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Alternative executive pay models supported by latest Principles of Remuneration, experts say

Updated guidance from institutional investors for remuneration committees designing executive pay packages will encourage the use of more diverse pay structures, provided that a company selects a model appropriate for its own business and is able to win support for that from its shareholders, an expert has said.

The 2016 version of the Principles of Remuneration (17-page / 524KB PDF), published by the Investment Association (IA), reflects extensive debate amongst members of the investor body, and comes three months after the publication of a report by an independent working group that it set up in 2015 to investigate ways to rebuild trust in executive pay structures, according to Lynette Jacobs of Pinsent Masons, the law firm behind Out-Law.com.

Among the recommendations of that working group was a move away from the currently predominant long-term incentive plan (LTIP) pay model, incorporating three year or longer vesting performance share awards, in favour of a more flexible approach allowing pay structures to better reflect the reality of each particular business.

Although the principles are not binding, Jacobs said the extensive debate in the run-up to their publication might also help secure greater support for the principles from voting IA members and companies, particularly given the "apparent political sensitivities and risks for both investors and quoted companies at this time".

"The fact that the principles now support the use of alternative structures to the current LTIP model, if appropriate and justified, should give greater confidence for companies, if they wish, to at least explore possible appropriate alternative models with their own key shareholders - despite understandable concerns, given some companies' recent experiences, that investors might not support them," she said.

"However, as the current peak year for remuneration policy renewals has started already, companies with 30 September to December year ends may already be well advanced with drafting their new policies , and so might find it hard to take all aspects of the 2016 Principles fully into account ," she said.

The IA is the trade body which represents the interests of the £5.7 trillion UK asset management industry, including both retail and institutional assets. Its Principles of Remuneration set out the views of the IA's members on executive pay, and are updated annually to take account of any trends and issues emerging from the previous corporate AGM season.

As in previous years, publication of the updated document was accompanied by an 'open letter' from the IA to the chairs of the remuneration committees of the companies that make up the FTSE 350 index of publicly-listed companies by share value (3-page / 227KB PDF). Jacobs said that this letter was "perhaps more focused on the restructuring of the Principles than similar letters have been in some previous years", and also seemed to have "a rather more imperative tone on some of its key points".

"Dominant 'other' themes in the letter  include the actual level, or quantum, of executive pay, previously a rather taboo subject, and the urgent need for companies to consider the current economic and political and social context when setting executive remuneration," she said.

"The updated document embraces CEO: median pay ratio disclosure, one of the three specific governance reform proposals made by Theresa May in July, " Jacobs  said.

Share plans and incentives expert Graeme Standen of Pinsent Masons said that the guidance set out in the document regarding pay ratios actually went beyond that recommended by the working group; suggesting as it did the use of pay ratios "not only as between the CEO and the 'median employee' but also between the CEO and the 'executive committee'".

"Discussions will no doubt continue as to the identity of the appropriate median employee, and how this may or should vary between companies in order to provide a relevant reference point," he said. "A pay ratio between the CEO and the executive committee may be a more meaningful comparator."

"There is no reference in the updated document to Mrs May's other specific proposals: to require some kind of annual binding vote on pay, and consumer and worker representation on boards," Standen said. "That makes sense, as the Principles address the governance of executive remuneration under the current legislation, and only engage with board best practice to that extent. The government is expected to publish a consultation document on possible governance reforms later in 2016, and there have been reports that ministers are trying to devise a more practical alternative to direct worker representation on boards."

The letter to remuneration committee chairs also highlights bonus target disclosure, and warned companies that the IA would monitor the quality of these disclosures through its corporate governance research unit, IVIS, Standen said.

"Reflecting improved disclosure by companies over the last year of financial targets, there is now reference also to shareholders' expectation of a thorough explanation of why personal or strategic targets have paid out and 'not just a description of non-financial performance indicators'," he said. "Adding weight to this expectation, an IVIS 'Amber Top' will be issued where it deems there is insufficient information on non-financial targets for shareholders to assess whether a pay out was justified, especially where financial targets have not been met."

IVIS monitors the performance of companies in the FTSE All-Share Index for compliance with corporate governance best practice. Although it does not provide voting recommendations to the institutional investors that make up the IA's membership, it uses 'red' and 'amber' top colour codes on its analysis to highlight breaches of best practice or areas of concern.

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