Remuneration dominated the ‘Shareholder Spring’ of 2012. Since then, remuneration has undergone an evolution at both regulatory and voluntary levels.
In the UK, the National Association of Pension Funds (NAPF) and Hermes Equity Ownership Services (Hermes EOS), alongside the BT Pension Scheme, RPMI Railpen and Universities Superannuation Scheme (USS) Investment Management, published their Remuneration Principles in 2013, setting out a framework for companies to use when devising their remuneration policies. The five principles encourage companies to change their reward structures and promote better alignment of interest with their long-term owners through increased and longer-term shareholdings.
USS and other investors were also involved in the GC100 Investor Group, which helped formulate guidelines for the UK’s binding vote on remuneration, which came into force on 1 October 2013 – so Switzerland is not the only country where legislation on remuneration has come into force (see Mandatory say-on-pay in Switzerland).
“In a number of circumstances, the existing remuneration structures were not fit for purpose,” says Will Pomroy, head of corporate governance at the NAPF. “Shareholders lost out while executives were walking away with overly generous rewards. Therefore, the alignment of interests simply was not there. The new binding vote on pay has provided shareholders with increased rights to hold companies more accountable for having appropriate pay policies.”
But few investors have welcomed such legislative moves.
“Neither companies nor investors were particularly supportive of the introduction of the binding forward-looking remuneration policy vote in the UK,” says Daniel Summerfield, co-head of responsible investment at USS. “The challenge is to try to rationalise the different votes on remuneration that we are going to have to act on, such as retrospective advisory votes, forward-looking policy votes and the issuance of shares for long-term incentive plans. The binding vote is a solution to a problem that did not really exist because we already had all the tools we needed to take action on remuneration if we wanted to. A binding vote is unlikely to make a material difference to the way remuneration is assessed.”
Colin Melvin, chief executive at Hermes Equity Ownership Services (EOS), warns of the need to make sure companies do not respond by seeking to maintain the same overall level of pay by increasing compensation that is not part of the regulatory scrutiny, such as pensions and pension contributions. Meanwhile Carmine de Noia, deputy director general of think tank Assonime, goes as far as calling a binding vote on pay hypocrisy, especially in countries with concentrated company ownership, because the majority of shareholders would never vote against.
“Our empirical evidence has shown that the net effect of a binding vote is that companies will have a less transparent remuneration policy with fewer details,” he says.
In Italy, company boards and their independent colleges, which oversee them, have had to disclose the individual remuneration of their members since 1998.
“This allows shareholders to compare all the details of the remuneration package,” says di Noia. “Italian remuneration reports are made up of two parts – the recommendation policy ex-ante and the remuneration figures paid out over the past year. Until now we have had a non-binding vote on the first part, except for banks and insurance companies where it is binding, and no vote on the second part. A non-binding vote has a lot of impact when 5% of shareholders vote against a proposal.”
But John Wilcox, chairman at corporate governance advisory Sodali, points out that a binding vote has not led to micro management of compensation by shareholders, as feared.
“Instead it has led to more dialogue and engagement by shareholders,” he says. “We tell company clients to come up with a remuneration plan that suits their business needs. Any red flags that could possibly be opposed, either by proxy advisory firms or shareholders, on policy grounds will be raised by us. If they are perceived to be sufficiently important to company goals, we do an outreach to company shareholders and proxy advisory firms and explain why they have decided on this compensation programme. And overall, these outreach programmes have been very successful.”
Under the EU Capital Requirements Directive (CRD) IV, variable pay at financial institutions will be curbed to a maximum of one-year base salary, unless the shareholders give explicit permission to increase variable pay to a maximum of two-times base salary.
“It is going to be interesting to see how financial institutions will deal with the new CRD IV requirements and implement the bonus cap in 2014,” says Bram Hendriks, senior corporate governance officer at ING Investment Management. “Will they, for example, look for creative solutions to work around the cap by increasing base salaries?”
Irrespective of laws and voluntary initiatives, companies are said to have made progress with their remuneration packages.
“For a long time, remuneration structures have been flawed, because in many cases companies do not link strategic company objectives to remuneration metrics,” says Summerfield. “But now some companies have begun to recognise the fact that they need to change their approach towards remuneration and move from traditional total shareholder return and earnings per share metrics and link remuneration much more closely to the delivery of their strategy and encourage material long-term share ownership by executives.”
Pay is becoming increasingly linked to company performance, adds Sacha Sadan, director of corporate governance at Legal & General Investment Management.
“Today it is much more of a conversation of what metrics make a company work and what things should we measure rather than its EPS and TSR,” he agrees.
This has particularly been reflected in the financial sector. Most of the larger systemic banks in Europe have become more transparent about their remuneration schemes for executive directors, including bonus targets, says Hendriks.
“It is an interesting development to see that some of these banks, such as Deutsche Bank, have started to link part of the bonus pay-outs to client and corporate culture related targets.”
A few companies have also begun to link remuneration to sustainability or environmental social and governance (ESG) goals.
“We are seeing more companies including key performance metrics that are non-financial in nature in their bonus and long-term incentive plans,” says Pomroy. “The extractives sector, such as mining and oil and gas, is an obvious area where it is relatively common for some non-financial metrics to be included within bonuses. In other sectors this approach may not be quite so widespread but there is definitely a movement in that direction.”
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