The greatly anticipated revised Principles of Remuneration (Principles) were published by the Investment Association (IA) on October 8, 2024, signalling a move towards greater flexibility in executive remuneration structuring.
As promised in the IA’s letter to the FTSE 350 Remuneration Committee Chairs in February 2024, the revised Principles are less prescriptive and rigid, allowing companies to better tailor remuneration arrangements to fit their circumstance in the hope that this will make the UK more attractive as a jurisdiction in which to list and remain listed.
Throughout the revised Principles, the language used and guidance offered is more flexible and open, allowing room for nuance and creativity when designing individualised schemes to incentivise management. Greater engagement and constructive cooperation between Remuneration Committees and shareholders is encouraged, with the benefits to both parties, and the importance of considering proposals on a case-by-case basis throughout, being emphasised.
The IA explicitly reiterates that the Principles are guidance and not rules and should only be considered as such. However, if the guidance is diverged from, Remuneration Committees are encouraged to fully explain their rationale to shareholders.
In line with aims to increase the UK’s competitiveness against countries such as the US, the Principles incorporate guidance on hybrid schemes for the first time and emphasise the value in understanding the impact of recruiting global talent on the company’s strategy and performance.
A detailed summary of the key revisions to the Principles is set out below.
Remuneration Committees
The Principles add a new sentence which provides that: “To make the best long-term decisions, the Remuneration Committee members, especially the chair, are expected to have sufficient expertise and experience of the company to fully understand its strategy, and have built effective relationships with other directors, management and shareholders.”
The recommendation that Remuneration Committees must not be over-reliant on their remuneration consultants has been replaced with the suggestion that Committees should have sufficient information and access to independent advice to allow them to make informed and independent decisions.
The Principles have removed the requirement for a non-executive director to have served on the Remuneration Committee for at least a year before chairing the committee. The specific requirement for committees to respond to shareholders in the event of a significant vote against a remuneration resolution has been deleted and more general guidelines encouraging committees to engage proactively and constructively with shareholders, taking into account their views and disclosing key decisions and reasoning to the shareholders, have been included.
We note that the revised Principles have dropped the requirement for Remuneration Committees to respond, consult and issue a statement where a significant (20%) vote against a remuneration resolution has occurred.
Shareholder consultation
The Principles stress that the purpose of shareholder consultation is for the Remuneration Committee to understand shareholder views rather than to just seek their approval. The importance of providing comprehensive information, fostering transparent dialogue, encouraging early engagement, acknowledging diverse shareholder perspectives, and disclosing how feedback is considered are emphasised and these themes are reiterated throughout the guidance contained in the Principles.
Levels of remuneration
The revised Principles shy away from the condemnation of excessive remuneration, and the principle of paying no more than is necessary, through the prescriptive and restrictive guidelines that were contained in the 2022 Principles. They rather focus on the fact that levels of remuneration should be analysed on a case-by-case basis, ensuring that they are appropriate to balance the expectations of shareholders and executives while taking into account the need to attract, retain and motivate talent and implement corporate strategy.
There should be a clear link between pay and performance, reflecting the achievement of short and long-term objectives and the creation of sustainable value for shareholders and material stakeholders while removing the requirement to have specific points of reference.
If the company is deriving significant revenues from particular markets, such as the US, or is competing for talent globally, the Remuneration Committee is encouraged to set out the impact of attracting global talent on the positioning of remuneration.
The guidance continues to state that benchmarking on its own to justify remuneration increases is not appropriate. Rather than stating that the use of median pay as a benchmark to determine remuneration is undesirable due to potential ratcheting, the guidelines simply warn that this could create upward pressure on executive pay without regard to performance.
The new guidance explicitly recommends that variable remuneration plans should be capped, with any material increases fully justified to shareholders and subject to consultation.
Malus and clawback
The malus and clawback provisions are less prescriptive than in the 2022 Principles and have been brought in line with the updated 2024 UK Corporate Governance Code.
The general recommendations that executives should agree to defined triggers, that all documentation is consistent and contain details of the triggers, that communication with participants is in line with the provisions, and that the process for enforcement should be documented remain.
Discretion
The new Principles have removed the specific requirement for discretion by Remuneration Committees to be exercised diligently and in a manner that is directly aligned with shareholders’ interests. Instead, there is guidance which encourages discretion to be used on a case-to-case basis taking into account the shareholders, material stakeholders, specific circumstances of the company and rationale for decisions while avoiding rewarding or penalising executives for factors beyond their control.
The guidance emphasises that discretion can have both positive and negative implications for executive remuneration and that shareholders are appreciative of disclosure.
Basic salary and pensions
Much of the previous guidance has been retained, albeit worded less prescriptively. The new Principles add that, where an executive director is recruited on a higher salary than their predecessor, the company should explain this decision to shareholders.
The majority of the prescriptive guidance relating to pensions has been removed, retaining only the key principles that “pension contributions for executives should be aligned with those available to the workforce” and that “no element of variable pay should be pensionable.”
