ISS / RREV's UK corporate governance policy is based on the policy and voting guidelines published by the National Association of Pension Funds (NAPF).
The changes contained in the new guidelines are quite numerous and there are several important updates. However, the themes and messages are largely consistent with those that we have seen before and elsewhere, with some coming across from the NAPF Corporate Governance Policy and Voting Guidelines. New provisions contained in the guidelines are set out below and, where the whole provision isn’t new, additional wording which has been added to an existing provision is shown in italics:
General Remuneration Policies and Practices
- Remuneration policies should be clearly disclosed, including how they promote achievement of the company's strategic objectives. Any divergence from the application of the stated policy when payments are made require an explanation of the circumstances that warranted the exceptional arrangement so that an assessment can be made as to whether it was justified.
- Sufficient detail should be disclosed about the performance targets adopted in order to allow shareholders to make their own assessment of whether they are appropriate. For example, EPS is a commonly used metric but the ways of measuring it may vary widely and so the variant adopted should be disclosed.
- Many investors are concerned that remuneration has become too complex and question its effectiveness in motivating management. Therefore, companies are encouraged to adopt simpler remuneration structures and require executives to hold greater numbers of shares for long periods.
- Any increases in total remuneration for executives should not be out of line with general increases at the company. Companies are discouraged from market benchmarking for pay reviews, unless it is applied infrequently (3 – 5 year intervals) and then only as one part of an assessment of remuneration policy.
- Boards must avoid rewarding for failure or for poor performance and the current economic environment should not become a justification to relax, revise, or abandon performance targets retrospectively. In addition, the members of the Remuneration Committee must also have a clear understanding of their responsibility to negotiate suitable service contracts when appointing an executive to the board and be able to justify severance payments to shareholders, ensuring that the full benefit of mitigation is obtained.
- It is considered good practice for companies to make variable pay elements subject to clawback provisions. Clawbacks should require the return of payments if the performance levels that determined payments made are shown, for whatever reason, not to be a true representation of the performance achieved.
- In cases where a remuneration committee uses its discretion to determine payments, it should provide a clear explanation of its reasons, which are expected to be clearly justified by the financial results and the underlying performance of the company.
- One-off pay awards to address concerns over the retention of an executive director have been shown to be ineffective and are therefore not justified.
- For shareholder alignment, the development of a meaningful shareholding by executive directors is expected, with 100 per cent. of basic salary now considered to be a minimum, with much higher shareholding requirements expected at larger companies or where the total remuneration package offers high multiples of basic salary.
- A rigorous approach to restraint over any increase in overall pay quantum is expected.
- Post-freeze 'catch-up' salary increases or benchmarking related increases are not generally supported. In order to restrain an increase in total remuneration, a significant salary increase should generally be offset by a reduction in variable pay.
- Where an executive is appointed at an 'entry-level' salary-point which the company expects to increase to a higher level once the individual has proved him/herself in the role, the road map for increases should be disclosed at the time of appointment.
- For bonuses paid, there is increasing shareholder pressure for companies to provide informative retrospective disclosure of targets set at the start of the year and the extent to which they were achieved. Any use of discretion and its impact on the award made should be clearly explained. Bonus payment levels should be justified by the company's profits.
- The annual report should set out the percentage deferred and whether deferral was or will be in cash or shares, with the share price used to determine the number of shares awarded also disclosed.
Long Term Incentives
- The forecast level of performance at the time of award should be located well within the lower end of the target range.
- Companies are encouraged to provide more informative disclosure on the extent to which performance targets have been met and the link with the amounts that vested.
- Performance periods longer than three years and compulsory post-vesting holding periods are encouraged.
- Dividends relating to the duration of the performance period may be paid retrospectively on shares that the executive retains after the performance targets have been measured, but no dividends should be paid on any part of the award that lapses. The practice of crediting dividend payments on undelivered shares or options after the end of the performance period or beyond a compulsory post-vesting holding period is generally opposed because, until after delivery, the participant is not a registered shareholder and, for example, cannot vote the shares at a company meeting and so therefore should not benefit from the rewards available to registered shareholders.
- An objective of long-term incentives is to achieve a strong alignment of the interests of executive directors with the long-term interests of shareholders. Some investors including many long-term investors such as pension funds and index trackers believe that this can be best achieved if executive directors receive shares that they are required to hold for a very long period. This is a relatively new approach, which diverges from the recent conventional approach to share awards in the U.K. market because awards may be based on meeting pre-grant performance criteria and vest without further reference to the achievement of performance targets. When considering whether to introduce such a scheme, companies should carefully assess whether it is appropriate for their business and strategy, provide clarity over the pre-grant award criteria, and ensure that the maximum award face value is significantly reduced to take into account the high expected value of such an award compared with one subject to conventional post-grant performance. In addition, for this approach to be meaningful, the recipient must be required to hold all the vested shares for an extended period in order to build up a very significant shareholding; the sale of shares awarded under such schemes is therefore not expected, hence they are often described as 'career shares.'
- Companies should have a policy for new service contracts that limits executive termination provisions to no more than one year's basic pay and benefits, generally with no specific agreement on the amount to be paid on termination. All payments should be subject to phased payment and mitigation. We continue to encourage companies to take steps to limit termination payments solely to meet contractual obligations applicable to that individual's service contract.
- The UK Government's draft proposals require a company to provide disclosure of contractual arrangements relating to exit payments. This is in line with our current guidance and is welcomed, as many companies currently only provide general disclosure on this important area. Therefore early adoption of this more detailed approach is encouraged for all companies.
- We will seek explanations for any payments made in excess of one year's basic pay and benefits, including what steps have been taken to mitigate the cost to the company. The vesting of outstanding long-term awards should be prorated for time and performance, and companies should explain any use of discretion. Where the termination arrangements do not appear to be justified, we may recommend that shareholders vote against the resolution to approve the remuneration report and, in cases considered to be extreme, the re-election of the chairman of the remuneration committee or other directors as we consider appropriate.
- Pension contribution payments and contributions for executives should be clearly disclosed and companies are expected to outline their pension policy. Any compensation to executives for changes in tax relief or pension contribution is not considered to be acceptable.
Payments on Appointment
- Companies should provide a statement of their policy for making on-appointment awards to new recruits from outside the company, as they are non-routine exceptions to normal pay arrangements. A full explanation of the process by which any on-appointment awards made were determined should be disclosed accompanied by a breakdown of the arrangements and quantum.
- Where such arrangements are necessary, the cost is expected to be kept to a minimum and not exceed the realistic value of rewards forfeited by changing employer. In principle, the vesting schedule of the on-appointment package should mirror that of the awards forgone and is expected to include a significant proportion that is subject to performance and liable to forfeiture on departure within a minimum two years of joining the company. Where the on-appointment arrangements do not appear to be justified, we may recommend that shareholders vote against the resolution to approve the remuneration report and, in cases considered to be extreme, the re-election of the chairman of the remuneration committee or other directors as we consider appropriate.