UK executive pay 'not fit for purpose', says Investment Association working group

In an interim report (13-page / 288KB PDF) published to coincide with a number of high-profile corporate annual general meetings (AGMs), the Executive Remuneration Working Group set up by the Investment Association (IA) was particularly critical of the "current dominance" of three- or five-year long-term incentive plans (LTIPs) as a means of rewarding chief executives. Use of these pay packages can result in "unintended or perverse consequences", particularly if the company's strategy or economic circumstances change before share awards become payable, according to the report.

Group chair Nigel Wilson, who is the chief executive of Legal and General, said that the current approach of UK listed companies to executive pay packages was "not fit for purpose", and had "resulted in a poor alignment of interests between executives, shareholders and the company".

"Greater transparency, clearer alignment of shareholder, company and executive interests, more accountability on the part of Remuneration Committees and greater engagement with and control by shareholders, working through company boards, are vital to restore confidence in a system widely seen as broken," he said.

The working group was set up last year by the IA, which represents the interests of the asset management industry and publishes influential 'principles of remuneration' best practice recommendations to assist its members when making their binding shareholder vote on executive pay. The IA intends to "respond promptly" about whether it will incorporate the working group's final recommendations, once these are published later this year, into the remuneration principles, the working group has said.

In the meantime, the working group intends to host a series of "roundtable discussions" on its interim conclusions with company representatives and the broader investment community in the coming weeks, as part of a consultation exercise that will inform its final report. Members of the working group include IA chair Helena Morrissey, who runs the fund manager Newton Investment Management, as well as Sainsbury's chairman David Tyler and Russell King, who chairs the remuneration committees of manufacturers Aggreko and Spectris.

Although the FTSE is trading at "broadly the same levels as 18 years ago and 10% below its peak", executive pay over the same period has more than trebled and outstripped growth in average wages, according to the working group's report. This "misalignment" has led to widespread scepticism and loss of public confidence, which is "ultimately damaging to the listed company sector", according to the report.

The working group found evidence of "disproportionate rises" in executive pay, driven by the use of 'median comparators' to align pay with that of competitors and the increasing outsourcing of remuneration-setting to external consultants. It said that remuneration committees had to become "more accountable for the decisions they take", using their discretion - both upwards and downwards - rather than relying on "formulaic outcomes". Specific areas on which the working group will seek further input as part of the consultation process include increasing transparency, whether through retrospective disclosure of performance targets or retrospective reporting of where the remuneration committee has used discretion; and increasing shareholder engagement. Companies also need to move away from "one size fits all" use of LTIP awards, and give remuneration committees more discretion to divide remuneration between fixed salaries, short-term bonuses and long-term restricted shares, according to the report.

Remuneration expert Suzannah Crookes at Pinsent Masons, the law firm behind Out-Law.com, said that the report's themes of transparency and engagement had been increasing areas of focus for the IA recently.

"The interim report makes clear that the working group is now looking for a shift in approach from companies, in order to restore confidence in the executive pay regime," she said.   

The interim report referred to the group's understanding that "a growing and disproportionate amount of shareholder-company engagement is spent discussing executive remuneration, to the detriment of other potentially more significant issues". Crookes said that this finding, which also appeared in IA's 2015 report on adherence to the Stewardship Code, was recently highlighted in the IA's 'Productivity Action Plan'.

"This report included as one of its actions, to consider the output from the working group in connection with executive remuneration," she said.

"The interim report gives a clear indication that it is time to "re-set expectations", in relation to pay structures and quantum. With the recent increase in companies introducing malus/clawback provisions, post-vesting holding periods and shareholding guidelines reflecting developments in the UK Corporate Governance Code and IA's own Principles of Remuneration, and in advance of many companies putting revised pay policies to shareholders in 2017, this does seem to be an appropriate time to take stock of these developments and review the overall impact on effectiveness of the current approach to executive remuneration," she said.