Guidance for Remuneration Committees
The following guidance is set out to help Remuneration Committees apply the ABI
Principles of Remuneration and ensure a proper level of shareholder protection.
Fixed elements of Remuneration
BASE PAY
Base pay should be set at a level which reflects the role and responsibility of
the individual, whilst respecting the principle of paying no more than is necessary.
Where Remuneration Committees seek to increase base pay the reasons should be fully
disclosed and justified. Salary decisions should not be taken purely on the basis
of simple benchmarking against peer companies. If benchmarking is used, the aim
should not solely be to match the “median” but to provide a point of reference for
determining the appropriate salary for the specific job. The constant chasing of
a perceived median has been a major contributor to the spiralling levels of pay.
Remuneration Committees should also be aware of the multiplier effect that increases
in base pay have on the overall quantum of remuneration.
PENSIONS
Pension provision can represent a considerable cost to the company and this should
be recognised by the Remuneration Committee when considering total executive remuneration.
Pension related payments should not be used as a mechanism for increasing total
remuneration. The pension provision for the executives should where possible be
in line with the general approach to the employees as a whole.
Payments in lieu of pension scheme participation should be clearly disclosed and
treated as a separate non-salary benefit. There should be informative disclosure
identifying incremental value accruing to pension scheme participation and any other
superannuation arrangements.
Changes in pension benefit entitlements or to transfer values reflecting significant
changes in actuarial and other relevant assumptions should be fully identified and
explained. Where changes to pension benefit entitlements or transfers are made at
the discretion of the Remuneration Committee, these should be made clear and justification
should be provided. Pensions paid on early retirement should be subject to abatement.
BENEFITS
Benefits should be fully disclosed and where significant the Remuneration Committee
should view them as an integral cost of fixed remuneration.
Variable elements of remuneration
Shareholders believe that a significant proportion of executive remuneration should
be performance related, and tied to the achievement of the agreed corporate strategy
and long-term value creation.
No element of variable pay should be pensionable.
ANNUAL BONUSES
Annual bonuses should incentivise performance and reward achievement in line with
the agreed corporate strategy.
Annual bonuses should exist to reward contribution to the business during the year
above the level expected for being in receipt of a salary. They should be clearly
linked to business targets, ideally through the KPIs reported in the Enhanced Business
Review. Where other measures are chosen these should be explained and justified.
The KPIs can be both financial and non-financial. The measurements chosen should
be quantifiable and the targets chosen should be set at the start of the year. The
performance measures and targets should be publicly disclosed. If the targets are
considered to be commercially sensitive they should be disclosed retrospectively.
Shareholders discourage the payment of annual bonuses to executive directors if
the business has suffered an exceptional negative event, even if some specific targets
have been met. In such circumstances shareholders should be consulted on bonus policy
and any proposed payments should be carefully explained.
Shareholders believe that companies should clearly disclose and justify the performance
measures chosen and the related targets. Where consideration of commercial confidentiality
may prevent a fuller disclosure of specific short-term targets at the start of the
performance period, shareholders expect to be informed of the main performance parameters,
both corporate and personal, for the financial year being reported on.
Following payment of the bonus, shareholders will expect to see a full analysis
in the Remuneration Report of the extent to which the relevant targets were actually
met.
Maximum participation levels should be disclosed and any increases in the maximum
from one year to the next should be explicitly justified.
Deferring a portion of the bonus into shares can create a greater alignment with
shareholders. However, this should not result in an increase in the overall quantum
of the bonus.
LONG TERM INCENTIVES
Long-term incentives exist to reward the successful implementation of strategy and
the creation of shareholder value over a period appropriate to the strategic objectives
of the company. Shareholders have a strong and clear preference for financial metrics
linked to value creation to be used in long-term incentive structures; where any
metric is non-financial, it should be quantifiable, linked to value creation and
disclosed. Performance measures and vesting conditions should be fully explained
and be clearly linked to the achievement of appropriately challenging financial
performance which will lead to enhancement of shareholder value.
Equity based long-term incentive schemes are the most effective way to align the
interests of participants and shareholders.
