Corporate governance

The five principles of good governance - remuneration

Simon Lowe Simon Lowe

Remuneration and executive pay are often in the headlines. Today we explore good governance through the lens of remuneration.

Executive’s actual salaries have not increased much, however, growth in value of long-term share options has led to an increase in the value of the overall pay package1. Simultaneously, the stagnating average pay across all employees has led to concern about disconnects between executive pay and employee salaries2.

High profile cases of shareholders rejecting or voting against remuneration policies were adding to public and governmental pressure to address executive remuneration.

Despite the many voices discussing the issue of executive pay, agreement between investors and boards on how to address the issue is less forthcoming2. Most companies are using best practice mechanisms such as LTIPs, long-term vesting and holding periods, and clawback provisions in their executives’ remuneration. At the same time according to the Financial Times, one in ten of the UK’s top 100 companies are reconsidering LTIPs and moving towards simpler share-based bonuses3 despite the government going quiet on its green paper proposals on increasing reporting requirements and simplification of the long-term incentive models4.

There are two important ideas for good governance on remuneration: clear reporting and transparent engagement.

Clear, concise and connected

The remuneration report should be clear and concise – similar to the rest of the annual report. Our 2016 Corporate Governance Review found that although 90% of the FTSE 350 include a clear remuneration policy, they are not concise enough. The average remuneration report is 18 pages long and continues to grow as reporting on pay gets more complicated. Remuneration committees should be leading the charge and working to make the policies and reporting requirements simpler.

A lack of clarity around the connection between performance, reward and strategy is one of the key reasons for shareholder dissent on the advisory vote. Explaining the links between strategy, KPIs and director’s remuneration can be difficult, but it provides meaningful insight into executive incentives and supports the long-term sustainability of a business.

The power of engagement

Three years after the new disclosure and voting on director pay5, it is more important than ever to ensure good governance through engagement and transparency between shareholders and boards.  

The current advisory vote system gives power to shareholders that, in many cases, provides an effective feedback loop. We see this in our research too - companies who face a dissenting remuneration vote are likely to respond to shareholder concerns in the following year’s report and expand in their explanations of shareholder engagement.

There is room for improvement; last year only 13% of the FTSE 350 stated in their annual report that their non-executive directors (NEDs) - which would include remuneration committee chairs - met with shareholders in person. And 43% said their NEDs made themselves available to meet with shareholders but no meetings occurred. Where shareholders are not exercising this control, this may relate more to engagement rather than deficiencies in the regulations.

Things to consider

  • Is it clear how the remuneration strategy connects to company strategy and purpose?
  • Is the remuneration strategy appropriate for the company’s industry, strategy and stage in the lifecycle?
  • Is executive remuneration proportional or connected to employee pay?
  • Who is involved? Does the remuneration committee engage remuneration consultants?
  • Are the CEO, CFO and Head of HR engaged in the process for setting remuneration for other directors? These relationships are a crucial part of the role of the remuneration committee, and should be thought through and reported on.
  • Good remuneration policies do not necessarily have to fit UK corporate governance norms, but they do have to be appropriate to the business. The remuneration policy should explain clearly why the policy is the best suited for the company.

It appears that changes on corporate pay are not on government's agenda for now, however, public pressure remains significant.

Overall pay should be proportional and focused on the long-term, the board should regularly engage with shareholders and other stakeholders on pay, and the report should be clear and concise.

References

  1. Grant Thornton: 2016 Corporate Governance Review
  2. Financial times: How paying chief executives less can help corporate performance   
  3. Financial times: Backlash spurs blue-chips to rethink pay plans
  4. GOV.UK: Corporate governance reform
  5. Legislation.gov.uk: The Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013