The Principles of Remuneration sets out guidance for remuneration committees on applying the IA’s principles and this year’s publication states from the outset that stakeholder interest in remuneration shows no signs of abating and will come into even sharper focus as a result of the differential effects that the cost-of-living crisis will have on those across income distribution.

The Investment Association advises that, “as companies and their Remuneration Committees seek to navigate this period, shareholders continue to expect that they balance the need to reward and incentivise management whilst reflecting the experiences and expectations of their wider stakeholders, and in particular employees”.

General guidance

Guidance in relation to executive directors’ pay has largely remained the same.

However, for non-executive directors, updated guidance is that their fees should reflect “the time commitment of their role on the Board and its sub-committees, and the scope and complexity of their role(s)”, and that any increases should also be properly justified.

Fixed remuneration

Given the costs of living backdrop, the IA guidance expects that executive salaries should not be increased at a rate greater than inflation or than the level for other employees without careful consideration or justification with regard to the wider employment context for that company. If base pay for executives does increase more so than for the wider workforce, companies should fully disclose its reasons for doing so. The IA also recommends that salaries are not set solely according to “market-level” or in line with peers and competitors, this being cited as a key reason for spiralling pay figures.

Members also expect that pension contribution rates for directors should be aligned with the rate given to the company’s workforce. Companies are expected to disclose the rate given to the majority of their workforce and how this rate has been calculated—for example, whether it is the average of all employees or the rate offered to new employees. The Financial Reporting Council may pick up on and query any misalignment in its annual review and regulatory role.

Variable remuneration

Members expect companies to be conservative with any increases in variable pay. In terms of annual bonuses, the IA has noted an increasing trend for using strategic targets and/or personal objectives, but its expectation is that most of the bonus should be tied to financial metrics, and any personal objectives should be linked to long-term value creation. Any changes to long-term incentives are expected to be fully justified and subject to prior approval from shareholders.

Expected falls in share price also raise the issue of windfall gains in relation to long-term incentive plan grants. Remuneration committees are expected to review the grant level and scale back awards where there have been reductions in the share price, in order to avoid executives benefitting from the lower share price. Committees are expected to explain to shareholders their consideration of potential windfall gains and the rationale behind their decisions, including if no adjustments are made.

ESG metrics

The guidance notes the increasing importance of managing ESG risks to the long-term strategy and value of companies.

It is recommended that committees should consider whether management of these risks should be included as performance conditions for variable remuneration. Any metrics should be quantifiable, have a clearly explained method of performance, and be linked to company strategy.

Next steps:

The IA expects the interest in remuneration from members, shareholders and wider stakeholders to only continue to grow in the wake of various drivers of economic uncertainty. These include the impacts of the COVID pandemic, the invasion of Ukraine, high levels of inflation and the cost-of-living crisis.

In this context, a focus on income distribution and widening inequality is expected to heighten, with executive remuneration becoming a key indicator for the state of corporate governance generally. The IA therefore recommends even greater restraint and sensitivity in 2023, and anticipates that most companies will seek shareholder approval for their remuneration policies.

Further information:

Click here for a copy of the IA’s Principles of Remuneration 2023.

Click here for a copy of the IA’s letter to remuneration committee chairs of FTSE 350 companies.

See “QCA findings on the role of non-executive directors” in White & Case’s third briefing for further insights from the Quoted Companies Alliance’s survey on non-executive directors.

This article was produced in association with White & Case UK’s Public Company Advisory team. Read their original alert here.