COVID-19 “expectations”

The IA’s COVID-19 guidance is direct in its approach. It both reiterates the themes of the April guidance and updates them. The guidance can be accessed here but in summary says:

• Other than in truly exceptional circumstances, The IA’s members think no bonus should be payable for the financial year 2020 or 2020/21 where a company has raised capital or sought Government support. Companies should be even more mindful than usual of the broader employee context: “….variable pay outcomes for executive directors may lead to workforce morale or productivity issues and also have significant reputational ramifications.”
• Remuneration Committees should show how they have taken indirect Government support such as business rate relief into account for the relevant tax years. The IA also makes clear that its members expect the suspension or cancellation of dividends to be factored into the 2020 annual bonus decision and its members want to know how decisions on remuneration overall for 2019 and 2020 have reflected dividend policy. They mention for example the exercise of malus provisions in respect of deferred bonus linked to the 2019 financial year or deduction from any subsequent out-turn.
• Performance targets should not be adjusted either for annual bonus or long-term awards and The IA expects Remuneration Committees to explicitly disclose that they have not done so. Where performance targets are, in their view, exceptionally, adjusted in the middle of the performance period, The IA encourages Remuneration Committees to engage with shareholders and disclose the reasons.
• The IA’s members do not want to see the cancellation of long-term awards or increases in variable pay to compensate for reduced pay as a result of COVID-19.
• Restraint in respect of base salaries is expected and The IA remains concerned about incremental increases to both base and variable pay.
• It is accepted that more discretion will be needed in respect of annual bonus outturns for the 2021 year and this should be matched with much greater transparency in respect of the way in which targets have been set (particularly important where the targets are lower). If pay outs are made under non-financial elements only, greater disclosure will be expected.  If bonuses are paid a higher portion of the bonus should be deferred into shares.
• Enhanced disclosure expectations will also apply when companies have made adjustments to variable pay performance measures as a result of exceptional circumstances such as rent concessions or waivers. The IA’s members want to see explicit disclosure as to what has been included/ excluded and the rationale.
• Remuneration Committees should disclose how they will assess windfall gains arising from long-term incentive awards granted in 2020 and, where the share price had fallen, also to disclose if the face value of awards has been reduced. Looking ahead, Committees should be “proactive” about reducing awards on grant. This applies as much to restricted share awards as it does to performance shares.
• The IA is expecting that where companies adopt targets with reduced growth rates and wider performance ranges, Remuneration Committees disclose the process of their decision making. The IA also emphasises heavily the need for Remuneration Committees to know what discretions they have in terms of pay outcomes and to commit to using them to ensure company performance and pay outcomes are aligned.
• Companies which are seeking to make major changes to their Directors’ Remuneration Policies may wish to wait given the uncertainties of the pandemic but changes aimed at aligning the policy with good governance should still be addressed such as those relating to post-cessation shareholding requirements, bonus deferral arrangements and malus and clawback provisions.

FIT’s view: In many ways, the updates provide a good illustration of the issues facing Remuneration Committees over the coming months.  Striking a balance between the interests of different stakeholders will rarely have been more difficult.

In our experience, the overwhelming majority of Remuneration Committees seek to do the right thing and will be sympathetic to the concerns of investors.  However, it is to be hoped that these guidelines will be applied with a degree of pragmatism. 

For example, many companies renewed their remuneration policies at the 2020 AGM season and, as part of this introduced pension alignment for incumbent executives.  Consistent with the guidelines then in force, this often involved reducing rates below 25% immediately and committing to reduce to the relevant all-employee rate from January 2023.  The new guidelines suggest that the rate should be tapered down over this period (e.g. 15% in 2021, 10% in 2022 and the all-employee rate in 2023).  It is one thing to expect companies which did not do this to now be assessed against a tougher standard.  However, the guidelines do not appear to draw a distinction between companies which have made such commitments and those which do not. In our view, it is likely to be counter-productive, in the context of low variable pay and numerous companies still applying salary waivers, to reopen something already settled in good faith.

A key element of this year’s remuneration reports will be the need for additional context for decisions taken.  Based on recent consultations, shareholders are likely to be supportive in the above example. 

While many companies may not expect to pay their directors bonuses for 2020, a number will take the view that some element of bonus has been well and truly earned and will wish to pay it out.  The IA is also encouraging companies to reduce 2021 LTIP grant levels (rather than retain the typical 2020 approach of granting the full multiple of salary but indicating that ultimate vesting may be reduced to avoid windfalls).  There is likely to be a difficult balance for Remuneration Committees to strike as, in our experience, many executives are prepared to accept low out-turns for 2020, and to accept that in-flight awards will lapse, but they will be less content if, even from the outset, 2021 LTIP awards which are all about future performance have been materially reduced. 

While The IA’s request for companies to “show us your workings” is not unreasonable, it may be more difficult to expect wholesale conformity to all their COVID-19 expectations. We can only hope that their members will adopt a more pragmatic approach in practice as most companies, in our experience, are trying to strike an appropriate balance in the interests of all stakeholders.