MM&K news 2019

  • November 25, 2019

    With the majority of parties now having published their manifestos, what clues do they contain as to the future direction of corporate governance and executive pay in the UK?

    This article is strictly apolitical – as countless polls have shown, it is impossible to predict how an election will be decided. However, irrespective of who wins (or perhaps which parties form a coalition) it is undoubtedly true that policies from one party can influence decisions of other parties.

    Even more crucially, when, as in the 2017 General Election, there was general consensus over an issue (such as pay ratios or increasing worker representation) changes followed within a year.

    So, what messages might we be getting from the manifestos?

    In terms of the Conservative party, unlike 2017, when actions around reward and pay were specific and targeted, the current manifesto raises only one point regarding executive pay:

    • “We will improve incentives to attack the problem of excessive executive pay and rewards for failure.”

    No explanation is given as to what “improving incentives” means in the context of ’rewarding failure’ or as to where those incentives are aimed and it seems a strange turn of phrase given that Remuneration Committee’s receive a flat fee in respect of their work on executive pay. NEDs are not supposed to participate in incentive pay plans but could this be a veiled recognition that whilst the remit of remuneration committees has expanded, their fees have not followed suit?

    Given the absence of anything more definitive, it is worth considering the Labour and Liberal Democrat manifestos.

    The main point of agreement in both documents is an extension of the requirement for large UK companies (i.e. those with 250+ employees) to report more “gaps in pay”. Both parties support an extension to record Black, Asian and Minority Ethnic (BAME) pay gaps. In addition, the Labour party would extend this to include gaps based on disability reporting and the Liberal Democrats to LGBT+ reporting.

    It is interesting to note that, in terms of gender pay reporting, Labour are proposing to extend the influence of government through the requirement that all large companies (listed or otherwise) will have to get government certification regarding their approach and level to gender equality.

    In terms of other common policy points, both Labour and the Liberal Democrats have indicated support for a proportion of a large listed company’s shares to be held in trust for employees. We assume such measures would be settled by an issue of new shares, thus diluting existing shareholders.

    The amount to be put into trust would be mandated at 10% by Labour (as previously indicated by Shadow Chancellor, John McDonnell) and, to avoid executives taking the largest share, the maximum payment receivable would be £500 per person per year.

    In comparison, the Liberal Democrats are only proposing a right for workers in large companies to request that a trust is created for employees.

    The other area of common interest in both manifestos is in respect of worker representation on Boards, with the Liberal Democrats suggesting that there should be one such person and Labour indicating that 1/3rd of the Board should be elected “worker-directors”.

    Only once things have settled after the Election will we have a better idea of what might occur in the short term.

    In terms of likely outcomes, the current Conservative government has expressed support already for BAME reporting and, therefore, it is strongly possible that this particular measure will be actively introduced within the next year.

    It is more difficult to tell with the other matters. However, given the general direction of travel, it is likely that issues of pay and corporate governance will be areas in which all parties (should they need to) are likely to feel that concessions could be made.

    For further information about the issues raised in this article or to discuss any questions you may have, please contact Stuart James.

  • November 25, 2019

    MM&K and its partner firm in the US, Holt Private Equity Consultants, have published their 2019 Survey Reports on Compensation in the UK and North American Private Equity and Venture Capital Fund Management industries.

    Nigel Mills reflects on some of the key findings in the Reports with regard to pay levels on both sides of the pond, and the levels of Management fees and Performance fees (or Carry).

    In October MM&K and Holt Private Equity Consultants published their 2019 European and North American Private Equity and Venture Capital Compensation Reports. The Reports are derived from Surveys that were conducted in the year into pay and incentive practices in the European and North American PE and VC fund management industries.

    Some of the key findings from the surveys and commentary thereon 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 both in the US and in Europe, 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.

    The stats from both North America and Europe showed significant increases in total cash compensation for non-partner investment professionals across all strategies. And, as in Europe, the North American VC data showed that the VC strategy, in particular, is doing particularly well in the United States.

