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Board pay: helping keep boards and Remcos out of the headlines

In the light of greater political, media and public scrutiny, companies, and in particular remuneration committees, must, more than ever, ensure that they are rewarding directors appropriately for performance.

The Linklaters Employment and Incentives team spend a great deal of time discussing pay and bonuses with Remco chairs concerned to get the balance right between rewarding performance and setting stretching targets. Their concern is not surprising. Take the recent examples of Carillion, Persimmon Homes and the University of Bath. Stories about either the size of pay/bonuses and/ or the seeming failure of the Remco, to ensure that pay-outs were tied properly to stretching performance targets led to both the chair and Remco chair at Persimmon, and to the Vice-Chancellor at Bath University, resigning.

Perhaps not surprisingly, discontent about board pay levels has now made its way on to the Government’s agenda. The series of changes it has proposed will have significant implications on the way board pay is set and monitored. In some cases those proposals may result in Remcos having more powers to intervene in Persimmon type circumstances, but will also bring a whole host of new considerations and challenges, both when setting pay/bonuses and at pay-out time.

Perhaps not surprisingly, discontent about board pay levels has now made its way on to the Government’s agenda. The series of changes it has proposed will have significant implications on the way board pay is set and monitored.

The changes will require companies to:

give Remcos power to reduce Long-term Incentive Plan (LTIP) awards when pay-outs do not reflect wider performance;

have at least five-year holding periods for LTIP awards;

disclose the CEO: UK employee pay ratio, explain annual changes and how the ratio relates to pay and conditions across the wider workforce;

report periodically on what they intend to do when any resolution results in more than 20% dissenting vote.

So what can you do to help make sure your organisation stays out of the headlines?

1

Boards need to understand and agree with the philosophy behind the Remco’s remuneration principles and be satisfied that bonus and LTIP targets are truly linking potential outcomes to company strategy and performance.

2

Remcos need to consider worked examples of the different share-based outcomes so that they are fully aware of the figures. That is really the only way Remcos can say that the projected levels of pay would be justified by the required performance.

3

Remcos should consider setting an overall absolute limit on the pay-outs and/or have full discretion to reduce them due to the company’s performance, or prevailing conditions at payment. They should also have comprehensive clawback arrangements to recover payments made.

4

Remcos should also not shy away from considering whether longterm performance measures are really appropriate for the company’s business. In 2016, an Investment Association-led working group suggested that companies should choose the pay structures which suit their businesses best, including awarding restricted shares with no performance measures but with significantly reduced size of awards (by at least 50%, compared to the LTIP award). So far, few companies have adopted this approach. That is largely because shareholders have not thought that the particular company’s proposed discount was sufficient. But the time may now be right to reconsider restricted shares: they provide certainty of outcome, allow reducing quantum and would eliminate the criticism that LTIP awards do not link pay to performance properly and result in inappropriate pay-outs.

5

Although generally considered as an imperfect and possibly unfair tool, the disclosure of CEO: UK employee pay ratio is becoming a reality. Disclosure will be mandatory. Boards need to consider the narrative explanation accompanying the ratio to both contextualise it and reduce the risk of anyone misrepresenting the statistics. Boards may need to explain or change your overall approach on pay policies across the company. This could be done as part of strengthening the workforce voice.

6

So what can you expect in 2018?

The focus on board pay in the context of fairness and trust in businesses will certainly continue. Companies will be expected to show restraint on board pay and to reduce it where necessary. This is also in boards’ interests. If they do not, the public register and CEO ratio disclosure will bring unwelcome attention and send the wrong message within their own businesses. And, as the current various bonus rows show, they could well end up with unwanted, possibly unfair, criticisms and resignations.

Summary

In summary, issues for boards, Remco chairs and HR to consider:

One

Has your Remco considered worked examples of the different outcomes of LTIP pay-outs? Is there an overall limit on the size of payouts? Are there comprehensive clawback mechanisms?

Two

Does your Remco have overall discretion to reduce LTIP pay-outs at the time of payment to take into account unforeseen circumstances?

Three

What is the CEO: UK employee pay ratio? Is it likely to present particular issues to the business? How can it be put in context?

Four

Should you change pay structures or practices in view of the ratio or workforce views?