- November 20, 2019
No matter whether you are a listed company or a private company, the most recent remuneration guidelines from the Investment Association are likely to affect your business in the future
To paraphrase an old saying, “when the FTSE sneezes, the rest of the market catches a cold”. Whilst the recent publication of the Investment Association’s Principles of Remuneration (“the Guidelines”) on 1 November is targeted initially at the largest listed companies, we have consistently seen practices and outlooks move into other listed and non-listed companies.
As a result, here are four particular points made by the IA which we think every business should be aware of going forwards.
The IA has indicated that alternatives to Long Term Incentive Plans (LTIPs) should now be actively considered. This statement can be confusing as the IA is not suggesting that rewards based on long term performance should be stopped – it is rather that the default position for companies should not be to use “Nil/Nominal Cost” Options.
A discussion of the potential alternatives will be undertaken in a future article. The key detail coming from this advice is the reiteration that any long-term plan for executives and key personnel should be aligned to the company’s strategy. It is, therefore, acceptable to use a style of plan which is not common amongst peers or comparators if it would be the best type of structure for your business and is aligned to company strategy.
- Pension Contributions
There is a strong and consistent message that senior executives should not receive higher pension percentages than the majority of their workforce. No new Directors should be awarded pension contributions above this level (typically expressed as a percentage of salary) and any incumbent directors should have their percentage reduced down to the same level as the rest of the workforce by the end of 2022.
- Remuneration Committee discretion and capping variable pay
Whilst the Guidelines acknowledge that the Remuneration Committee may need to exercise discretion at particular times, the indication and examples used are all in respect of using discretion to limit payments and it is clear that this is the expected direction of travel.
In particular, there is an encouragement to not pay any variable pay at all if there has been “an exceptional negative event” (such as a significant health and safety failure or a poor outcome for clients).
There is also a suggestion that variable pay should be capped at a maximum – to be set for each Company by its own Remuneration Committee.
- Notice Periods
Payments to exiting Directors should be limited to what is in the contract (i.e. no “ex-gratia” payments) and be limited to salary, pension and benefits already in the contract. Where bonuses are due, these should only be paid if the individual is a “Good Leaver” and the Remuneration Committee should state on what basis this definition is made.
Only time will tell if these new approaches will flow down to the rest of the market as a trickle or a surge. However, the continued tone is one of greater restraint over executive pay.
For further information or to discuss any questions you may have, please contact Stuart James.
- November 19, 2019
Remuneration Planning for Management Succession
On 18 November, MM&K hosted the latest in its series of Remuneration Dinners. The guests on the evening included Company Chairs, Remuneration Committee Chairs / Members and CEOs. The discussion topic for this event was Remuneration Planning for Management Succession.
The topic was introduced by MM&K’s CEO Paul Norris who contended that Management Succession was an important matter, not always given the priority it deserves.
The following are excerpts from his opening address:
“It may be a universally accepted principle that succession planning is important but it does not seem to have been universally embraced. One listed company, when asked about succession planning replied: “We are a small head office team and don’t have the time to be thinking about that.”
Many family-owned companies are reluctant to do any succession planning at all. For those companies, the closer relationship between shareholding and management and the potential conflicts between the interests of the family and the interests of the business are complicating factors. The key decision of whether to select the next CEO from inside or outside the family may be influenced as much by family needs or preferences, as it is by business requirements. Objectivity can lose-out to emotion.
Another reason for hesitation might be that deciding to embark on a succession planning is like deciding to buy life assurance. It’s a sensible thing to do but having to grapple with the inevitable is something we would rather not be reminded about and, in any case, it’s way off into the future, isn’t it? But the future is uncertain, which simply strengthens the case for planning.
There are good reasons to plan
• Avoiding unwanted disruption: Because management change can affect many aspects of a business:
– culture and values
– risk management
– business continuity
– strategy and growth
– board effectiveness,
the absence of planning create potential for unwanted disruption.
• Knowledge transfer: The Baby-Boomers are approaching (or have reached) retirement. Remuneration policy can play a major part in how to motivate those workers to stay and educate their younger colleagues in Generations X and Y, some of whom will be tomorrow’s top management?
