Game-changer on Boardroom Pay in the UK?
The Executive Remuneration Working Group (ERWG), set up last year under the auspices of the Investment Association, has published its much-anticipated final report on simplifying and re-aligning executive pay in the UK. The ERWG hopes that this report will have a major influence on how executive remuneration in FTSE companies is structured.
The remit of the ERWG was to conduct an independent review of executive remuneration in order to find workable solutions to the problems inherent in the current system of executive remuneration, which is frequently said to be broken. It reported on an interim basis in April of this year and has followed that up with round-table discussions prior to publishing its final report.
The ERWG’s core recommendation remains the same. It concludes that the current “one size fits all” approach to executive remuneration (i.e. salary/benefits/annual bonus/LTIP) simply cannot, almost by definition, be suitable for all companies. Remuneration committees should have the freedom to move away from it. In fact, the ERWG describes greater flexibility as “the” solution to “the” problem with executive pay!
The difficulties that stand in the way of that change are acknowledged and the ERWG has made nine further recommendations designed to re-establish trust and strengthen relationships with shareholders. None of these additional recommendations are particularly novel and it remains to be seen whether they and the other guidance offered will be sufficient to coax remuneration committees out of the perceived safe harbour of the existing model. The clear acknowledgement that change needs to come from both sides is an encouraging output from the working group. Having said that, and it comes as no surprise, there is a renewed emphasis on disinfecting the relationship between companies and investors through increased transparency. The ERWG pulls no punches in asserting that without greater transparency (amongst other things), there may not be sufficient trust to enable companies to explore more bespoke solutions for the compensation structure of executives.
The ERWG has recommended two possible models as alternatives to reliance on traditional LTIPs (although this is not intended to be an exhaustive list). These are:
the deferral of bonuses into shares; and
restricted share awards vesting in stages over 3-5 years (with no performance conditions).
At the interim stage there was a third model (performance on grant) but that has been deemed to be unworkable due to the long time frames involved. The ERWG declined to add market value options to this list. Where LTIPs are used, the model of a three-year performance period followed by a further two-year retention period is endorsed. Guidance is offered on a number of inter-related issues including shareholding guidelines, prevention of rewards for failure and the discount factor when moving from LTIP awards to restricted share awards. A discount factor of 50% is endorsed as a basic starting point (i.e. other factors aside, the value of restricted shares awarded would normally be half the value of shares that would otherwise have been included in an LTIP grant under an existing plan).
Interestingly, shareholders involved in the ERWG’s discussion groups did not request greater consultation on pay matters. In fact, they would like to reduce the time spent on this area through more effective and timely consultation – which loosely translates into a request to focus on the key issues and not to bother consulting on everything. For good measure, the ERWG makes the point that just because there has been consultation there won’t necessarily be support for the conclusion.
The ERWG noted that its remit was to find ways of simplifying executive pay rather than reducing it. However, the two are not unrelated and the detailed recommendations touch on process and disclosure in this area. In the past, significant changes in the structure of executive pay have often resulted in overall increases in remuneration and it will be interesting to see if the recent pressure exerted by shareholders during the 2016 FTSE100 AGM season prevents that from happening again. In particular, if there is a move away from LTIPs how will the compensating increases in other remuneration elements be portrayed in the media?
Theresa May has promised to have another go at tackling excessive remuneration through more legislation. The ERWG has not had enough time to consider these proposals in detail, albeit its members do not appear to be convinced. They note in particular that the change from advisory to binding votes is likely to encounter similar problems to those that resulted in the watering down of the original proposals from the Coalition Government in 2010. Mrs May’s ideas are about increasing stakeholder influence in the governance system in the hope that it will bring boardroom pay under tighter control. That rather indirect approach contrasts with the ERWG proposals, which are intended to have a much more direct effect on executive remuneration by promoting changes to the remuneration policies that most FTSE companies will put to their shareholders for renewal in 2017.
The Investment Association will now be considering what changes are needed to its guidelines on executive remuneration as a result of the ERWG report but most companies that are due to put a new remuneration policy to shareholders for approval in 2017 will, no doubt, already be working out whether they should be considering significant changes to their policies. The ERWG has stressed that remuneration committees should be placing less reliance on remuneration consultants, but it is hard to see this type of decision being made without heavy input from external advisers.
As the saying goes, the proof of the pudding will be in the eating, but we will need to wait until 2017 to see how many remuneration committees have the stomach for such radical change.