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Article | Executive Pay Memo – UK

Executive compensation year-end wrap-up

Regulatory, corporate governance and investor developments in 2020

Executive Compensation
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By Paul Townsend , Alex Little and Gareth Thomas | December 18, 2020

In this year-end issue of Executive Pay Memo UK, we review the 2020 executive pay developments in the UK and look ahead to 2021.

It’s been a busy end to 2020 with the most influential UK proxy advisors – the Investment Association (IA), Institutional Shareholder Services (ISS) and Glass Lewis (GL) – having formally set out their latest positions on executive remuneration and potential areas of scrutiny ahead of the 2021 AGM season, including specific perspectives on how they expect companies to take the impact of COVID into account. We have also directly engaged with a range of significant institutional investors to gather their ‘house’ views.

This article is a high-level overview of the key focus areas which have emerged from the guidance and insights from investors.

  1. 01

    Year-end decision making

    The impact of COVID-19 has been the main issue to contend with during 2020 with proxy advisors focused on how companies have responded on a range of stakeholder issues when determining their voting recommendations. This has led to an enhanced set of expectations around decision-making and disclosure as follows:

    Alignment with broader stakeholders and ‘red lines’ for incentive payments

    There is a broad consensus between proxy advisors and shareholders over the need for remuneration committees to consider broader stakeholder experiences when making decisions in relation to executive pay outcomes. Whilst there is general recognition that the impact will be different for each company (and encouragement for remuneration committees to take account of their individual circumstances), clear views have been expressed that approving incentive payments would be contentious in circumstances where:

    • Direct government support or capital raising has been sought
    • Indirect Government support (e.g. business rates relief) is a large performance factor
    • Employees have experienced pay cuts or large-scale redundancies
    • There is continued dividend suspension or cancellation
    • There are adjustments to performance targets: shareholders do not support performance targets being adjusted for the impact of COVID-19 for in-flight bonus and LTIP awards generally.

     

    the IA have said that they would not expect the payment of any annual bonuses for FY20 or FY20/21 where government support has been taken

    There is variation in the degree of emphasis different investors / proxy agencies place on each of these factors. For example, the IA have said that they would not expect the payment of any annual bonuses for FY20 or FY20/21 where government support has been taken, unless there are ‘truly exceptional circumstances’. In relation to the employee experience and cancellation of dividends, the IA position is a marginally softer expectation that these will be ‘taken into account’ when determining remuneration outcomes. We noted during our consultation with investors that some intend to take a particularly ‘hard line’ on executive pay where COVID redundancies have been made and early indications suggest ISS will do so too.

    The use of discretion

    Where any of the factors above are relevant, there will be a minimum expectation that the remuneration committee at least considers the use of downwards discretion to incentive outcomes (bonus in particular) rather than simply taking the formulaic result based on performance against set targets. It will be important for the directors’ remuneration report to explain why discretion was or was not exercised given the specific circumstances of the company.

    Narrative and disclosure

    A consistent theme throughout the new guidance is the importance placed on disclosure, which places as much emphasis on why decisions made were appropriate to the company’s circumstances and what the remuneration committee took into account as it does the remuneration outcomes themselves.

  2. 02

    Arrangements for 2021

    It will be important for remuneration committees to explain whether and how discretion has been applied and the factors they will take into account

    If decision-making going into the end of 2020 wasn’t complex enough, recent proxy advisor guidance and shareholder expectations on executive pay have also evolved in forward-looking areas for 2021 including:

    Target setting

    Target calibration is challenging in the best of times but especially so in light of the uncertainty of a global pandemic. Proxy advisors have acknowledged that the impact of COVID may lead to a reduction in performance target ranges or wider ranges. It will be important for remuneration committees to disclose the process it has been through to set the targets and explain why they are appropriate and stretching.

    Windfall gains

    Proxy advisors were pragmatic about companies not applying haircuts to LTI awards made at a time when share prices were generally depressed due to the initial impact of COVID. However, this was with the understanding that remuneration committees would be prepared to exercise discretion on vesting to mitigate against potential windfall gains. It will be important for remuneration committees to explain whether and how discretion has been applied and the factors they will take into account in determining whether a windfall gain has been generated.

  3. 03

    Don’t forget the basics

    Although COVID can dominate current decision making, other voting items should not be forgotten in 2021.

    Executive pensions continue to be a hot topic as investors and companies respond to the 2018 UK Corporate Governance Code requirement for executive pensions to be aligned with those of the wider workforce. The market continues to move fast in this area and the focus is now on companies committing to aligning by the IA’s deadline of the end of 2022. IVIS will now issue an automatic ‘Red Top’ for any company that has not put forward a ‘credible plan’ for this and operates executive pension levels above 15% of salary (a hardening of their approach in 2020 which was focused on levels above 25%). ISS have indicated that their own views align with this expectation.

    The IA, ISS and GL all view the introduction of post-employment shareholding policies as good practice. In particular, the IA expect the introduction of post-employment SOGs in any new remuneration policies and that they should extend to two years post-employment at the level of the company’s in-employment SOG (or the level held at the point of departure if lower). There is now an enhanced expectation with shareholders keen to understand the enforcement mechanisms which the Remuneration Committee has in place to ensure that post-employment shareholding policies are enforced once a director has left the company and that this should be disclosed.

  4. 04

    ESG

    A growing focus on Environmental, Social and Governance (ESG) strategy and its linkage to executive compensation. Remuneration committees have always been encouraged to consider including strategic or non-financial performance criteria in variable remuneration, however the focus has now shifted from personal or strategic objectives in prior performance years, to whether ESG metrics are appropriate to include within incentives. We expect that this will become a ‘when’ not ‘if’ issue for most companies over the next 12 to 36 months.

    Emerging practice may be for ESG metrics (increasingly focused on environmental and sustainability measures) to be weighted more heavily with an increasing appearance in LTI

    Historic/current practice has typically been focused on inclusion of ESG metrics in the annual bonus with a small weighting. Emerging practice may be for ESG metrics (increasingly focused on environmental and sustainability measures) to be weighted more heavily with an increasing appearance in LTI and we are working with a number of companies on the adoption of ESG metrics.

Willis Towers Watson’s View

2020 has been far from a quiet year in terms of new developments. As the focus has been on responding quickly and effectively to the COVID-19 pandemic, this has brought new expectations and standards for executive pay and decision-making into the balance. There has been a significant shift and remuneration committees are expected to take into account the experience of all stakeholders during decision making and also explain the process through enhanced, transparent, and lucid disclosure.

No two companies’ experience has been the same throughout 2020

No two companies’ experience has been the same throughout 2020 and shareholders and their representative bodies will expect their principles-based guidance and standards issued in 2020 to be reviewed carefully by companies and taken into account in decision-making - in-particular, the ‘red-lines’ around when it may or may not be palatable to pay out bonuses.

The 2021 AGM season is shaping up to be a pivotal one for many FTSE companies who will need to navigate a number of forward-looking challenges, whilst also making a clear and convincing case to shareholders on why decisions taken in relation to 2020 outcomes were appropriate. Willis Towers Watson’s executive compensation practice is here to aid companies on this journey.

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