Older employees are not necessarily less motivated than their younger colleagues but they are likely to have different priorities and need to be motivated differently. Where it is important to retain them to pass on their knowledge and experience, flexibility around working times and pay policy can help.
• Maintaining a strong governance framework is important for all companies: The UK Corporate Governance Code requires Nominations Committees of quoted companies to maintain an effective succession plan, based on merit and objective criteria and which promotes diversity, cognitive and personal skills.
Remuneration committees are responsible for ensuring remuneration policy promotes long-term growth in shareholder value in accordance with strategy and the company’s succession and risk policies.
Governance principles set down the requirement but leave it to companies to determine the policy which works best for them. So, there is plenty of scope. Nomination and remuneration committees should combine to:
– identify the core competencies required to be a member of the board/leadership team; and
– develop a pay policy to assess and reward performance against those core competencies.
Remuneration policy can help employees see their relationship with the company in a long-term perspective and thereby retain the talent for the future.”
Having established the benefits of considering succession planning, Paul went onto address the potential dangers and made the observation that a failure to plan involves risk.
“A failure to grapple with the issue of succession might give rise to stakeholder concerns about stability, competitiveness and growth because how well it is managed represents a key measure of board effectiveness.
The company also risks the prospect of having to take unplanned, reactive action, which might result in unwanted cultural and value changes on the arrival of a new CEO and delay in finding a new CEO may be disruptive and have an adverse effect on performance, morale and confidence.
Following on from this thoughtful introduction, a wide range of practical issues were addressed in discussion over dinner. Whilst the Chatham House Rule applies, a note of the topics aired will be circulated and will provide the basis for an article in the December edition of our Newsletter. In the meantime, the following are some of the key aspects arising from the evening:
Drawing the strings together
• Succession planning is part of risk management; it is a vital task for boards to address; how well it is managed represents a key measure of board effectiveness
• Identifying, developing and assessing the competencies required for leadership are essential
• Knowledge transfer from more experienced employees plays a key role in succession planning
• Remuneration policy has a major role to play in the development, assessment, retention and recognition processes
• Nomination and remuneration committees should combine to develop and retain the next generation of leaders.
- November 19, 2019
Towards the wider use of deferred share plans
Study by the “Purposeful Company”
The Purposeful Company is an independent voluntary think tank set up in 2015 with the support of the Bank of England to help transform British Business by identifying with like-minded companies changes to policy and practice aimed at creating long-term value. The think-tank has published extensively on policy matters relating to Executive Pay, Corporate Governance and Investor Stewardship.
In October 2019, it published a report which considered the use of deferred share plans by British companies. Increased use of such plans was the main recommendation of the Investment Association Working Group in July 2016 (a body comprising investors and major companies, to address the future of executive remuneration which was seen by many commentators to be broken). The Working Group’s headline recommendation was to simplify pay structures and get away from existing long-term incentive plans which were recognised as not working effectively for most companies. Shareholders wanted companies proactively to consider whether alternative performance incentives may better align pay with a company’s strategy. In particular the earlier report sought to encourage the use of Deferred Share Plans, such as restricted stock plans, in preference to the ubiquitous Performance Share Plans (LTIPS). The latter were considered to be the cause of undue complexity in executive pay packages.
In the three years since this report, very few companies have taken up this recommendation. Only about 5% of FTSE 350 companies use them. This new report seeks to address this problem and re-open the initiative – to find out if there is still support for greater adoption of deferred share plans amongst investors and companies (there is), to explore further their benefits and to find what the barriers are to wider adoption. The report is in two parts – the Key Findings and Recommendations and the Full Report.
The report steering group comprises five people, mostly business school academics. They engaged with over 100 organisations (asset owners, asset managers, companies, proxy advisors and remuneration consultants) and reviewed the experience of 19 companies that are currently operating deferred shares. Three-quarters of investors and companies believe that deferred shares are the best approach in the right circumstances. Deferred shares include restricted shares (awards of shares with no further performance conditions, other than possibly a minimum performance underpin condition prior to vesting) deferred bonuses or performance-on-grant awards. For full effect the deferral should be very long-term and ideally include a period when the executive is no longer in the role.
