Executive briefing – May 2021

Reflections on the 2021 AGM season

Backdrop

The pre-COVID context was already challenging for Remuneration Committees: institutional shareholders and commentators were clear that they expected restraint at the top and for companies to demonstrate the fairness of executive pay, and Remuneration Committees were already grappling with policy changes such as pension equalisation and post-cessation shareholding guidelines.    

COVID-19 hit which has thrown new specific problems into the mix.  This is making pay setting even more challenging. Remuneration Committees need to apply judgment to strike a balance between the varying views and expectations of investors (and their proxy advisors) and the need to operate policies fairly for executives who are making key decisions in the interests of their companies.

There are two opposing forces which have intensified through the pandemic: on the one hand some shareholders demand restraint and on the other leadership teams argue – with some justification – both that any negative impact on financial performance is not through any ‘fault’ of management and that they have never worked so hard.

In the global financial crisis, when pay hit the headlines there were accusations that executives were shielded from the downturn. However, as the focus on societal fairness and the interests of a wider group of stakeholders has grown, Remuneration Committees are generally applying greater restraint in respect of 2020 outcomes and how pay is set for 2021. These pressures need to be weighed against the continued need to recruit, retain and motivate executives, particularly in the context of the opportunity for many executives to earn significantly higher levels of remuneration in PE-backed companies.  Many companies are reporting increased market pressures especially in recruitment and indeed there have been several examples of companies asking shareholders to support their responses and they have often faced resistance.

The following have proved to be the key areas of focus of the voting agencies and the main reasons for shareholder dissent in 2021 so far:

• Salary increases above workforce levels or new directors being appointed on salaries higher than their predecessors irrespective of the explanation.
• Bonus and LTIP payouts where performance has been disappointing, particularly where Government aid (or made redundancies) was taken and not reimbursed.
• Use of upwards discretion to protect executives from the impact of the pandemic.
• Failure to put in place a credible plan to align pension contributions with those of the workforce.
• The introduction of atypical incentive structures unaccompanied by a compelling rationale.

Analysis

The following is based on analysis of the remuneration reports of the earlier of the FTSE 350 December year-end companies to publish their annual reports.  This covers three-quarters of FTSE 350 December year-ends. 

AGM voting outcomes

The restraint shown by most Remuneration Committees has been reflected in voting outcomes so far in 2021:

• The median voting outcome on remuneration-related resolutions to date in 2021 remains high, with support around the mid-90% mark (97% for remuneration reports and 94% for policies), broadly in line with the previous few years.
• However, a significant minority of companies have received votes against remuneration-related resolutions of 20%+ (13% of remuneration report resolutions and 21% of policy resolutions).
• Just one company has lost its remuneration report vote so far in 2021.
• The influence of ISS remains significant (while that of Glass Lewis continues to increase) – typically a vote against recommendation from ISS correlates with a c. 20% to 45% vote against. 

Base salaries

• Around half of FTSE 350 companies reduced salaries for a period temporarily following the initial lockdown.
• Half of CEOs received no increase for 2021 (this had been closer to a third of companies in recent years prior to the pandemic) and the median increase for CEOs for 2021 is less than 1%.
• Those companies seeking to award above-workforce increases – even strong performers – have often met with criticism from the voting agencies.
• There are some limited examples of companies – where rationale has been particularly compelling or where increases are phased – for whom significant above-workforce uplifts have been supported at AGMs in 2021.

Pension alignment

Pressure remains to set out a credible plan to reduce executive directors’ contribution rates to the workforce level.  The Investment Association (‘IA’) expects parity to be achieved by the end of 2022 and the voting agencies are moving towards this.  Market practice has shifted rapidly in response to the pressure.  Where companies have sought to “grandfather” contribution rates for incumbents, this has become a potential flashpoint for investors, particularly where contribution rates are high (15% of salary plus).

• Amongst the FTSE 350 c.90% are either already aligned or have committed to alignment by the end of 2022.
• A further 4% have committed to alignment by a date beyond the end of 2022.

Annual bonus outcomes

• Around 65% of FTSE 350 December year-ends have paid a bonus and only 4% of companies have paid a full bonus (the median is 40% of maximum compared with 60%-80% over recent years).
• Around 40% of companies made discretionary downward adjustments – the majority reducing to zero (often waiving the non-financial elements of the bonus).
• Very few (5% of companies) have disclosed the use of upward discretion for the bonus with mixed results albeit many investors are willing to support where there has not been an element of state aid (or made redundancies or cancelled dividends) and a compelling justification is set out.
• There have been several examples of significant votes against remuneration reports in 2021 as a result of a perceived misalignment between performance and bonus outcome or where issues of ‘fairness’ have been identified (e.g. where the company has relied on state aid which has not been repaid or where there have been redundancies). 

