Last October Guerdon Associates reported that the UK Investment Association (UKIA) was trying to simplify and improve pay practices at UK listed companies (see HERE). This is important to listed company boards, as the UKIA remuneration guidelines have been, in effect, the “granddaddy” of all other stakeholder proxy voting guidelines in Australia as well as in the UK.
As expected, the UKIA’s Executive Remuneration Working Group has issued an Interim Report.
The Working Group, which includes representatives of companies, investors and asset owners, has made a series of proposals ahead of a consultation, to take place during the next few weeks.
The proposals are centred on resetting the expectations both of listed companies and investment managers around pay structures, to overhaul the “current dominance” of Long-Term Incentives (LTIs), which the UKIA says often results in a poor alignment of interests between executives and shareholders.
The Working Group argues we should move away from the “one-size-fits-all model”, and that companies when deciding on executive pay structures should consider a range of other options, based on their own business strategies and circumstances.
While boards and other stakeholders have heard these words before, it is heartening that they are being said by UKIA, given that its Remuneration Principles have had such a significant influence not only on UK practice, but also in Australia (see their current principles HERE).
Nevertheless, some remain skeptical, given that it has been claimed that the UKIA’s guidelines set the pattern for “one size fits all” in the first place. The same skeptics think that the primary purpose of guidelines seems to be one or more of:
- Advising people who cannot think for themselves
- Setting parameters for people who do not have the time to think for themselves
- Reducing the costs involved in the effort required for people to think for themselves
While we would hesitate to use quite the same language, for institutional investors the third alternative is most likely. It takes a lot of time, and therefore money, to read disclosures, understand them, and work out which is the better framework for executives to deliver on their investment. This is why proxy advisers and other governance professionals have become an important adjunct to investment management. It is simply cheaper to have guidelines and/or outsource the proxy voting analyses.
The report’s observations on page 6 are sensible, and include:
- LTIs are intended to motivate executives to achieve certain goals over a longer period. However, companies can find it challenging to set targets that will still be relevant to their strategy and the wider economic environment in three years’ time. This can lead executives to feel that they have little or no control over the outcomes of the awards. This can be particularly true when LTIPs use relative measures. This loss of “line of sight” between an executive’s contribution and the outcome of the LTI limits the effectiveness of the remuneration model.
- In addition, fluctuations in payouts, the uncertainty attached to LTIs and the introduction of restrictions such as malus, clawback and holding periods have also had the effect of driving up the overall size of executive remuneration, since remuneration committees must increase fixed pay to achieve the remuneration levels they require to retain their executives.
The alternatives considered suitable are a great advance on the strait jacket “one size fits all” within existing guidelines, and include:
- The current model (a grant of equity that vests based on performance measured over a three to five-year period against a series of pre-agreed targets.)
- For short business cycle companies, a bonus paid partly in cash, with a significant proportion paid in equity that vests over a significant time period for longer-term alignment.
- A grant of shares awarded based on performance achieved over the previous three years. The grant of shares then vests three to five years after grant. This permits a grant on performance for which it is too hard to set targets over three years, but with a shorter period for vesting than the prior two alternatives.
- For very long term business cycle companies, an annual grant of restricted shares, which will vest after a period of time based on continued employment.
With these models being acceptable, we wonder, how many board directors for long cycle resources companies with 40 year investment horizons will now put up their hand for serving on the remuneration committee?
The Interim Report will now form the basis of a series of roundtable discussions with stakeholders across the investment chain. In particular comments are being sought in regard to the following:
- Given the increased amount of certainty with alternatives such as restricted awards, how would the value of LTI awards be translated to reduce the quantum?
- What restrictions need to be in place to prevent payment for failure under alternative structures?
- What size and holding period are appropriate for shareholding guidelines to maintain long-term alignment of executives with shareholders?
- Is any action/behavioural change required on the part of companies, remuneration committees, shareholders and other market actors in order to implement alternatives or to accept a wider range of structures?
Overall, the UKIA Working Group paper has many encouraging aspects that we trust will be seriously considered by all stakeholders. Read it HERE.
The UKIA has informed the working group it will review promptly whether to adopt its eventual final recommendations in its Principles of Remuneration.
So, it seems, decisions will not be drawn out.
Accordingly, look forward to an eventual replacement of the “one size fits all” to a “4 sizes fits most” set of guidelines coming soon.© Guerdon Associates 2022 Back to all articles