All new incentives or any substantive changes to existing schemes should be subject
to prior approval by shareholders by means of a separate and binding resolution.
Any change in quantum should be fully explained and justified.
Scheme and individual participation limits must be fully disclosed in share incentive
schemes.
The operation of share incentive schemes should not lead to dilution in excess of
the limits acceptable to shareholders.
Windfall gains may arise if the level of share or option grants expressed as a multiple
of salary is maintained after a substantial fall in the share price. Where this
risk exists, grants should be scaled back.
Retesting of performance conditions is not acceptable.
Performance driven vesting criteria can incorporate a combination of absolute and
relative return targets, and a linkage with shareholder returns.
Remuneration Committees should satisfy themselves that when using in isolation either
comparative or absolute performance metrics the result does not produce outcomes
that are not in line with the overall performance of the company, its future prospects
or the experience of its shareholders over the performance period.
Alignment and outcomes
QUANTUM
Quantum of remuneration is a matter of concern to shareholders. Levels of pay that
do not reflect corporate performance undermine the ability to reward success and
represents excess rent extractions. It is the responsibility of the Remuneration
Committee to ensure that the quantum of executive compensation is appropriate. Shareholders
are likely to object to levels of pay that do not respect the core principles of
paying no more than is necessary and a linkage to sustainable long-term value creation.
In fulfilling this responsibility, the Remuneration Committee should seek specific
points of reference against which the appropriateness of quantum can be judged.
Useful reference points, which should help avoid unnecessary disagreements with
shareholders, include:
- A stated policy that links aggregate remuneration to overall corporate performance.
High pay for exceptional performance is consistent with this approach.
- The remuneration policy of the company as a whole. Remuneration Committees should
assess the appropriateness of changes in the quantum of executive remuneration in
the context of the company overall, including changes in employee remuneration more
broadly.
- A relevant and fairly constructed peer universe. It is undesirable simply to use
“median” pay as a benchmark since this, if used broadly, can lead to ratcheted increases
in remuneration.
It is unacceptable that poor performance by senior executives, which detracts from
the value of an enterprise and threatens the livelihood of employees, can result
in excessive payments to departing directors. Payment for failure cannot be tolerated.
Boards have a responsibility to ensure that this cannot occur both when negotiating
new contracts and when agreeing any payments when contracts are terminated.
EXECUTIVE SHAREHOLDINGS
Executive directors and senior executives should build up significant shareholdings
in companies. Unvested share based incentives should not be allowed to count towards
the holding requirements and these requirements are not a substitute for performance
metrics under share based plans.
NON-EXECUTIVE SHAREHOLDINGS
Shareholders encourage non-executive directors to own shares in the company. Chairmen
and non-executives may receive part of their fees in shares bought at market price.
However, shareholders consider it inappropriate for chairmen and independent directors
to receive incentive awards geared to the share price or corporate performance that
would impair their ability to provide impartial oversight and advice.
DISCRETION
Discretion can help Remuneration Committees to ensure that the outcomes of executive
pay schemes properly reflect overall corporate performance and the experience of
the shareholders in terms of value creation.
Shareholders expect that discretion should be exercised diligently and in a manner
that is aligned with shareholders’ interests.
The use of discretion should be clearly disclosed. Remuneration Committees will
be held accountable for the way discretion is used.
Discretion should only be exercised within the previously agreed boundaries and
maxima. If these are exceeded then shareholders will consider excessive payments
to be ex gratia in nature.
SPECIAL AWARDS AND EX GRATIA PAYMENTS
Special or one-off awards are not generally favoured. Effective remuneration planning
involving a balance of short and long term plans, carefully selected and calibrated
performance measures and targets, and annual grants, should make exceptional awards
unnecessary. A need for special grants, particularly for continuing management,
indicates poor planning by the Remuneration Committee. Special awards may be acceptable
when, for example, a new team is brought in to turn around a company. When such
awards are made the Remuneration Committee must justify them.
Experience has shown that retention awards for main board directors rarely work.
Retention concerns on their own are not sufficient grounds for remuneration to increase.
Shareholders are not supportive of the practice of paying transaction related bonuses.
