Executive briefing – June 2022

Themes from the 2022 AGM season

Backdrop

Numerous commentators expected 2022 to be a difficult AGM season for many companies: most had set targets for FY2021 at the peak of the pandemic and – following a quicker than anticipated recovery – ultimately, in many sectors, those targets were significantly outperformed.  These outcomes have been against the backdrop, in the first half of 2022, of a deteriorating economic outlook, spiralling inflation, a “cost of living squeeze” and industrial strife.   In addition, in this increasingly febrile context, a number of companies have faced difficult decisions relating to:

• Changing performance measures and/or targets for in-flight awards
• Continuing to pay bonuses despite taking government support without repayment and/or cancelling dividends
• Above workforce salary increases for Executive Directors and/or increases in incentive quantum

Alongside these specific post-pandemic issues, the “normal” issues that can pose problems for companies subsist, such as those relating to recruitment and terminations, a lack of meaningful bonus disclosure, and a failure to align Executive Director pension contributions with those of the wider workforce.

Pressure on workforce-wide salary budgets continues to intensify as companies respond to the “cost of living squeeze”, the strong labour market and the high inflation environment. However, companies tread a difficult line as they are wary of adding to fixed costs before – as predicted by some analysts – a potential recession. We are seeing this tension play out in real time as industrial action hits a number of companies across a range of industries. In this context, Executive Director salary increases relative to those of the workforce are facing particularly close scrutiny in 2022. 

In addition, the focus on the alignment of pay with environmental, social and governance (ESG) strategy is becoming ever keener. The market is evolving quickly in response and we have seen a significant uptick in 2022 in the proportion of companies embedding such measures in their incentive arrangements.

Voting outcomes

Directors’ remuneration report

To date, 27 Main Market companies have suffered “significant” votes against their advisory directors’ remuneration report resolutions in 2022 (i.e. votes of more than 20% against, with the additional consequence that they will be added to The Investment Association’s public register). Of these, four companies have lost their resolutions (i.e. receiving less than 50% support).

The main reasons for significant votes against in 2022 so far are summarised in the chart below (in some cases there are multiple reasons cited, hence the overall percentages total more than 100%):

By far the most common reason for shareholder dissent has been in relation to high incentive payouts, primarily where there are perceptions of misalignment between incentive outcomes and the wider stakeholder experience. A particularly hot topic has been in relation to receiving and not repaying government support (and/or cancelling dividends) whilst continuing to pay bonuses to executives. The proxy agencies have taken a particularly hard stance on this issue, generally providing a rebuke even where companies scaled back the formulaic outcome. However, we note some companies did escape reprimand if they made a commitment to repay furlough support in the future, or if they repaid other more valuable support instead (e.g. rates relief).

There were also a number of companies which did not take government support, but where investors were not convinced that there was sufficient stretch in the targets. This was reflective for some companies of the 2021 targets being set in the midst of the pandemic, prior to the subsequently quicker than expected recovery. It also highlights that the views of proxy agencies and shareholders on this issue tend to be asymmetrical: they expect companies to moderate down for perceived tailwinds which benefit outcomes but not to adjust upwards for headwinds outside of management control. 

Whilst difficult to quantify, it does appear that “repeat offenders” tend to antagonise the voting agencies and shareholders in particular, and this tends to translate to lower levels of support for remuneration-related resolutions.

Directors’ remuneration policy

To date eight companies have had a significant (20%+) vote against their policy resolution in 2022.

The most common reason for dissent has been an increase in potential incentive quantum. This includes increases to the annual bonus and/or LTIP award level absent, in the view of shareholders and proxies, compelling rationale.

The introduction of alternative incentive structures such as value creation plans has also been an issue for some companies (in particular where the proposed arrangements are considered to be too generous relative to the previous ones).

Re-election of the Chair of the Remuneration Committee

Investors (and proxy agencies) are more willing than ever before to use the vote against the re-election of the Chair of the Remuneration Committee to signal dissatisfaction on remuneration issues.  That said, this is generally reserved for serial offenders and/or where there is a very significant departure from best practice, and significant dissent is uncommon.

In 2022, there have been a small number of cases of dissent against the re-election of the Chair of the Remuneration Committee. One, for example has highlighted an in-year issue relating to inappropriate termination payments to a former Executive Director (and was also reflective of the company having experienced large votes against the policy and remuneration report in previous years).

Salary increases

Whereas the average workforce salary increases in late 2021 and early 2022 were c. 1%-2%, we have subsequently seen this increase to c. 3%-5% as the current norm with the pool for promotional/exceptional increases as much as a further c. 1%-2% (rather than the more typical 0.5%).  This increase is in response to companies having evaluated the environment and, in many cases, having increased their previously planned salary budgets to address the competitive labour market and very acute inflationary pressures everyone is facing.

Annual inflation in the UK is now running at c. 9% and is predicted, according to the Bank of England, to continue to rise this year to reach a peak of slightly above 11% in the Autumn. This compares to an average of c. 2.5% over 2021 and a stable period pre-Covid where rates were regularly well under 2%.