    As most observers will know, the ability to reward and incentivise key talent in this industry is very dependent on the revenues that the firms make from management and performance fees (or carry). It is interesting to observe the slightly differing fee structures as between the European and North American Houses. In both territories, the standard fee structure remains 2% Management fee and 20% Carry (two and twenty). These still represent the median numbers for all participating houses both in Europe and North America. However, when one delves a little deeper, one sees that whilst this is still the standard for the Buy-out and growth capital houses, the numbers look a little different for the VC houses and for the fund-of-fund entities.

    In Europe, the median annual management fee for VC funds is 2.3%, whilst in North America it is 2.4%, perhaps unsurprisingly quite a bit higher than for the Buy-out houses. In sharp contrast to this, for fund-of-funds managers, the typical annual management fee is 1%, both in Europe and in North America, and for larger funds it is actually some way below this.

    20% carry is still the norm for the large majority of independent direct investing fund managers, although one does still see quite a number of 25% carry plans in VC houses in the United States. In fact, the upper quartile figure for VC Carry in North America is 25%, whilst in Europe it is 21%. This would suggest that over 25% of VC funds in the United States have a carry percentage of 25% or greater.

    Interestingly (and in our view rather surprisingly) we have not seen much movement in these figures over the last ten years or so. However, the one area where we are starting to see some movement is in the hurdle rates of return applying to carry plans. In the European Report, 18% of carried interest plans now have a hurdle rate of less than 8%. A few years ago, there would not be any plans (in the UK at least) with hurdle rates below 8%.

    One last interesting statistic relating to differences we are seeing between European Houses and North American firms is to do with how widespread the Carry is among the members of the firm. In North America it seems that over 80% of the carry is spread among the partners and only c 18% goes to non-partners. In Europe, we are seeing carry being spread more widely among the more junior investment professionals with only c 68% of the carry being allocated to the partners. It may well be that in the UK, in particular, there is a greater recognition of the need to incentivise and retain the more junior investment professionals in a very competitive market place. Offering them a small slice of the carry can help to do this.

    Readers wishing to obtain more information on this survey should contact Nigel Mills or Margarita Skripina.

  • November 25, 2019

    Revised and Strengthened UK Stewardship Code sets new world-leading benchmark

    Nigel Mills summarises some of the changes in the new Code and the impact it will have. One key change is that signatories now have to explain their Stewardship approach in their alternative investments such as PE and Infrastructure.

    The Financial Reporting Council (the FRC) launched a significant and ambitious revision to the UK Stewardship Code at the end of October 2019. The Code was last updated in September 2012.

    The Code was originally introduced to enhance the quality of engagement between investors and companies to help improve long-term risk-adjusted returns to shareholders.

    The new Code (the UK Stewardship Code 2020) substantially raises expectations regarding how money is invested on behalf of UK savers and pensioners.

    The new Code focuses on protecting the interests of UK Savers and pensioners by seeking to ensure that their money is managed (and invested) responsibly with a new emphasis on creating long-term value and while doing so, considering sustainable benefits for the economy, the environment and society.

    The FRC’s Chief Executive, Sir Jon Thompson said “I encourage institutional investors, asset managers and their service providers to sign up to the new Code and demonstrate that they are operating across their businesses to these high standards of Stewardship.”

    The new Code contains 12 principles for asset owners and asset managers and six separate principles for service providers. Each principle is supported by reporting expectations which indicate the information which a signatory to the Code should include in its Stewardship Report. The structure is different from that adopted by the UK Corporate Governance Code (which relies on principles and supporting provisions).

    The new Code makes it clear that: Environmental, particularly climate change, and social factors, in addition to governance, have become material issues for investors to consider when making investment decisions and undertaking stewardship.

    Signatories are now expected to explain how they have exercised stewardship across asset classes beyond just listed equity, such as private equity and infrastructure and in investments made outside the UK.

    The Code is voluntary and operates on a comply-or-explain basis. The Financial Reporting Council monitors compliance with the Code.

    Whilst the Code is voluntary, there is no doubt that the pressure is on for all UK asset managers to sign up to it, whether it be in connection with their listed investments or their unlisted ones. Asset managers are required under the FCA COBS to disclose the nature of their commitment to the Code or, where they do not commit to the Code, their alternative investment strategy.

    It does appear that the very large majority of the traditional UK fund management community have already signed up to the Code. This includes many UK hedge fund managers.
    However, there seems to be a large number of PE fund managers that have not yet signed up. We would suggest that those businesses will need to consider doing so.

