UK’s Investment Association’s long slide to encouraging mediocity

The UK Investment Association, whose members manage £7 trillion in assets across the globe, has released its updated guidance for the upcoming 2018 voting season. As the forerunner in establishing “say on pay” and other governance guidelines, the IA has had, and will continue to have, a major influence on governance standards in both the UK and Australia.

As has become the norm, the IA sent an open letter to remuneration committee chairmen of FTSE 350 companies outlining its areas of focus. It reflects UK thinking that has been brewing over recent years (see, for example, HERE, HERE,  and HERE). While elements can be considered governance improvements, there are also aspects that should be cause for concern to all investors and the directors they elect.

While the IA would never dream of saying it, mediocrity continues to be the theme of the moment. The IA noted large companies’ efforts to reduce variable awards in the previous season and stated its expectation that this would spread to the broader market in the coming season. It also expressed its disapproval of incremental increases in the maximum variable remuneration opportunity and noted that “automatic” increases to base salary flow through to the whole package. The focus is on justifying executives’ level of pay in the social context.

Ayn Rand must be spinning in her grave.

But perhaps not. The IA has an antipathy to inflation-based executive pay increases. A rationale for increases is necessary, and catch-up increases avoided if possible. We know Ayn would say “pay them what they are worth”, rather than CPI adjusted pay. But we are not sure the IA is saying the same thing.

The IA mindset can be problematic, since if executive remuneration cannot keep up with market rates within a company, it will be easier for other companies to poach executives. Executives would also realise that the only way to maintain a market level of remuneration is to let themselves be poached – a situation that is definitely not in shareholders’ best interests.

We also understand the frustration investors must have with boards lavishing high incentive payouts for less than stellar performance. But the IA solution to reduce variable pay opportunity, taken to its extreme, would mean the no-hopers being paid the same as the stars. Instead, the IA could do more to encourage boards to better differentiate pay on the basis of performance. They go part way in their focus on performance hurdle disclosure (see below), but then in effect reduce its impact through encouraging less incentive opportunity.

The IA would like to see voluntary disclosure in the upcoming reporting season of CEO to average UK worker pay ratio. It also expects disclosure of the CEO to the executive team ratio, indicating it would like to see companies make reference to this when setting executive pay. In other words, the IA would like to see a reduction in the ratio, with the emphasis on reducing pay at the top end rather than enhancing it at the bottom end.

We hesitate to say that this seems part of a slide towards collectivism, in case Ayn starts her spinning again. Perhaps the IA is just positioning itself to have a dialogue with a newly elected PM Jeremy Corbin post Brexit?

The Investment Association admitted that its membership was divided on using restricted shares instead of long term incentives (where the shares are time but not performance hurdled, with a corresponding reduction in quantum). A concern its members have had is that those companies where long term incentives were not paying out would adopt the non-performance tensioned incentives. Sounds like a bob each way.

The IA also reminded companies that the choice was not between granting restricted shares or traditional long term incentives, but any structure that would best suit the company’s situation.

On safer ground, the IA has set a requirement on the disclosure of bonus targets – 12 months after the bonus is paid to the executive. It also stated that members wanted more disclosure on why personal or strategic targets pay out, and not just a description of the indicators. There is also scepticism, as there is in Australia, around using adjusted earnings figures for performance measures. These requirements would benefit transparency, and unlike the IA’s emphasis on reducing potential incentive pay for performance, serve to ensure pay levels vary according to merit.

To read the open letter and updated guidelines in their entirety, see HERE.



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