Investment Association updates Principles of Remuneration for 2020

The trade body has published its annual update to its Principles of Remuneration (20-page / 840KB PDF), its influential guidelines setting out investor expectations and best practice on executive pay for FTSE companies. Publication comes ahead of the 2020 AGM season, when many listed companies will be putting new remuneration policies to a shareholder vote for the first time since 2017.

The IA, in a letter to chairs of remuneration committees of FTSE 350 companies (2-page / 208KB PDF), emphasised the need for incentive structures that appropriately reflect the company's long-term strategy and which deliver sustainable results for all stakeholders. It is encouraging them to consider alternatives to the traditional long-term incentive plan (LTIP) model where this is appropriate and "aligned with the company's strategy".

Share plans and incentives expert Lynette Jacobs of Pinsent Masons, the law firm behind Out-Law, said: "Although the new IA Principles have not introduced anything fundamentally new, they place greater emphasis on certain themes which have been on remuneration committees' agendas for a few years. However, the new IA Principles are clear that shareholders expect remuneration committees to take faster and more concrete action towards achieving these goals".

The updated principles recommend that remuneration committees be given discretion to cap vesting at a specific monetary value. Committees should decide on the level at which this discretion would be exercised, and how it would be implemented on an individual basis. Committees continue to be encouraged to use discretion in relation to variable pay awards where the business "has suffered an exceptional negative event", which now explicitly includes health and safety failures and other events which impact on the company workforce.

Remuneration committees continue to be encouraged to spell out the circumstances in which 'malus and clawback' provisions, allowing for performance-related remuneration to be withheld, reduced or recovered, will apply. Malus and clawback provisions will vary by company, although the principles now directly refer to the examples given in the Financial Reporting Council's guidance on board effectiveness misstatement of accounts, serious reputational damage and corporate failure.

In last year's update, the IA set out its expectation that pension contributions for executive directors should be aligned with the majority of the company's workforce. It is now expecting remuneration committees to put a credible action plan in place to align pension contributions for incumbent directors with the majority of the workforce by the end of 2022. Annual reports should disclose the pension contribution rate available for the majority of the workforce, and explain how that figure has been derived.

James Sullivan-Tailyour of Pinsent Masons said that the 2022 deadline "may be a challenge for companies with long-standing directors whose employment contracts entrench their pension contribution entitlements".

"However, institutional investors have made very clear that they expect companies to be taking decisive action on directors' pension arrangements, and that directors should not be receiving compensation for reduced pension entitlements," he said.

Best practice is for directors' employment contracts to retain flexibility for the remuneration committee to alter pension contribution rates, but where that is not the case companies will need to consider what other tools they have at their disposal to reduce pension entitlements for incumbents," he said.

The updated principles also include a new section on 'leavers', which re-states best practice in this area. Leavers' notice periods should begin "immediately when a decision has been made that an executive has resigned or the board has decided that an individual is leaving the company", and payments in lieu of notice (PILONs) limited to salary, pensions and other contractual benefits and reflect the length of the notice period. Annual bonuses should only be paid to 'good leavers', and deferred bonuses should continue to be settled in shares and paid on the normal timetable.

The IA now expects that remuneration policies should include provisions requiring departing directors to hold on to a proportion of their shares for at least two years once they have left the company, "to ensure the long-term value of the company is prioritised".

Fleur Benns of Pinsent Masons said that enforcement of these provisions "poses a significant legal challenge" for remuneration committees.

"Companies will need to think carefully about whether the arrangements they put in place are robust and ensure the company has oversight over compliance," she said. "The right mechanisms will be specific to each company, but are likely to involve a combination of amendments to existing plan rules, revising shareholding policies and the establishment of corporate nominee accounts."