    For further information contact Nigel Mills.

  • November 25, 2019

    “Does making the rich poorer make the poor richer?” – a new concept or just a misuse of Sir Winston Churchill’s quote “You don’t make the poor richer by making the rich poorer”.

    This month, the High Pay Centre (HPC) held an event to talk about pay and the increasing gap in incomes between those at the top and those at the bottom. In recent years, executive remuneration has attracted a lot of attention and is being thoroughly scrutinised by the media. So, can the Robin Hood effect be achieved without sending the economy into a turmoil?

    A panel consisting of representatives from the HPC, the Institute for Fiscal Studies, the GMB union and an independent writer/researcher, presented their thoughts on the topic. In this presentation only one side of the coin was discussed – how to make the rich poorer. The panel promoted the idea of wealth re-distribution but failed to identify how this is to be achieved. They also failed to mention the potentially negative effect of government intervention in the economy.

    This event has yet again highlighted, that while the HPC was set up to be an independent organisation it is nonetheless politically orientated.

    Robert Joyce, Deputy Director of the Institute for Fiscal Studies (one of the speakers) – used the latest available data from HMRC (2014-2015), to produce a report entitled: “The characteristics and incomes of the top 1%”. According to this report, across all income tax payers in the UK, the median tax payer has an income of about £22,000 per year, while at the 99th percentile, taxable income is £162,000. The top 0.1% earn a taxable income of about £650,000 and above.

    It is important to understand that the study includes the self-employed, entrepreneurs, business owners, partners and investors. So, the comparison is between salaries in some cases and total income in others. This is a skewed statistic which compares apples with pears and is used as a weapon to back a particular view rather than to offer objective comment on the topic.

    Robert Joyce also highlighted, that the dramatic income gap appeared in the period from 1980 to 1990. Since then, the top 1% of earners have continuously pulled away from the rest.

    So, could we attribute this gap in incomes between top and bottom to the reduction in income tax rates from 83% in 1979 to 40% in 1989 (for the top rate)? And if so, could the rapid growth in the country’s GDP in that period and subsequently be the result of tax reform and top earners being rewarded for top performance?

    The graph below represents the figures for GDP according to the Office of National Statistics:

    Sir Winston Churchill said: “For a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle”.

    In the current general election, campaign wealth re-distribution and change in tax rates are subjects both major parties are addressing. It remains to be seen what the majority of population think.

    For more insights on the executive pay please contact Margarita Skripina.

  • 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.

    • LTIPs

    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
    – diversity
    – 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.

    For more information about remuneration planning and management succession please contact Stuart James or Paul Norris.

  • 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.

    For further information contact Damien Knight or Stuart James.

  • 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.

    Readers wishing to obtain more information on this survey should contact Nigel Mills or Margarita Skripina.

    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.

    For more information, please contact: Margarita Skripina or Paul Norris.

    Click here to reserve your free copy of the executive summary

  • 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.

  • December 18, 2018

    Launch of the Wates Principles for large private companies

    As we have already mentioned in our “Executive Remuneration Landscape” article, which was published in our September e-newsletter, 2018 has been one of the most eventful years in terms of remuneration governance in the UK.

    Earlier this year we saw the publication of the 2018 UK Corporate Governance Code, which is applicable to all companies with a premium listing on the London Stock Exchange and states general corporate governance principles for them to comply with.

    Now, as we reach the end of the year, the Wates Principles for large private companies have been launched for companies to adopt for financial years starting on or after 1 January 2019. This new requirement applies to companies that have either or both of the following characteristics, and will cover about 1,700 private businesses:

    • more than 2,000 employees;

    • a turnover of more than £200m, and a balance sheet of more than £2bn.

    The companies that adopt the Wates Principles as a suitable framework are expected to apply them fully and provide a supporting statement explaining how the Principles have been applied to create good corporate governance.

    Ahead of the Launch of the Principles, the FRC organised a consultation, which closed on the 7 September 2018. As a result of this, we can see that a lot of respondents support the initiative; however, some expressed a concern about the ambiguity of the Principles.

