Updated ABI remuneration principles align pay with company strategy, says expert

The ABI has updated its Principles of Executive Remuneration in light of the new rules regarding listed company directors' pay. Share plans and incentives expert Judith Greaves of Pinsent Masons, the law firm behind Out-Law.com, said that the document would provide "helpful guidance" to UK listed companies, as they updated their own policies on executive remuneration ahead of the introduction of the binding shareholders' vote at their next AGMs. The ABI produces updated guidance annually in its role as a representative of insurers, many of which are significant institutional investors.

"These guidelines reflect a number of developing themes; with a clear steer that bonus pay-out to executives is discouraged, even if some specific performance targets have been met, if the business has suffered an 'exceptional negative event'," she said. "Applying these types of performance adjustment or clawback provisions in the real world can be tricky."

"At the end of the day, the guidelines make clear that what matters most is that remuneration is clearly aligned with strategy. Whilst shareholders will challenge pay structures that they see as too generous, or as insufficiently long-term, there is also a clear statement that high pay for exceptional performance is acceptable," she said.

The revised guidance reflects the "significant changes" to the way in which companies have had to report on, and shareholders vote on, executive remuneration since 1 October 2013. Company shareholders were given a legally-binding vote on executive pay from this date for companies whose accounting period ended on 30 September, alongside the introduction of new remuneration reporting requirements. Annual reports must now contain more information about how directors have been and will be paid, along with information about how this relates to company performance. This information is intended to assist shareholders in deciding whether to approve the company's pay policy.

In their role as institutional investors, ABI members have a fiduciary responsibility to their clients to ensure long-term value creation in the companies in which they invest, according to the guidance. This responsibility involves ensuring that clients' capital is efficiently invested and that the companies they invest in are well-governed and run in the interests of shareholders.

As part of this, company remuneration policies and practices should be aligned with shareholder interests and promote sustainable value creation, the guidance says. Shareholders look to the company's remuneration committee to protect and promote their interests, by setting executive remuneration within the context of overall company performance. Policies should support performance, encourage the sustainable financial health of the underlying business and promote sound risk management for the benefit of investors, according to the guidance.

"Undeserved remuneration undermines the efficient operation of the company," the guidance says. "Excessive remuneration adversely affects its reputation and is not aligned with shareholder interests."

The guidance does not prescribe or recommend a particular remuneration structure, instead stating that it should be "appropriate for the specific business, and efficient and cost-effective in delivering its longer-term strategy". Remuneration structures should, however, be "simple and understandable", preferably by limiting variable remuneration to a single annual bonus and a single long-term incentive scheme. Incentives should also have a long-term focus, including a "high degree of deferral and measurement of performance over the long-term".

Remuneration structures should also include provisions that allow the company to 'claw back' sums already paid, and 'performance adjustment' or 'malus' clauses allowing it to adjust bonuses or long-term incentives before they have vested and been paid. The circumstances in which these clauses can be implemented should be agreed and documented before awards can be made. The Financial Reporting Council (FRC) is currently consulting on whether such clauses should be required of listed companies through the UK Corporate Governance Code.

The document also contains detailed guidance in respect of variable pay, such as annual bonuses and longer term incentives. It clarifies which shares and share incentives should be allowed to count towards the satisfaction of directors' shareholding requirements, and makes it clear that measuring performance achieved before the incentive is granted will not usually be appropriate.

More specific guidance is also given on leaver provisions in long-term incentive plans. It is suggested unvested share awards should normally lapse on termination for cause or through the individual's choice; may vest on a pro-rated basis at the end of the performance period in cases of ill health, redundancy and retirement; and early vesting may be appropriate, subject to performance targets, on death or certain corporate events.

"Remuneration committees are now required to set out their policy on departures," said share plans and incentives expert Judith Greaves. "The new guidance does not provide any additional steer where, as frequently happens, departure is by mutual agreement; other than to reiterate the principle that 'payment for failure cannot be tolerated'."