Academic research in the UK and the US indicates that share ownership alone can provide sufficient motivation to increase share value. There is also evidence that companies using restricted stock outperform those using LTIPs. It is not necessary to have performance hurdles. However, not everyone accepts this view and there is, potentially, considerable resistance to the introduction of a deferred share plan. Whilst such a plan is simpler than an LTIP, there is likely to be a lot of work and consultation persuading shareholders and proxy agencies that it is a measure to support. The two reports provide a lot of evidence and recommendations to help companies that wish to implement a plan. They consider that IA guidelines and proxy advisor guidelines will be revised in time for the 2021 season and companies planning a deferred share plan can use this to set their timetable for change.
- October 25, 2019
MM&K has published its 2019 Survey Report on Compensation in the UK and European Private Equity and Venture Capital Fund Management industry.
Nigel Mills reflects on some of the key findings in the Report which supports the hypothesis that this sector is in boom times.
On 14th October MM&K published its 2019 European Private Equity and Venture Capital Compensation Report. The Report is derived from the Survey that we conducted in the year into pay and incentive practices in the European PE and VC fund management industries. This is the 25th consecutive year that we have conducted a survey of this kind. This year we collected data from 44 different European PE and VC fund management firms who provided us with data on 1,700 incumbents.
This is our most comprehensive survey for a number of years (since 2008) and it has provided us with another fascinating insight into the world of private equity and venture capital fund managers’ pay.
The 44 firms can be broken down as follows in terms of investment strategies:
(i) Buyout, mezzanine, growth capital and infrastructure – 23 firms;
(ii) Venture capital – 16 firms; and
(iii) Fund of funds and secondaries – 8 firms.
Three firms invested in more than one strategy.
Some of the key findings from the survey are set out below.
The headline takeaway is that the market for top quality talent in the sector remains extremely competitive. We see that the sector generally is booming with a large number of firms recruiting, either with a view to simply increasing their headcount to deal with the strength of the business pipeline or in some cases to move into the sector for the first time.
About 67% of firms across all investment strategies reported increasing their investment staff numbers (100% of Venture Capital firms) and, 56% their support staff in 2018.
Around 75% of firms are expecting to increase the number of their investment professionals in 2019, and about 58% are expecting to increase their back-office staff numbers.
The median 2017 to 2018 increase in total short term cash for investment professionals across all investment strategies ranged from 19% to 40% depending on grade, with the more junior positions seeing the largest increases in take home pay. Within these figures it was the more junior positions in the venture capital houses who fared best of all, although across the board Associates and Analysts all saw healthy increases in their take home pay. Part of these increases were the result of generous increases in base salaries (typically between 6% and 12%) but the main component was the increases in bonus levels.
The reason why the more junior roles seem to be seeing the largest increases in their bonus levels is, we believe, a recognition by their bosses that these individuals are the future lifeblood of the business, the rising stars and perhaps the most difficult to retain given the competitive market that they are in.
We are not surprised to see the venture capital investment managers having such large increases in their bonus levels for the 2018 performance year. VC generally had a great year in 2018 with venture capital funds raised in the year exceeding previous highs.
Also, in the UK, venture capital investment increased by 21%, more than double what it was in 2015. 698 companies were venture-backed: a 44% increase.
In contrast to management buyouts which seem to have had a bit of a slowdown, the venture capital industry appears still to be booming with European VCs still deploying capital at a record pace. The total amount of venture capital invested in European companies was up 61% in in the first half of 2019.
It is not surprising to see that over 40% of firms are expecting their bonuses to be paid to their investment professionals for 2019 performance to increase again over 2018. And no firms are expecting bonus levels to fall, either for partners or non-partners.
Next month we will provide some further commentary on the findings from our European Report and also from the North American Report which has also recently been published.
MM&K has had a particularly busy year advising alternative investment management firms on their pay levels and remuneration structures. Our clients this year have included family offices, buy-out and venture capital fund managers and infrastructure fund managers.
- October 25, 2019
Global Trends in Corporate Governance – new research by MM&K and our partners in the GECN Group
The global investment landscape is changing. Investors are under increasing pressure to consider carefully the long-term sustainability of their investments and to demonstrate that their engagement and investment strategies are designed and executed with the best interests of the end-beneficiaries in mind. The revised UK Stewardship Code, published on 24 October is evidence of this. Consequently, investors are making more demands from their portfolio companies particularly in the area of engagement.