    We, in MM&K, support the initiative of the Wates Principles; the proposed Principles are short, logical points that map out the way towards a transparent corporate governance practice. The companies that apply the Principles will be able to develop/improve all aspects of their corporate governance. We also think that application of the Principles will generate a positive change in the relationship with stakeholders.

    Without a doubt, the “BHS scandal” was a trigger to the formalisation of corporate governance practices in the UK for private companies. It is unlikely that the Principles would have prevented the scandal from happening; however, there is hope that it would have made the board aware of the damaging effect of their actions for other stakeholders. And this is one of the purposes behind the Principles – to bring awareness into the boardroom.

    An especially remarkable aspect of the Principles, in MM&K’s view, is their “apply and explain” nature. It highlights the point that one size doesn’t fit all. Private companies have an opportunity to apply the Wates Principles the way they see fit. The freedom of interpretation makes the Principles appealing for a larger number of companies.

    On 12 December, the FRC held a launch event for the Wates Principles, which yet again affirmed that the Principles are welcomed by the attendees, as many large businesses already have similar corporate governance policies in place; the Principles are viewed as a guideline to consistent reporting practice. The discussion panel saw additional value created for companies that adopt the Principles, and view it as a competitive advantage.

    One of the points raised, as a part of a discussion at the launch even, was an adoption of a “Name and Fame” practice for monitoring purposes by the FRC. As a result, the FRC hopes to provide an illustrative guide on the good examples of the Principles’ adoption or of good corporate governance in general.

    The Wates Principles were not designed for companies to “tick the boxes”, but to provide guidance towards a healthy corporate governance environment. The Principles are designed to help companies of all sizes and types to understand the good leadership and performance essential for a successful business.

    For further information contact Margarita Skripina.

  • December 18, 2018

    The Investment Association’s new principles of remuneration for 2019


    On 22 November 2018, the Investment Association (“IA”), wrote to the chairmen of the remuneration committees of FTSE 350 companies attaching its updated Principles of Remuneration.

    These changes to the IA guidelines have been made against the backdrop of the new remuneration provisions in the UK Corporate Governance Code and the changes to the reporting of directors’ remuneration which is due to come into force for accounting periods beginning on or after 1 January 2019.

    However, it appears that many of these principles are aimed at reducing the risk of “excessive” pay or increasing the justifiability of pay.

    Main areas in respect of the principles of remuneration

    The main policy areas for the new principles are as follows:

    Levels of Remuneration

    It was noted that levels of remuneration must reflect corporate performance and pay should be no more than necessary and linked to long term value creation.

    The remuneration committee should seek points of reference against which appropriateness and quantum of pay is judged. Useful reference points are:

    • prescribed policy that links remuneration to overall corporate performance

    • the remuneration policy of the company as a whole

    • fairly constructed peer universe

    • remuneration paid to groups of employees including the median, upper and lower quartile through the use of pay ratios


    The IA observed that the discretion of the remuneration committee can assist in ensuring that executive pay schemes properly reflect overall corporate performance and value creation. It also observed that payment of variable remuneration to executive directors should be discouraged even if specific targets are met where the business suffers a negative effect and in such circumstances shareholders should be consulted.

    The IA recommends that:

    • the remuneration committee should be accountable for the way in which discretion is used and should have sufficient legal power to exercise discretion

    • discretion should be used diligently, aligned with shareholders’ interest

    • discretion to be exercised within policy boundaries

    • use of discretion should be clearly disclosed

    Pay for Employees below Board Level

    The IA recommended that:

    • the remuneration committee should have a role in pay for senior management and review workforce remuneration especially where the levels of pay or the risks associated with the activities are material to the overall performance

    • the remuneration committee should fully explain why the pay figures are appropriate where they are reported and disclose any action necessary to rectify issues

    Shareholder Consultation

    IA expressed its concern that shareholder consultation is being used as a validation of decisions taken by the remuneration committee rather than taking and understanding shareholders’ views.

