The IA has been asked questions about how conflict in Ukraine might affect LTIs but the answers lie in the boardroom, not in statements from the IA
April 19, 2022
Many readers will be aware that last month, the IA issued its response to two issues arising from Russian sanctions and the economic impact of Russia’s invasion of Ukraine, namely:
- LTI award sizes in light of the recent fall in share prices; and
- Whether a six-month delay in setting LTI targets would be appropriate, owing to continuing uncertainty.
The IA’s response contained warnings to remuneration committees about the importance of avoiding windfall gains and the need to ensure award sizes are appropriate. On target-setting, the IA concluded, in a move that distinguishes its earlier guidance on COVID; “The ongoing macroeconomic impact of the Russian invasion including the increase in energy costs, should not in itself be a reason for delaying target setting.”
So far, so unsurprising. But this episode raises a number of questions, including:
- Why were these two issues raised at all? and
- In what circumstances might it be appropriate to delay setting or, more controversially, amend, LTI performance targets?
Recent market data indicates that the FTSE100 has fallen more than 5% since the start of 2022 but is about 5% higher than it was a year ago. The FTSE250 has fallen by about 15%, similar to the German DAX40 and French CAC.
Market share prices fluctuate – it’s one of the reasons why most LTIs adopted by established listed companies provide for annual awards.
Unlike COVID, the impact of which could not reasonably have been foreseen, energy price rises have been foreshadowed as have Russia’s territorial ambitions in Ukraine and western Europe’s dependence on Russian gas. Whilst many, if not all, companies are likely to be affected by rising energy and commodity prices and the effect of sanctions, many fewer are likely to be directly affected by the conflict in Ukraine. Companies most likely to be directly affected are those with supply chains or major production or technology development facilities there. They will have looked carefully at the risks.
Investor guidance (and good governance) requires LTI design to support business strategy. Boards are responsible for formulating strategy and for assessing the associated risks to the business, which might affect its ability to produce acceptable returns to shareholders. Business plan projections will take account of those risks, as will remuneration committees when setting targets linked to LTI awards.
If management choose to adopt a new strategy because the old one is not deemed to be working, that is their call. Would it not be reasonable, however, for shareholders to expect management to achieve pre-existing targets with their new strategy – on the grounds that the new strategy is management’s (current) view on how best to achieve the targets it has agreed with shareholders?
That being said, the answer to the question of whether it can ever be justifiable to make in-flight amendments to LTI targets must be yes. But it’s going to depend on the specific circumstances of each business. A delay in setting targets does not seem to be the answer and could be risky.
Perception can be a more powerful determinant of sentiment than reality. Appearing to wait to see which way the wind is blowing before setting the direction of travel might appear to be like having cake and eating it. If management are seen to be treated (or seeking to be treated) more favourably than the workforce or other stakeholders having an interest in their businesses, corporate governance issues arise, potentially risking criticism, including on ESG grounds. It has been reported in the press recently that FTSE100 companies are already bracing for battle with their shareholders in this year’s AGM round on matters concerning ESG and pay.
If setting LTI targets is not feasible, a better course might be to suspend the whole LTI plan, as some companies have done in recent years, and make awards of restricted stock to retain a management team that is recognised as doing a good job in difficult times – whilst ensuring that the action taken for management is not inconsistent with the wider workforce and taking account of all stakeholders’ interests.
There is no doubt that both the direct and indirect effects of conflict in Ukraine, whether or not they might have been foreseen, raise questions for companies about how, if at all, to adapt their remuneration policies. The answers will not be found in a statement from the IA. They must be found in the boardroom.
To discuss any of the points raised in this article, please contact Paul Norris.