MM&K, together with our partners in the GECN Group (Global Governance and Executive Compensation Group) recently interviewed 25 global investors to understand the issues which are of most concern to them, their views on the way companies engage and their thoughts about the most important future trends.
Board effectiveness is a key issue for investors and from Australia and Asia to the EU, UK and US, three high-profile issues consistently emerged in connection with environmental, social, and governance (ESG) concerns:
(1) Climate change
(2) Human capital and diversity
(3) Executive pay.
During the interviews, investors expressed deep concerns that corporations are not providing enough transparency in their disclosures to show alignment between shareholder, other stakeholder and executive interests on these issues.
The research highlights the importance of corporate responsiveness and engagement with investors and provides insights into the areas in which investors and other stakeholders are challenging corporations and governments to look beyond shareholder value and “do the right thing”.
The report on this research, which also identifies approaches companies can usefully adopt to gain most value from their investor engagement programme, will be available shortly. An executive summary is available now. To receive your free copy, please click the link below.
- October 25, 2019
FRC’s transition to ARGA sailing into in the Doldrums
In our July Newsletter, we wrote about the Financial Reporting Council’s (“FRC”) programme of transition into the Audit, Reporting and Governance Authority (“ARGA”), a statutory body with enhanced regulatory powers to address corporate governance failures and audit malpractice.
What, if anything, has happened in the meantime to demonstrate progress? This is, clearly, a question exercising Sir John Kingman, whose 2018 report was severely critical of the FRC and was the catalyst for its transition to ARGA. But the recent Queen’s Speech contained no reference to the legislation required to provide statutory underpinning for ARGA and to bestow the powers it needs to operate effectively. This has prompted Sir John to write to BEIS expressing concern that this omission will allow the FRC to drift along in a toothless, half-reformed state.
That is not to say that no progress has been made and Sir John Kingman recognises this. Former HMRC CEO, Sir Jon Thompson and former GlaxoSmithKline CFO, Simon Dingemans have taken-up their roles as CEO and Chair respectively of the FRC (ARGA), in place of Stephen Haddrill and Sir Winfried Bischoff. Simon Dingemans is also a former partner at Goldman Sachs. Both new men have strong financial and commercial credentials, augmented in Sir Jon Thompson’s case by leading roles within Government departments – an indication perhaps that ARGA’s new leadership team is unlikely to have any trouble managing relationships with company boards, auditors or Government.
The FRC’s goal is to recruit an additional 80 employees in 2019/20. Its 2018/19 Annual Report indicates that the Enforcement Team has been increased by 25% to deliver more timely and effective enforcement of audit standards. Whilst audit may grab the headlines, the FRC’s remit extends far beyond, including the UK Corporate Governance Code, to which far-reaching amendments were made in 2018 and the Stewardship Code.
On 24 October, the FRC published a “substantial” and “ambitious” revision to the Stewardship Code. The revised code, which comes into force on 1 January 2020, extends to service providers as well as asset managers, to help the investment community develop and align a consistent approach to stewardship.
Signatories’ annual reports must describe their stewardship activities across all asset classes (including alternative investments) wherever situated and the results of those activities, including engagement and their voting records. Signatories will also be expected to take ESG factors into account and will be required to explain their investment strategy and culture, and how they relate to their stewardship activities. Finally, signatories will be expected to work together with regulators and industry bodies to identify and manage systemic risks.
This signifies a move towards greater transparency, which is to be applauded. However, it also means there will be a greater workload, which will require higher resource levels. And importantly, if the FRC is to operate as an effective partner and regulator (not only for the investment community but for UK companies and audit firms, as well) it must also have the legislative underpinning as recommended by Kingman. This raises questions about the incursion of political bias into the equation and the need for adequate safeguards, but the path has been laid and the failure to include proposed legislation in the recent Queen’s Speech leaves the FRC potentially becalmed as a regulator without the teeth to deliver its remit. If that comes to pass, all the good work may count for nought.