Annual bonus for 2021

• Most companies are retaining the broad bonus structure.  However, reflecting the difficulty of setting performance targets in the current context, some have increased the non-financial element and/or have removed any profit underpin, and there have been limited instances of companies disclosing that they are splitting the performance year and setting separate H1/H2 targets.
• Increasing quantum in the present context is challenging, and proposals for increases to the bonus have generally met with resistance from the voting agencies and from investors (even amongst strong performers even though there have been some isolated cases of support for increases where performance has been very strong and quantum is not considered excessive).
• Notwithstanding the difficult context, around 10% of companies have proposed increases in bonus potential and 15% of companies have proposed increases in incentive potential as part of revisions to new policies whether through an uplift in bonus, LTIP or a combination of the two.
• There is a clear increase in the already keen focus on ESG (see section below).

While analysis of remuneration reports does not yet reflect it, the target setting process for 2021 is leading to wider ranges than previously, influenced by a concern that, while a significant number of companies have awarded no bonuses for 2020, they feel it is not appropriate to set target ranges which have very little, if any, chance of achievement for 2021.

LTIP vesting

• The median LTIP vesting level amongst FTSE 350 December year-ends is around 35% of maximum (compared to levels of around 60%-70% over recent years).
• Vesting levels in the large majority of cases (c. 95% of companies) have been determined in line with the normal formulaic outcomes.  
• Of the small minority making discretionary adjustments, half did so downward and half upwards.  The instances of upward discretion have so far elicited adverse reaction from proxies and shareholders. 

LTIP for 2021

Remuneration Committees are considering carefully the approach to making LTIP awards in 2021 and whether the structure and quantum remain appropriate.  They are also considering the timing of awards, whether there should be any scale back to reflect a lower share price or scope to use discretion upon vesting, and the most appropriate performance metrics to use at a time when there is very little ability to forecast beyond the next quarter. 

• Size of award – Where there was a significant year-on-year fall in the share price during 2020, companies either scaled back the grant level or built in a commitment to consider the exercise of discretion to remove windfall gains at vesting. IA guidance suggests the latter should be avoided in 2021 but only a small minority of FTSE 350 companies (less than 10%) have disclosed a lower award quantum for 2021 so far noting that the strong recovery in share prices since the launch of vaccinations may have mitigated the need for companies to consider such action.

• Change of measures – While over half of companies have made no changes to their LTIP measures, we have seen a significant minority changing or reweighting measures (including, for example, increasing the weighting on TSR due to the difficulty of setting robust financial targets at the current time) and around 20% have either introduced non-financial measures or increased the weighting.
• Delay grants/setting measures – Many companies delayed their grants or the setting of measures during 2020 but there have been far fewer companies delaying the disclosure for 2021.

Atypical incentive arrangements

• We continue to see a greater acceptance of restricted shares.  On top of the 20 or so new schemes introduced in 2020, we have seen 13 plans proposed by FTSE All-Share companies in 2021 so far. One of these is a rare example of a company introducing a blend of restricted shares and a more traditional LTIP. In addition, one company proposed a one-off ten year restricted share plan although the proposal was withdrawn.
• A small number of companies have adopted more highly-geared one-off ‘recovery’ plans. 
• One company has combined its annual bonus and LTIP in order to increase line of sight and to address the difficulty associated with setting medium- to long-term targets in the present context. 

Linking incentives to ESG strategies 

ESG has become a key strategic pillar for many companies and institutional investors.  In response, we are seeing the influence of ESG on remuneration packages becoming clearer and the prevalence and weighting of ESG-related performance measures increasing.

• Over 80% of companies now have ESG measures in the bonus and/or the LTIP.
• ESG features most commonly in the bonus – 75% of companies have ESG measures in the bonus with a typical weighting of c. 15%-20%.
• Around 35% of companies have ESG measures in the LTIP, with a typical weighting of c. 20%.
• The most common measures in the bonus are related to ‘social’ (e.g. diversity, engagement, health and safety) and in the LTIP are related to ‘environmental’ (e.g. decarbonisation).

Share ownership guidelines

• Around 10% of companies have increased in-employment guidelines for 2021.
• Over 90% of companies now operate post-cessation guidelines.
• Of those companies operating post-cessation guidelines, 60% comply with The Investment Association’s guidance (i.e. 100% of the in-employment guideline to be held for two years after leaving) and although over one-third disclose that certain exemptions are allowed (e.g. purchased shares and LTIPs granted pre-policy).

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.

This email is confidential. If you are not the intended recipient, please delete the email and do not use it in any way. FIT Remuneration Consultants LLP (FIT) does not accept or assume responsibility for any use of or reliance on this email by anyone, other than the intended addressee to the extent agreed in the relevant contract for the matter to which this email relates (if any). Consistent with data protection regulations, if you would like to review our records relating to your contact details or to request their removal from our systems, please contact us at info@fit-rem.com. While all reasonable care has been taken to avoid the transmission of viruses, it is the responsibility of the recipient to ensure that the onward transmission, opening or use of this message and any attachments will not adversely affect its systems or data. No responsibility is accepted by FIT in this regard. FIT is a limited liability partnership registered in England under registered number OC364396, with its registered address at 1 Duke Street, London, W1U 3EA.