    IA recommends that:

    • consultation needs to focus on major strategic remuneration issues

    • details of whole remuneration structure should be put forward so that the investors are provided with a full picture and sufficient information so that they can make an informed voting decision

    • shareholders’ feedback and response should be listened to by companies

    • remuneration committee should understand the voting policies of the shareholders

    • after the end of the consultation process and before finalising details in the remuneration report, the remuneration committee should review policies taking into account subsequent events occurring in between so that the proposal remain appropriate

    Malus and clawback

    The IA observed that the current standard trigger events (gross conduct or misstatement of results) for malus and clawback are rarely used in practice. Moreover, even if a trigger occurs, it is difficult to relate the same to an individual director. It therefore recommends a significant strengthening of these provisions.

    The new principles recommend that:

    • a “more substantial” list of specific circumstances should be established when malus and clawback could apply and they should also be disclosed to the shareholders

    • the malus and clawback terms are set out clearly and accepted by the executive (executives should sign a form of acceptance at the time of the award)

    • LTIP rules, allied documentation and communications materials are consistent in relation to the scope and application of malus and clawback provisions

    • remuneration committees should develop clear processes for assessing whether malus or clawback is triggered and how and when they will exercise a discretion to apply the such provision; the process and decision must be clearly documented

    Shareholding requirement

    The new principles include a recommendation that:

    • executive directors and senior executives should build up a significant shareholding

    • executives are encouraged to purchase shares out of their own resources to align their interests with the other shareholders

    • remuneration committees should set out minimum shareholding levels and the time period in which to reach them for executives and also the consequences for non-compliance

    • shares only count towards an executive’s shareholding if vesting is not subject to any further performance conditions; unvested shares not subject to performance conditions can count on a net of tax basis; vested shares subject to a holding period or clawback count towards the shareholding requirement

    • shareholding used in hedging arrangements or as collateral for loans should be fully disclosed

    Post-employment shareholdings

    The new principles include a recommendation that:

    • companies should set up post-termination shareholding requirement for a period of at least two years and at a level equal to the lower of the company’s shareholding requirement in force immediately before leaving or the executive’s actual shareholding on leaving

    • remuneration committee should determine the structure and processes (which might involve using an employee benefit trust or nominee arrangements) to ensure compliance with the post-employment shareholding requirement

    • the post-termination shareholding requirement should be introduced for all new and existing executive directors as soon as possible and by the next remuneration policy vote at the latest.


    The new principles include a recommendation that:

    • pension contribution rates for executives should be aligned with those available to the majority of the workforce

    • new executive directors and directors whose roles are being changed should be appointed on the new pension contribution level

    • contribution rates for existing directors should be reduced over time to comply with this requirement. Clearly this reduction cannot be made without the agreement of the director concerned

    Restricted Share Awards

    Restricted shares (in the UK) are awards of shares (or nil cost options) which vest to the relevant director based on time only and not according to main performance conditions. The new principles include detailed recommendation on the awards of restricted shares, including:

    • restricted share awards may be appropriate depending on the sector and situations such as turnaround situations; they should be assessed on a case-by-case basis, considering the context and the strategic rationale

    • remuneration committees should have the ability to exercise discretion on vesting outcomes to ensure there is an appropriate connection between pay and performance and non-payment on failure; some investors have expressed a preference for a quantitative underpinning condition to be achieved prior to vesting

    • vesting periods for restricted share awards should be at least five years; in addition, the post-employment shareholding rules should also apply

    • if there is a proposal to switch to restricted share awards, investors will consider the company’s previous approach to remuneration, comparing the proposed award levels, performance and vesting criteria with previous award levels and performance conditions

    • if the company moves from an LTIP to a restricted share awards, the remuneration committee should consider the appropriate discount to award levels; the discount should be at least 50% and grant levels should be held without gradual increase.

    Leaver provisions

    A new ‘leaver provision’ has been added with a recommendation that:

    • individuals who are not ‘good leavers’ should be regarded as ‘bad leavers’; in other words there should not be any ‘intermediate leaver’ category

    • for ‘good leavers’, only a portion of the award may vest based on time in service and achievement of the original performance conditions; however, if the award needs to vest early, for example on death, awards should vest by reference to performance criteria achieved over the shorter period

    • deferred bonus and LTIP awards should continue to be satisfied in shares and subject to appropriate performance conditions

    • appropriate mitigation clauses should be included in awards to deal with individuals retiring as a good leaver to take up further executive roles

    For further information contact Michael Landon.

