.

And, as those who attend our annual forums for investors and directors will know, the responses from institutional investors indicated that they could not agree among themselves what was good governance. Some investor responses to to the report were that the alternatives did not fit their own guidelines. Therefore, those institutional investors also consider them unacceptable. This attitude goes full circle, so that any attempts at reform have little chance if they are more widely held.

The thrust of the report leans toward leaving it to boards to decide what works best for the company. This seems a bit weak, given that companies told the Working Group (and acknowledged in their report), they are concerned that what would work best for them would not be acceptable to investors. Investors who were consulted on the process said there was already sufficient flexibility for companies, pointing to the handful of companies brave enough to have done something different.

There has also been a fair amount of angst from investors and proxy advisers associated with having to learn and understand many different remuneration structures and the engagement this will involve. In other words, it is simpler to tick a box than actually think through whether the remuneration arrangements are fit for purpose.

The Working Group’s response was that it believed more flexibility will see companies gravitate to simpler pay systems that will not be difficult to understand.

The UKIA has stated its intention to review its Principles of Remuneration in light of the recommendations of the Working Group. This will be the big test as the UKIA Principles are used for the assessment of executive pay policies. Changes to the Principles quickly find their way into the guidelines of all the proxy advisers and institutional investors.

Once that happens, there is a reasonable likelihood that some, if not all, of these changes will find their way to Australia. Boards and Remuneration Committees will be well-served in their deliberations if they have some regard for or consideration of the Working Group’s recommendations.

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