IA’s ‘light touch’ approach signals increased pay flexibility

UK companies have been given a green light to be more competitive on senior pay. The Investment Association has written to companies telling them they can choose the remuneration structure which is most appropriate for their business strategy, and that they have more scope for tailored arrangements for their most senior executives. We’ll speak to a share plans expert about the need to check carefully the wording of bonus scheme rules before making awards under that particular incentive arrangement.

Back in February the Investment Association published guidance on executive remuneration for UK-listed companies. It took the form of a letter to Remuneration Committee chairs spelling out how it recognises the need for UK companies to be able to compete for senior talent given the relative attractiveness of a listing in the UK compared to the US where senior executives can command a significant premium for their services compared to current FTSE practice. It means, going forward, there is greater scope for higher potential pay, albeit with a need for clear alignment between reward and performance.

The implications of the IA’s letter are discussed by our share plans team in their Out-Law article: ‘Investment Association: UK should be competitive on senior pay.’ Lynette Jacobs says the IA’s stance ‘will be appreciated by all, and particularly truly large companies who compete in the international space for senior talent, especially the US.’ James Sullivan-Tailyour warns that companies wishing to implement incentive arrangements which are ‘outside the box,’ whether in terms of structure or award quantum are “strongly advised to consult with larger shareholders as it remains likely that such arrangements will only be blessed by shareholders in exceptional circumstances.” 

Given the IA’s stance, many large UK-based companies are now reviewing their incentive arrangements, including their discretionary bonus schemes which remain a very effective and popular tool used by HR teams and managers to incentivise high-performance and boost employee retention. Typically, schemes will be labelled as ‘discretionary’ and so decision-makers often take that to mean it is within their gift to decide who receives a bonus, and the amount. Only when challenged do they realise their ‘discretionary’ scheme is not truly discretionary at all and therein lies the problem. 

James Sullivan-Tailyour advises clients on the drafting of schemes, including discretionary bonuses, and earlier he joined me by video-link from the London office to discuss this. I put it to James that it’s a bit odd that a scheme labelled ‘discretionary’ is not living up to that description. 

James Sullivan-Tailyour: “Yes, that's absolutely right, Joe, and it might perhaps seem a little bit unfair because if a bonus scheme is labelled as discretionary it's a fair assumption that it ought to be treated as discretionary but there are a number of areas where companies can trip themselves up and tip what they intended to be a discretionary bonus scheme into something that's more contractual in nature, or where the scope of their discretion is limited. The first area where companies can trip themselves up is when a new employee joins the business, in their employment contract baking in some kind of contractual entitlement to participate in a bonus scheme. If that's the case, then it can really cut across any discretionary bonus scheme rules you have in place. The employment contract entitlements will trump the bonus scheme rules unless you've got that employment contract drafting very carefully limited to make sure that the bonus scheme rules prevail. Even where a bonus scheme is discretionary, and labelled as such, sometimes there can be a little bit of lack of follow through in actually how the bonus scheme rules work themselves. A discretionary bonus scheme might go on to talk about the fact that payments will be made on a certain date rather than payments may be made or might be made of poor performance conditions are met. Then the other area where there can sometimes be some issues is if there's a lack of follow through. So, if a discretionary bonus scheme truly is a discretionary bonus scheme, you might think that would get you all the way but there can be some legal limitations on the extent to which an employer can exercise its discretion entirely as it sees fit. There are obviously limitations such as the duty not to act arbitrarily or capriciously and to act honestly and in good faith but, also, sometimes bonus entitlements can crystallise into contractual entitlements through custom and practice. So, if you think you operate a discretionary bonus scheme but in fact you always pay out bonuses by reference to particular pre-set criteria every year and you've done it for 10 or 15 years, in year 16, when you suddenly decide that you want to change the bonus parameters and take into account other factors, you may find that the law is effectively going to prevent you from doing that because you've created contractual entitlements for your employees. So there are all these areas that can limit the scope of a company's discretion and potentially even convert what you think is a discretionary bonus entitlement into something that's more akin to a contractual right.”

Joe Glavina: “So what’s the practical advice on how to help protect the business from disputes like this?”

James Sullivan-Tailyour: “Well, I think firstly you need to make sure that your bonus scheme rules are really carefully and tightly drafted to make sure that all the discretions you and your board may need to rely on are referenced and captured in your bonus scheme documents. This is an area where we sometimes see that the drafting is wanting in a few areas. So bonus schemes can often have been knocking around a business for a number of years and the drafting is a little bit out of date. Also, I think in a very well thought through in terms of how bonuses are intended to be calculated, and all of the profit metrics that might go into that, but there isn't the same level of detail and precision in the drafting when it comes to things like leavers or payment dates, or other factors aside from those financial performance metrics that the board might want to consider when making a bonus determination. So I think that's the first thing that it's really important to get right. I think the second thing it's really important to get right is how you go about communicating how the bonus scheme works with participants and that’s about emphasising to participants the truly discretionary nature of the scheme. It isn't just the case that if we have a good financial year, bonuses will be paid, and helping participants recognise that there are wider stakeholders that the board needs to consider, and a whole host of other factors that might go into determining a bonus outcome and that can be a really useful way of mitigating the likelihood of any future disputes because participants should, at least in theory, be aware of the discretionary nature of the scheme and not just think that ,well, if we've achieved this amount of profit I should be receiving this amount of bonus. The final point I'd make is it's also really helpful if you do get into the position of having a dispute, that you've got a really clear paper trail that evidences how the board has in previous years, and in the bonus year that's in dispute, gone about properly exercising its discretion. What can often be very unhelpful is all of the documentation is set up to create a discretionary bonus scheme but then the board minutes, or the RemCo minutes, either are not there to support the fact that in this particular year a bonus outcome was determined on a discretionary basis, or even the board's or RemCo’s minutes point in an entirely different direction and show that in all previous years the RemCo has just looked at profit and nothing else. It is in those types of scenarios where you're giving potential ammunition to a litigant who might want to come along and dispute their bonus outcome for a year.”

That Out-Law article by the share plans team is called ‘Investment Association: UK should be competitive on senior pay.’ We’ve included a link to it in the transcript of this programme for you. 

LINKS 
- Link to Out-Law article: Investment Association: UK should be competitive on senior pay (pinsentmasons.com)