CLAWBACK AND MALUS
The inclusion of clawback and malus provisions in scheme designs and executive contracts
is a recognised way to prevent executives receiving rewards that are undeserved.
Shareholders expect to see such provisions included in relevant arrangements and
for them to be enforced when appropriate.
PAY FOR EMPLOYEES BELOW BOARD LEVEL
The Remuneration Committee should be cognisant of pay and conditions elsewhere in
the Group and take them into account when determining executive remuneration.
The Committee may have a role in determining pay or having oversight of remuneration
at below board level. This is of particular relevance where the levels of remuneration
or the risks associated with the activities involved are material to the Group’s
overall performance.
TAXATION
Remuneration committees should not seek to make changes to any element of executive
remuneration to compensate participants for changes in their personal tax status.
Remuneration structures that seek to increase tax efficiency should not result in
additional costs to the company or an increase in its own tax bill. Remuneration
Committees should be aware of the potential damage to the company’s and shareholders’
reputation from implementing such schemes.
CONTRACTS AND SEVERANCE
Companies should follow the Principles and Guidance contained within the ABI and
NAPF Statement on Executive Contracts and Severance and the UK Corporate Governance
Code. The Statement is available at:
http://www.ivis.co.uk/ExecutiveContractsAndSeverance.aspx
Appendix 1 - Additional Guidance
The following guidance may help remuneration committees when implementing remuneration
policies and structures.
PERFORMANCE CONDITIONS AND VESTING
Remuneration Committees should choose performance criteria that are linked to long-term
value creation.
The definition and calculation of any performance measurement should be clearly
disclosed.
It should fully reflect the performance of the business as a whole and should be
applied consistently across measurement periods.
The setting of a premium exercise price is not a substitute for performance conditions
in accordance with this Guidance
Total Shareholder Return (TSR) relative to a relevant index or peer group is one
of a number of generally acceptable performance criteria. However, Remuneration
Committees should satisfy themselves prior to vesting that the recorded TSR or other
criterion is a genuine reflection of the company’s underlying financial performance,
and explain their reasoning.
The calculation of starting and finishing values for TSR should be made by reference
to average share prices over a short period of time at the beginning and end of
the performance period. Lengthy averaging periods should be avoided. Where TSR is
used as a performance criterion and the chosen comparator group includes companies
listed in overseas markets, it is essential that TSR be measured on a consistent
basis. The standard approach should be for a common currency to be used. Where there
are compelling grounds for the calculation to be based on local currency TSR of
comparator group companies, then the reasons for choosing this approach should be
fully explained.
Threshold vesting amounts should not be significant by comparison to annual base
salary. Furthermore, award structures with a marked ‘cliff-edge’ vesting profile
are considered inappropriate, particularly where there may be clustering of performance
outcomes around the average.
Full vesting should be dependent upon achievement of significantly greater value
creation than that applicable to threshold vesting.
Sliding scales are a useful way of ensuring that performance conditions are genuinely
challenging. They generally provide a better motivator for improving corporate performance
than a ‘single hurdle’.
Comparator groups used for performance purposes should be both relevant and representative.
Where only a small number of companies are used for a comparator group, Remuneration
Committees should satisfy themselves that the comparative performance will not result
in arbitrary outcomes. Awards should not vest for less than median performance.
COST
The primary information that should be disclosed includes:
- The potential value of awards due to individual scheme participants on full vesting.
This should be expressed by reference to the face value of shares or shares under
option at point of grant, and expressed as a multiple of base salary.
- The maximum dilution which may arise through the issue of shares to satisfy entitlements.
MEASUREMENT OF THE PERFORMANCE PRE-GRANT
Shareholders expect that future performance should govern the vesting of options
or share awards. Measuring performance achieved prior to the point of grant is generally
not considered a suitable alternative.
CHANGE OF CONTROL PROVISIONS
Scheme rules should state that there will be no automatic waiving of performance
conditions either in the event of a change of control or where subsisting options
and awards are ‘rolled over’ in the event of a capital reconstruction, and/or the
early termination of the participant’s employment. Remuneration Committees should
use best endeavours to provide meaningful disclosure that quantifies the aggregate
payments arising on a change of control.