  • December 13, 2018

    MM&K Annual Survey shows positive trends for Venture Capital Firms but a slowdown for Private Equity Firms

    MM&K has published its 2018 PE/VC Compensation Report. The Report, published annually, provides participating houses with comprehensive and incisive up-to-date information and data on both the quantum and structure of remuneration paid to individuals working in and for PE & VC fund management entities in the UK and continental Europe.

    2018 Outlook

    The outlook for 2018 is now becoming clearer and in terms of deal activity, the statistics show a rather mixed picture.

    European Private Equity (“PE”) activity, as measured by deal count, declined throughout the first three quarters of 2018. At the end of Q3, annual deal flow throughout Europe is showing a 15% decrease in the number of deals compared to the same period in 2017. Deal Value is also down by some 15%, suggesting perhaps that the uncertainty over Brexit is having an effect.

    In contrast to PE, the Venture Capital (“VC”) industry appears to be booming with European VCs deploying capital at a record pace. However, the number of deals is slightly down on the same period as last year.

    Looking at exits, it appears that there has been a 24% decrease in the number of PE exits in the first three quarters compared to the same period last year. This is in contrast to Venture, which has seen European exit activity at a four year high. The value of VC exits in the first nine months has exceeded their value in the whole of 2017.

    But on another downbeat note for PE, LPs have so far committed €56bn to European funds that closed in the first nine months of the year, a noticeable decrease in committed capital compared to the same time period last year.

    What all this will mean for PE and VC compensation next year is difficult to predict, although it suggests that the VC community will for once be seeing better rewards (relatively) than the PE houses. We would expect though that the industry’s focus on ensuring that the middle ranking investment roles are well rewarded (and therefore able to be retained within their current firms), will continue.

    Whether these trends will affect the remuneration structures of both VC and PE portfolio companies, is another question…

    If you are interested in finding out what else our 2018 Survey has to say, or are already thinking ahead to remuneration in 2019, please contact Nigel Mills or Margarita Skripina for further details.


  • December 5, 2018

    New Investor Remuneration Guidelines

    As we move into 2019, the investor institutions and proxy agencies have been busy, producing their revised remuneration guidelines.  After a very active year in corporate governance there are, not surprisingly, a lot of changes.

    Starting with Glass Lewis: this major voting advisory agency has just issued its 2019 Proxy Guidelines specifically for the UK .  It is really worth reading, not least because the document provides the best summary we have seen of all the UK corporate governance regulations and other initiatives from 2018, put together in one place.

    Their new guidelines focus particularly on the capability and evaluation of the board and its committees and the guidelines on remuneration itself are generally modest. One curious rule is that target bonuses should not exceed 50% of the bonus maximum.  MM&K considers that that this is misguided. The right relationship between the maximum bonus and the on-target bonus is not a matter to be dictated by rules.  It depends on the dynamics of the business, the extent to which out-performance is possible or likely and the sensitivity of forecasting.  There are businesses where target and maximum should be the same and others where 50% is fully justifiable.

    On 22 November, The Investment Association (IA) issued its new Principles of Remuneration,  with a letter to Remuneration Committee Chairs from Andrew Ninian, its Director of Stewardship and Corporate Governance.

    The new principles generally tighten up remuneration governance along the lines that the IA has been advocating since its Working Group reported in July 2016.  The circumstances and requirements for describing Malus and Clawback have been clarified further; further guidelines around the use of restricted shares have been introduced; and tougher requirements for directors’ shareholding are stipulated, including the need for a post-retirement shareholding period of at least two years.

    It is clear that the IA sees reduction in the levels of executive remuneration as a legitimate goal.  For example, it mandates that, as soon as it is achievable within the limits of existing contracts, directors’ pension contributions should be aligned with those available to the workforce.  This rule, of course, is there to meet the requirement of Provision 38 in the 2018 UK Corporate Governance Code which comes into force from 1 January.  But it is also evident that IA members are coming under pressure from their clients to keep a ceiling on pay in “issuing companies” and curbing pensions is a gesture in this direction as well as appearing to be a move to reduce the gap between executive and general employee remuneration.  The IA press release says that “investors  will expect companies to pay pension contributions to Directors in line with the rate given to the majority of the rest of the workforce, rather than giving higher payments as a mechanism for increasing total remuneration.” In fact, the level of directors’ contribution has never been used as such a mechanism.   It has its roots in history, when all directors were on final salary schemes and the level of contribution was dictated by much higher final salary directors earned.  The DC contributions have been coming down over time as they could never be sustained at a level to match the old DB benefits. In any case, it is all rather academic as the HMRC Annual Allowance reduction of contributions to £10,000 a year means that most executives will receive cash in lieu and over time we expect that to become part of salary.

