Executive pay – beware your remuneration approach for 2023

United Kingdom

Employment law
ESG
Financial services

25-11-2022

Stakeholder pressure for fair pay in the current economic climate is increasing, with the “S” of ESG firmly on the agenda

What do stakeholders and investors want to see in 2023 remuneration policies?

The Investment Association (IA) recently published its updated Principles of Remuneration for 2023, highlighting key areas it believes Remuneration Committees (RemCos) should focus on in the forthcoming AGM season. These include:

being mindful of widening inequality of pay and excessive awards at a time when employees are struggling financially;
aligning the pension contributions of executive directors with the workforce; and
guidance on the use of ESG metrics.

Specific recommendations

The IA’s recommendations are aimed primarily at companies with a main market listing but also those listed on other public markets such as AIM. The IA’s letter to RemCo Chairs considers that companies should:

in light of macroeconomic challenges, adopt a sensitive approach to executive pay (as was required during the COVID pandemic). This means incentivising performance whilst ensuring executives’ experiences are commensurate with shareholders, employees, those affected by the cost of living crisis, vulnerable customers, suppliers and other major stakeholders;
clearly communicate their approach to shareholders;
not follow the IA’s general principle that executive pay should be limited to inflation or the pay rise of employees, but instead show additional restraint on executive director salary increases “if they are needed”, in light of the cost of living crisis and the potential impact increases might have on the whole workforce;
show restraint on increases in variable pay and allow for flexibility and discretion on performance targets;
carefully consider reducing vesting outcomes relating to performance in 2020 if they result in windfall gains;
ensure any ESG metrics are linked to company strategy, are quantifiable, and avoid unnecessary complexity; and
ensure pension contribution rates for executive directors are aligned to the majority of the workforce by the end of 2022.

Unsurprisingly, in the current economic climate and given the increased focus on ESG, the principles set out by the IA are similar to the issues that were raised in a letter to RemCo chairs from the Financial Conduct Authority in August 2022.

Reporting on executive pay – key link to ESG

It is clear that stakeholders believe that more could be done to address executive pay concerns.

The Financial Reporting Council’s (FRC) November 2022 Review of Corporate Governance Reporting under the UK Corporate Governance Code highlighted that there was work to be done in this area. On remuneration, the FRC’s key points/criticisms were:

Of 93 companies stating they engaged with shareholders, only 70 reported engagement on remuneration matters, with little explanation about how they take account of such feedback;
Over 70 companies received significant votes against remuneration-related resolutions (which may well be linked to the lack of engagement noted above);
ESG metrics in incentive schemes (which are increasingly including wider D&I targets), like any others, should be clearly linked to the company’s strategy, and as such companies should ensure they have explained weightings, level of achievement and how this translates into granted awards; and
Too many companies simply explained remuneration policies to the workforce without including detail about how executive pay aligns with the wider company pay policy, and there was little two-way dialogue.

Large private companies meeting a certain threshold (and not already subject to corporate governance reporting) must also disclose corporate governance arrangements in their directors’ reports. Many follow the Wates Corporate Governance Principles. In February this year, the FRC’s first in-depth assessment of large company reporting found that general information on remuneration was good, but information on companies’ rationale for remuneration structures was lacking, as was consideration of risks regarding remuneration levels and pay ratios (either through compulsory CEO pay ratio information, or through the use of disclosed pay ratios).

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