In the event of a change of control, the key determinant of the level of awards
vesting should be underlying financial performance. Also, any such early vesting
as a consequence of a change of control should be on a time pro-rata basis i.e.
taking into account the vesting period that has elapsed at the time of change of
control. Remuneration Committees should satisfy themselves that the measured performance
provides genuine evidence of underlying financial achievement over any shorter time
period. They should explain their reasoning in the Remuneration Report or other
relevant documentation sent to shareholders.
PRICING AND TIMING OF AWARDS
The price at which shares are issued under a scheme should not be less than the
mid market price (or similar formula) immediately preceding grant of the shares
under the scheme.
Options granted under executive (discretionary) schemes should not be granted at
a discount to the prevailing mid-market price.
Repricing or surrender and regrant of awards or ‘underwater’ share options is not
appropriate
The rules of a scheme should provide that share or option awards should normally
be granted within a 42 day period following the publication of the company’s results.
LIFE OF SCHEMES AND INCENTIVE AWARDS
No awards should be made beyond the life of the scheme approved on adoption by shareholders,
which should not exceed 10 years.
Shares and options should not vest or be exercisable within three years from the
date of grant. In addition, options should not be exercisable more than 10 years
from the date of grant.
Where individuals choose to terminate their employment before the end of the service
period, or in the event that employment is terminated for cause, any unvested options
or conditional share-based award should normally lapse.
In other circumstances of cessation of employment[1], it is to be expected
that some portion of the award will vest, to the extent of the service period that
has been completed but subject to the achievement of relevant performance criteria.
In general the originally stipulated performance measurement period should continue
to apply. However, where in the opinion of the Remuneration Committee, early vesting
is appropriate, or where it is otherwise necessary[2], awards should
vest by reference to performance criteria achieved over the period to date.
Where options vest, in the event of death or cessation of employment of the option
holder or where a company is taken over (except where arrangements are made for
a switch to options of the offeror company), or where they have already vested at
the time of such event, they must be exercised (or lapse) within 12 months. Where
the performance measurement period applicable to an option extends beyond the point
of cessation of employment options must be exercised within 12 months of vesting
following the end of the performance measurement period.
Any shares or options that a company may grant in exchange for those released under
the schemes of acquired companies should normally be taken into account for the
purposes of dilution and individual participation limits determined in accordance
with this Guidance.
[1]Such circumstances may include disability, ill health, redundancy,
retirement or analogous reasons for departure of a ‘good leaver’ nature.
[2]Such circumstances may include death and also occasions such as takeover
of the company or sale or transfer of the business undertaking where awards are
not being rolled over into equivalent awards in the successor entity or new employer.
JOINT VENTURE COMPANIES AND SUBSIDIARY COMPANIES
Shareholders generally consider it undesirable for options and other share-based
incentives to be granted over the share capital of a joint venture company.
Discretionary grants over shares of a subsidiary company should only be made in
exceptional circumstances. Where companies can justify doing so in terms of contribution
to overall value creation, shareholders may consider exceptions subject to the following:
- Participation in subsidiary company schemes is restricted to those whose time is
fully allocated to that subsidiary. Parent company directors should not participate
in such schemes.
- There is full disclosure of the accounting treatment used when recognising the cost
of option or share awards.
- Grants of options or share awards are subject to appropriately challenging performance
criteria.
- Dilution limits relating to the subsidiary company should be disclosed in the context
of parent company dilution limits.
- The methodology for valuing the subsidiary company shares and in the case of option
awards the measurement of volatility of those shares should be disclosed. The party
responsible for the valuation process should also be disclosed.
- Any entitlement or obligation to convert subsidiary company shares to parent company
shares should be disclosed.
Shareholders may consider further exceptions where the condition of exercise is
subject to flotation or sale of the subsidiary company. In such circumstances, grants
should be conditional so that vesting is dependent on a return on investment that
exceeds the cost of capital and that the market value of the shares at date of grant
is subject to external validation.