Some companies have focused their salary review processes in light of the impact of inflation on the lower paid.  We have seen a range of actions being taken by companies including, for example, (i) guaranteeing a minimum absolute (£) increase for the lowest paid (e.g. average increase of 4%, but with a minimum increase of, say, £1,000); (ii) one-off payments to help staff with increases in the cost of living (e.g. £1,000 payable to all staff below senior management level); (iii) differentiating increases by grade or by earnings (e.g. increase of 4.5% for those earning less than £50,000, increase of 2.5% for those earning over £50,000); and (iv) rescheduling of annual salary review to be able to better deal with employee concerns over inflation (e.g. accelerating the 2022 review to earlier in the year).  Historic and global practice suggests that, in the context of prolonged periods of high inflation, more companies consider the adoption of mid-year reviews; however, we have yet to see much evidence of this in the UK so far and companies are generally monitoring the situation.

There continues to be a firm expectation that Executive Director salary increases should be in line with those of the workforce (or lower) and around 90% of Main Market companies have increased the CEO’s salary at or below the average workforce level so far in 2022. However, far fewer companies have frozen Executive Director salaries in 2022 than in previous years (less than 10%) – last year, primarily in response to the pandemic, close to 60% of CEOs received no increase (closer to a third of CEOs in years prior to COVID-19).  Above-workforce increases for Executive Directors – even amongst strong performers – have generally been met with criticism in 2022 (albeit with some examples – where rationale has been particularly compelling or where increases are phased – of such uplifts being supported).

The median CEO and workforce salary increase figures so far in 2022 are both 3%.  However, most of these were actually set in the latter part of 2021 before inflation had significantly increased and we are already seeing higher workforce increases generally being reported amongst the March 2022 year ends that have released accounts so far.  In our view, the median workforce increase is likely to move up from 3% to closer to 4%-5% once all the March year ends have reported. These increases are well below current levels of inflation which will likely be a source of tension and result in potentially higher turnover in a buoyant labour market albeit one increasingly tempered by inflationary pressures. We expect to see more examples of companies innovating to retain employees and support them through the cost of living squeeze (e.g. more use of one-off payments to employees below management level).

The rise of ESG measures

ESG has become a key strategic pillar for many companies and investor pressure for associated metrics in incentive plans is growing.  In response, we are seeing the influence of ESG on remuneration packages becoming clearer and the prevalence and weighting of ESG-related performance measures rapidly increasing.

Over 80% of FTSE 350 companies, for example, are now using ESG-related measures in their bonus scheme and over 30% have such measures in their LTIP.  Of the 80% of companies operating ESG bonus measures, close to 50% operate with distinct, forward-looking metrics, with the remaining 30% including less well-defined ESG metrics as part of the ‘personal’ or ‘strategic’ element of a bonus scorecard. We expect the trend to continue with more companies adopting separate ESG components in their bonus schemes and more use of ESG criteria in LTIPs.

The most common bonus measures are related to ‘social’ (e.g. diversity, employee engagement, health and safety) with ‘environmental’ measures (e.g. CO2 reduction) also prevalent; and LTIP measures are most commonly related to ‘environmental’ measures as companies, for example, work through their strategies for reducing carbon emissions.

The guidance from investors has become clearer. Whilst there has been acceptance so far of input measures or ones involving the creation of a roadmap for improvement, the expectation going forwards is for ESG metrics to have clear strategic importance, be material to the business and quantifiable. In due course, we expect clarity of reporting of ESG measures and outcomes and their degree of stretch to be a greater point of investor focus.

Conclusion

Many of the issues that flared up over the COVID-19 period will now start to fall away and some return towards “normality” can be expected. That said, the current geopolitical and economic environment is increasingly volatile as we move through 2022, impacting wage negotiations and company growth projections. This combined with competing views from a range of stakeholders will mean remuneration committees will need to consider the broader landscape carefully.

The pandemic showed that formulaic remuneration outcomes are not always appropriate and in 2022 we have seen record bonus payouts often as a result of a low starting point and a quick recovery. Given the global context and the predicted downturn in the economy, outcomes in respect of 2022 may well be lower. In any event, shareholders will expect remuneration committees to use discretion to ensure outcomes are appropriate by applying judgment where necessary, taking into consideration the full range of stakeholder experiences. This theme is here to stay.

In addition, given all the uncertainties, we may see a continuation of companies switching to restricted shares with appropriate underpin conditions that may be tested in an uncertain future. However, companies simply changing structure for the increased certainty, should ensure that the application of any underpins is clearly understood, particularly as to when it may be appropriate to apply scale-back. As participants will have exchanged quantum for certainty, it is important that underpins are not regarded as performance conditions although it seems likely that investors and, particularly proxies, will expect to see some level of reduction in some cases.

If you wish to discuss anything arising from this briefing, please ask your usual contact at FIT or call us on 020 7034 1111 or email us at Info@fit-rem.com. 

This paper is intended to be a summary of key issues but is not comprehensive and does not constitute advice. No legal responsibility is accepted as a result of reliance on the contents of this paper.

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