Annual bonus
The Principles maintain much of the guidance contained in the 2022 Principles, albeit in a less prescriptive manner and providing scope for more flexibility through the inclusion of guidance on the now more commonly accepted use of non-financial metrics, such as the management of ESG risks.
The Principles now include the following guidance allowing for a reduction in mandatory bonus deferral: “If an executive director has met the shareholding guideline, shareholders may support a reduction in the level of deferral for the relevant director, provided that the Remuneration Committee still has sufficient ability to exercise malus and clawback provisions.”
Special awards
The Principles continue to warn against the potential negative perceptions caused by special awards or ex-gratia payments but remove the specific commentary advising against such awards as contained in the 2022 Principles. The Principles now contain points for consideration by the Remuneration Committee when making such awards which encourage the drafting of a well-designed remuneration policy which eliminates the need for special awards and the engagement with, and disclosure to, shareholders when such an award is proposed.
Long-term incentives
The new Principles have completely rewritten the previous guidance on long-term incentives (LTIs). The detailed information on specific structures has been replaced with larger sections providing guidance on the general terms and technical conditions of LTIs with further specific advice being given on performance share plans, restricted share plans, hybrid schemes and value creation plans.
Specific guidance on matching shares, joint venture companies, subsidiary companies, all-employee schemes, performance on grant schemes and options has been deleted.
Aside from this, much of the retained guidance remains similar. It is emphasised that shareholders are expected to understand the philosophy that Remuneration Committees adopt and how this supports company strategy and value creation. In turn, committees are expected to explain to shareholders the rationale and appropriateness of the chosen type of LTI. A new paragraph on the use of ESG performance conditions in LTIs has been included.
Restricted share plans
The Principles now provide more generalized guidance on restricted share plans (RSPs), stating that both the benefits and risks of such plans should be taken into account on a case-by-case basis and that Remuneration Committees must justify their choice of remuneration structure by demonstrating how it aligns with the company’s strategy, culture and long-term success. Specific examples of circumstances when a RSP may be appropriate have been removed.
The 2022 Principles stated that the discount rate must be “at least” 50% while the 2024 Principles state that in certain circumstances, a discount rate other than the typical 50% may be appropriate thereby allowing flexibility to have both higher and lower discount rates.
The statement that some shareholders express a preference for quantitative underpins to have been achieved prior to vesting has been removed, as has the entire section on the importance of considering the previous approach of the company to remuneration. The 2024 Principles have, however, added that an annual vesting of restricted shares is generally not supported by shareholders.
Hybrid schemes
A new section has been included which recognises the importance of hybrid schemes, usually a combination of performance shares and restricted shares, in companies that have a significant US footprint and/or compete for global talent.
Hybrid schemes should follow the guidance contained in the Principles on PSPs and RSPs, with the RSP portion being discounted to reflect the lower risk. The vesting period for a hybrid scheme is expected to be at least five years, with no accelerated vesting or early release of shares.
Value Creation Plans
The dissuasive guidance contained in the 2022 Principles, stating that Value Create Plans (VCPs) are not considered standard arrangements, has been neutralised to accept that VCPs are becoming more commonly accepted and used (despite scepticism and resistance remaining from some Investors).
Therefore, caution and diligence is advised, early engagement with investors and material stakeholders recommended and a number of key issues are flagged for the Remuneration Committees to address before implementation of any VCP. The guidance also specifically states that a VCP must reward the creation of substantial value over at least a five-year period.
Grant windows
Issued shares should be priced “at” mid-market price at the time of grant, rather than at “not-less” than mid-market price.
The 42-day window in which grants should be made now only applies to executive directors and the direct reference to the Market Abuse Regulation (MAR) has been removed. All-employee share plans are excluded from this, as well as from the 10-year limit on the life span of a scheme.
Dilution
The Principles state that appropriate dilution limits for the company should be adhered to and they now expressly envisage that Remuneration Committees may seek approval from shareholders for dilution limits higher than 10% in exceptional cases (such as a recently listed high growth company wanting to incentivise its key employees), provided that full rationale and a disclosure of timelines for realigning with standard dilution limits is provided.
The 5% share dilution restriction for executive (discretionary) schemes has been deleted in its entirety.
Our thoughts
The revised Principles are a welcome development from the IA, enabling companies to tailor incentives and executive remuneration structures to better suit their objectives, which of course vary from sector to sector and company to company.
However, those companies that were expecting significant relief from the restrictive nature of the previous Principles will find that the new provisions only provide flexibility where they manage to engage and convince shareholders that what is being proposed is the right course in the given circumstances. If the proposals are acceptable to shareholders, the Principles will not stand in the way. Where they are not, the Principles will not help.
Therefore, whether companies manage to take advantage of this increased flexibility and feel emboldened to embrace change will to a large extent depend on what shareholders think of the proposals put to them by remuneration committees.
It will also be interesting to see if voting and proxy agencies will adopt a less prescriptive approach to their review of remuneration reports and voting recommendation in light of the new Principles. There will undoubtedly be a lot more development to come in this area in the near future.
Rasmus Berglund is a partner in the remuneration practice and Bronwyn van Wieringen is a trainee solicitor at Macfarlanes.