Exceptions will apply in the case of an overseas subsidiary company where required
by local legislation, or in circumstances where at least 25% of the ordinary share
capital of the subsidiary company is listed and held outside the group.
DILUTION
The rules of a scheme must provide that commitments to issue new shares or re-issue
treasury shares, when aggregated with awards under all of the company’s other schemes,
must not exceed 10% of the issued ordinary share capital (adjusted for share issuance
and cancellation) in any rolling 10 year period. Remuneration Committees should
ensure that appropriate policies regarding flow-rates exist in order to spread the
potential issue of new shares over the life of relevant schemes in order to ensure
the limit is not breached.
Commitments to issue new shares or re-issue treasury shares under executive (discretionary)
schemes should not exceed 5% of the issued ordinary share capital of the company
(adjusted for share issuance and cancellation) in any rolling 10 year period. This
may be exceeded where vesting is dependent on the achievement of significantly more
stretching performance criteria. The implicit dilution commitment should always
be provided for at point of grant even where, as in the case of share-settled share
appreciation rights, it is recognised that only a proportion of shares may in practice
be used.
ESOTs AND ALL-EMPLOYEE SCHEMES
Employee Share Ownership Trusts - ESOTs
ESOTs should not hold more shares at any one time than would be required in practice
to match their outstanding liabilities, nor should they be used as an anti-takeover
or similar device. Furthermore an ESOT’s deed should provide that any unvested shares
held in the ESOT shall not be voted at shareholder meetings. The prior approval
of shareholders should be obtained before 5% or more of a company’s share capital
at any one time may be held within ESOTs.
Where companies have provided for an ESOT to be used to meet scheme requirements,
they should disclose the number of shares held by the ESOT in order to assist shareholders
with their evaluation of the overall use of shares for remuneration purposes. The
company should explain its strategy in this regard.
All-Employee Schemes
All-Employee schemes, such as SAYE schemes and Share Incentive Plans (SIPs) - (formerly
known as AESOPs), should operate within an appropriate best practice framework.
If newly issued shares are utilised, the overall dilution limits for share schemes
should be complied with. The Guidance relating to timing of grants (except for pre-determined
regular appropriation of shares under SIPs) applies.
Appendix 2 - Schedule A of the UK Corporate Governance Code[3]
SCHEDULE A THE DESIGN OF PERFORMANCE-RELATED REMUNERATION FOR EXECUTIVE DIRECTORS
The remuneration committee should consider whether the directors should be eligible
for annual bonuses. If so, performance conditions should be relevant, stretching
and designed to promote the long-term success of the company. Upper limits should
be set and disclosed. There may be a case for part payment in shares to be held
for a significant period.
The remuneration committee should consider whether the directors should be eligible
for benefits under long-term incentive schemes. Traditional share option schemes
should be weighed against other kinds of long-term incentive scheme.
Executive share options should not be offered at a discount save as permitted by
the relevant provisions of the Listing Rules.
In normal circumstances, shares granted or other forms of deferred remuneration
should not vest, and options should not be exercisable, in less than three years.
Directors should be encouraged to hold their shares for a further period after vesting
or exercise, subject to the need to finance any costs of acquisition and associated
tax liabilities.
Any new long-term incentive schemes which are proposed should be approved by shareholders
and should preferably replace any existing schemes or, at least, form part of a
well considered overall plan incorporating existing schemes. The total potentially
available rewards should not be excessive.
Payouts or grants under all incentive schemes, including new grants under existing
share option schemes, should be subject to challenging performance criteria reflecting
the company’s objectives, including non-financial performance metrics where appropriate.
Remuneration incentives should be compatible with risk policies and systems.
Grants under executive share option and other long-term incentive schemes should
normally be phased rather than awarded in one large block. Consideration should
be given to the use of provisions that permit the company to reclaim variable components
in exceptional circumstances of misstatement or misconduct.
In general, only basic salary should be pensionable. The remuneration committee
should consider the pension consequences and associated costs to the company of
basic salary increases and any other changes in pensionable remuneration, especially
for directors close to retirement.
[3]Reprinted with kind permission of the Financial Reporting Council