Designing remuneration policy for the “new normal”
June 29, 2020
All of us have had to make major adjustments to our lives over the past three months. Boards of directors and their remuneration committees are no exception. Many companies have been required to make transformational changes to their operations and their remuneration policies, and may yet have to make more.
Here are five key agenda items for remuneration committees as companies navigate their way to a successful transition to the “new normal”, whatever that might look like for them:
In many cases, corporate objectives and related performance targets, set before lock-down for both annual bonus and LTIs, will not be achievable. The Investment Association recently published guidance on the way investors expect companies to deal with this. However, their approach may not work for everyone.
Some have commented that the current, economic situation, highlights the importance of relative performance, particularly TSR. We do not share this view.
Remuneration committees and investors should be concerned about the ability of relative TSR comparisons to produce maximum vesting for management, despite lower returns to shareholders. Mitigation, based on the underlying financial performance of the company determined at the discretion of the committee, may do little to avert criticism if it is perceived, at a time when executive pay is likely to be subject to even closer scrutiny, that executives have not shared the pain with investors.
Three-year rolling LTI cycles will be affected, possibly up to 2022, by 2020 performance. As a result, many companies have had (and will have) to re-think the design of their incentive programmes, paying particular attention to:
• funding and
• performance measures / targets.
MM&K has written about the emergence (and benefits) of restricted share plans as a way of retaining executive talent and aligning their interests with those of their shareholders over time. We expect this trend to quicken.
2. Use of discretion
In our experience, remuneration committees are sometimes wary about exercising discretion, on the grounds that they will be damned if they do and damned if they don’t. However, we expect to see greater use of discretion, particularly in relation to annual bonus, as committees battle with the difficulty of identifying performance targets and need to find some basis on which to set incentive awards.
But the exercise of discretion requires care. More than ever, committees need to be in touch with remuneration policies for the wider workforce, whose incentives may be formulaic. It may be hard for the committee to justify a maximum bonus award for top executives after exercising discretion to adjust for missed objectives if, in the wider workforce, bonus awards are reduced owing to missed targets.
Proxy agencies oppose discretion. This is not likely to change but there is pressure to reduce their influence, which should reduce the dependence placed on their views by some committees. Therefore, committees need support to develop clear policies which they can justify to stakeholders. Early engagement to present well thought-through proposals to investors has never been more important.
A stronger focus on diversity and inequality, apart from disclosure requirements, is likely to create heightened attention on the CEO pay ratio, which will require committees to balance carefully:
• performance and competitiveness
• ESG priorities and
• customer, employee and shareholder expectations
as part of their assessment of the justifiability of the company’s remuneration policy and practice.
Committees may also be asked to pay interim bonuses to retain key executives. Such awards must be considered on their individual merits. However, committees might consider the quid pro quo of a commitment to repay the award if the executive resigns before the end of the financial year to which the bonus relates.
Remuneration data for 2019 may be unreliable in relation to 2020 and, possibly, 2021. Committees will need to work with their HR departments and external advisers to reach decisions about the positioning of remuneration for the next year or two.
It may, therefore, be prudent to make an early start on the 2020 review.
5. Working practices
Mass scale working from home has transformed working practices, aided by technology. It will be interesting to see its effect on pay policies; lower pay as a trade-off for a better lifestyle or higher pay because there are fewer people to do the work?
Lower employee numbers are likely to increase focus on diversity and impact on training, recruitment and culture. Unless the “new normal” is the same as the “old normal” (which is looking increasingly doubtful), companies will need their remuneration, recruitment, diversity and ESG policies to come together to manage the future.
With thanks to our friends at Johnson Associates Inc. in New York, whose observations about pay in the financial services sector, in which they are specialists, provided the inspiration for this article. For further information or if you would like to discuss any of the points or issues raised, please contact Paul Norris.