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Coronavirus - Executive pay and rewards - UK

  • United Kingdom
  • Coronavirus - Workforce issues
  • Employment law
  • Financial services

07-05-2020

Coronavirus and executive pay: the issues

The COVID-19 pandemic has prompted an economic crisis that has far surpassed that of the financial crash in 2008.

The implications for executive pay against the backdrop of furloughed staff, lay-offs, staff pay freezes, temporary part time working and redundancies are significant and media reports have unsurprisingly focused on the disparity between senior executive pay awards and their employees who rely on government support and public money under the Coronavirus Job Retention Scheme (CJRS).

On 31 March 2020 the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) wrote to systemically important deposit-takers and insurers urging restraint with regard to dividends and variable remuneration. Additionally, the Investment Association (IA) has produced guidance to UK listed companies on shareholder expectations on executive pay and how remuneration committees should reflect the impact of COVID-19 on executive pay.

Whilst recognising that a one-size-fits-all approach is unlikely to suit all firms, it is clear that firms should take a number of considerations into account in their approach towards whether or not to (and if so, by how much) adjust executive pay and rewards.

Variable pay during the COVID-19 pandemic: what guidance is there?

On 31 March 2020 the European Banking Authority (EBA) issued a statement on dividends distribution, share buybacks and variable remuneration in light of COVID-19, urging banks to act prudently. The EBA asked competent authorities to request banks to review their remuneration practices, policies and awards to reflect the current economic situation. In particular, variable remuneration should be set at a ‘conservative’ level. The EBA states:

To achieve an appropriate alignment with risks stemming from the COVID-19 pandemic a larger part of the variable remuneration could be deferred for a longer period and a larger proportion could be paid out in equity instruments.

The PRA and the FCA accordingly wrote to seven systemically important banks asking them to confirm that they would not pay any cash bonuses to senior staff, including all material risk takers, and that they would take appropriate further action over the coming months with regard to the accrual, payment and vesting of variable remuneration. Whilst addressed to the larger banks, the regulators’ recommendations set an approach that should be taken into account by other financial institutions, in light of their own particular circumstances.

The IA guidance reminds U.K. listed companies of the IA Principles of Remuneration and sets out guidelines on when and how to adjust executive variable remuneration. It notes that the issue of remuneration is a tricky one; there is a need to balance incentivisation of executive performance at a time of great stress whilst ensuring the ‘executive experience’ is in line with that of shareholders, employees and other stakeholders. In light of this, shareholders will expect remuneration committees to consider the use of discretion or malus provisions to reduce any deferred shares relating to the 2019 annual bonus. Alternatively, this should be fully reflected in the FY2020 bonus outcomes. You can read more about the IA guidance in our briefing.

Firms seeking to apply the guidance will need to ensure that their remuneration policies and plans contain sufficient flexibility to comply with the recommendations and should take care not to effect any breach of contract when freezing variable pay or making other downward adjustments.

COVID-19: how can executive pay affect your reputation?

Investor and public perceptions are key and decisions on executive remuneration will be scrutinised to ensure that they are aligned with business decisions about the wider workforce and the interests of the company.

Executive pay has symbolic value and is often reported on in negative terms in the media, particularly in light of comparisons with median worker pay rates. In times of crisis, those at the top are expected to share the burden of falling profits.

The High Pay Centre published a report in April 2020 ‘How are UK-listed companies responding to the economic shutdown?’ urging restraint on pay and dividends. Whilst financial institutions have generally not participated in the government’s CJRS, doubt is cast on the probity of those firms that receive public money and continue to reward senior executives.

Indeed, Hans Cristoph Hirt, head of stewardship and engagement at the corporate governance firm Federated Hermes, set out his expectations on executive pay against the rising backlash against what are perceived to be excessive rewards at the top:

Management remuneration should be appropriately aligned with the experience of the wider workforce and society and adjusted taking a company’s circumstances into consideration.

The asset manager Schroders also wrote to U.K. companies urging chief executives to ‘share the pain’. However, the fact that many pay awards vesting now relate to earlier more profitable years will not necessarily soften the perception that those at the top are not sharing the burden with the workforce.

CEO pay ratios and governance

As if media attention were not robust enough at this time, firms required to report on CEO pay ratios under the Companies (Miscellaneous Reporting) Regulations 2018 will be under particular scrutiny. Investors in particular will be examining executive pay structures and excessive pay gaps will not wear well with them. Indeed, the International Corporate Governance Network published an open letter on 23 April 2020 advising firms that executive pay should reflect the experience of the overall workforce, including pay level reductions or bonus awards:

Even for managers performing capably during this crisis, the priority to preserve a company’s long-term financial health must take precedence over bonus considerations.

Remuneration policies should therefore seek to treat all staff and senior executives equitably and appropriately share financial sacrifice. More generally, the Financial Reporting Council (FRC) guidance asks remuneration committees to consider: ‘How do workforce incentives support our culture and encourage the desired behaviours?’. This will entail a holistic look at incentives across the workforce to ensure that incentives are aligned and reflect current circumstances.

Reporting figures under the 2018 Regulations will reflect the financial year beginning on or after 1 January 2019 and first reporting is in 2020. It is expected that firms reporting under the 2018 Regulations will need to provide clear and meaningful explanations, particularly as, due to the nature of variable pay, performance-related bonuses may be received some time after they are ‘earned’.

Clearly, the publication of what may be perceived to be a significant pay gap between a CEO and their average worker at a time of great crisis would be problematic for stakeholders and the wider public. A commitment to reduce executive pay in FY2020 in the narrative to the CEO pay ratio report may alleviate any backlash, where decisions on pay have already been taken.

What are other firms doing and what should we be doing and when?

According to the High Pay Centre estimates, 37% of FTSE 100 companies and 31% of FTSE 250 companies have reduced executive pay.

Cuts to CEO salaries of between a third and a fifth are most common. Only 13% of firms have cancelled or reduced bonus or long-term incentive payments (LTIPs), although many firms have of course adopted a ‘wait-and-see’ approach. The High Pay Centre has expressed its surprise that at the time of its report, only a third of the UK’s leading companies had restrained executive pay although many firms are still making decisions on variable remuneration and dividends.

As to the ‘when’, decisions will depend to a large extent on how significantly firms have been affected by the crisis to date and what the future looks like. Importantly, where steps are being taken to cut pay or shed staff, executive pay policies should be aligned with current workforce measures.

Remuneration committees are urged to look at executive pay in the light of what is happening with the company’s workforce and consider whether payments or grants of LTIPs should be reduced or deferred, whether malus or clawback should be applied (and checking whether these provisions are robust enough) and whether cash bonuses should be reduced or cancelled. Separately, communication with stakeholders (including the workforce) and clear, consistent messaging is key to minimising the risk of negative press. The problem with a ‘wait-and-see’ approach is that it will not be well received if any impact to the rest of the workforce is imminent.