To discuss any points arising from this article, please contact: Paul Norris.
- October 24, 2019
Getting in is easy. But are you sure you know how you are getting out?
The recent changes proposed by the FCA due to the Woodford Investments situation should be an important reminder to private companies as well as listed ones
Recently, the FCA advised that it would finally be going ahead with a rule change that it proposed last October. Under this change of rules, a new investment category of ‘funds investing in inherently illiquid assets’ (FIIA) will be created. Funds that fall into this category will be subject to additional requirements, including increased disclosure of how liquidity is managed.
Whilst these changes will not come into effect until 30 September 2020, it is worth considering whether your business – and in particular any privately held, owner led businesses – would fall into this definition of a FIIA (despite being unlisted).
Without doubt, long term incentive plans (“LTIPs”) are important in all companies and businesses as a tool to assist with both long term retention and productivity. Studies undertaken into this area show that the mere act of having some form of LTIP increases retention by about 1/3rd.
However, it is the prospect of a meaningful pay out under an LTIP which can be the motivating factor for many executives and employees.
Unfortunately, over the past few years, we have seen many LTIPs which are ultimately ineffectual because there is no practical and cost effective way for payments to be made – the most typical example of this is where a private company issues shares but there is no subsequent sale of the business to third parties. The individual is left holding a share which will not have any value unless the existing shareholders (directly or via the company or an EBT) purchase the shares – methods which may not be popular due to the increased costs involved.
Should you consider that your LTIP might have fallen into this category, there are incentive structures that could still deliver your key commercial aims.
For further information or to discuss any questions you may have, please contact Stuart James.
- October 24, 2019
New UK Stewardship Code comes into force on 1 January 2020
The Financial Reporting Council (FRC) has made significant changes to the UK Stewardship Code which will come into effect in January 2020. The Code will then require Investment Companies to report annually on their “stewardship activity”.
Changes to the code include:
• Extending the Code to include asset owners (pension funds and insurance companies) service provides and asset managers
• Annual reporting on stewardship activity (including voting records in their investee companies)
• Particular emphasis on environmental, social and governance factors during decision making
• Asset owners laying out their stewardship across different asset classes (including investments outside of the UK)
• Setting out stewardship practice within the organisation including how they have demonstrated this in the previous year
The full code can be downloaded from the FRC here
Nigel Mills will be giving his views on how this may effect asset owners including in particular Private Equity Fund Managers in our November newsletter. To sign up for our newsletters please click here.
- September 30, 2019
Board Effectiveness: the next lever of value creation
Increasingly investors look into how organisations are governed and how effective the top decision-making bodies of organisations really are. In this white paper, Dr Sabine Dembkowski of better Boards Ltd, sheds light on research findings and reveal the seven hallmarks of effective boards. The seven hallmarks are proven to create more effective boards and are set to be the next lever in the value creation process. Read more or contact Paul Norris for further information.
- September 27, 2019
Issues which are of most concern to investors and how they are dealing with them
MM&K is the UK member firm of the Global Governance and Executive Compensation Group (GECN), a consortium of independent advisory firms specialising in executive compensation and corporate governance and jointly serving clients in more than 30 countries.
As investors are demanding more today than ever before from the companies in which they invest their capital, successful engagement between corporates and investors is an essential element of good corporate governance. GECN is about to publish a report on Global Trends in Corporate Governance: Investor Expectations in Corporate Governance and Executive Compensation, which examines investors’ perspective on these and other issues that are important to them, and how they are raising these issues as part of their engagement with their portfolio companies.
The report’s contents are based on feedback obtained from 25 comprehensive interviews with some of the largest asset owners and managers, including both active and index investors, as well as organisations which advise them.
In addition to direct quotes from participants, the report also includes an analysis of quantitative data relating to corporate governance practices and the differing approaches investors take when they feel management and the board fail to address their concerns.
Using the interview feedback, the report identifies seven approaches companies can adopt to help ensure that their investor engagement is both constructive and successful.
This research provides a global and regional perspective on the issues of greatest importance to investors and suggests how corporates can anticipate these issues and respond to them in the most effective manner.
To obtain a copy of the report or to discuss corporate governance and investor engagement in general, please contact Paul Norris.