    The IA is turning up the gas on corporate governance compliance. On 5 December it wrote to 32 companies in the FTSE All-Share which have appeared on the Public Register for both years. The letter expresses concern that these companies are on the Public Register for the exact same resolution in 2017 and 2018, suggesting that they did not respond sufficiently to investor views and in doing so are risking more shareholder dissent in the future. 15 of these are for Remuneration Report resolutions.

    MM&K will be writing a fuller article on the new IA guidelines for our December Newsletter. Click here to subscribe to our monthly e-newsletter.

    The new IA guidelines are reflected in new house guidelines from Legal and General Investment Managers (LGIM), who updated their Principles on Executive Remuneration on 28 November.

    The largest proxy agency, ISS, updated its 2019 Proxy Voting Guidelines for Europe, the Middle East and Africa on 19 November.  Changes include the criteria for voting down a director and a requirement for remuneration committees to develop a formal policy for post employment shareholding.  Like Glass Lewis, they say that the target bonus should typically be set at no more than 50% of the maximum bonus potential, with a demand for a robust explanation for any payments above target.  The intention behind this is to stop excessive payments for mediocre performance.  But we consider it is a blunt instrument.

    ISS have sharpened up the guidelines on LTIP performance measurement and shareholding periods. They encourage performance periods longer than three years and a total holding period of five years. They suggest that on-target vesting for LTIPs should be less than 25% if the total grant is a large multiple of salary.

    If a company’s share price has materially declined, the guidelines say, committees should consider reducing the size of LTIP grants.  ISS are trying to avoid the situation where the number of shares covered by the grant is increased in order to preserve the face value of the grant.  This can lead to excessive reward if the share price bounces back.

    Finally they advise dilution limits in line with the IA guidelines.

    The various guidelines can be downloaded by clicking on the links.  For further information contact Damien Knight.

  • November 27, 2018

    Valuation of share-based remuneration:  importance of underlying assumptions

    There are particular circumstances when a company needs to calculate a fair value of share options or performance share awards.  As the majority of performance shares in the UK are structured as nil-cost options this article refers throughout to options only. The most common circumstances are:

    1. To recognise an accounting expense under IFRS2 or FRS102 (the Finance Director’s nightmare)

    2. To agree the taxable value of the grant with HMRC – this can be needed, for example, to determine the taxable value (if any) on the acquisition of restricted securities, including growth shares or JSOP interests.

    3. To ‘benchmark’ share-based rewards against competitive practice more precisely than would be possible using the ‘face value’ of the shares involved, for example where there are different performance conditions for the company’s own share-based rewards and for those of a comparator company.

    4. To compare the value of share-based incentives with other parts of the remuneration package, where a trade-off between elements is being considered: such as a choice between share-based incentives and cash payments, or between different forms of long-term incentive.

    In each case, another party has to be satisfied that the resulting fair value is indeed fair – the auditor on behalf of the shareholders, HMRC, the remuneration committee and the executives receiving the grants.  Executives frequently prove to be the hardest to convince.

    Nevertheless, it is probable that very few of these parties really understand the mathematics involved, and most take the calculation on trust or apply some standard formula.  In fact, the final value is surprisingly sensitive to the valuation assumptions, such as share price volatility and the expected period before an option-holder chooses to exercise (“option life”).

    Volatility is the key to calculating the value of share options and performance share awards with market-based vesting hurdles.  The future pay-off from an option is a positive value or zero, depending on whether the share price at the time of exercise is higher than the exercise price (which is usually, but not necessarily, the share price at grant).  There are two components to the price increase: the underlying drift of the share price (a function of market expectations) and the extent to which the seemingly random daily changes add up to produce a resultant increase or decrease. If a share price experiences large daily fluctuations, we say that it has high volatility.  With a more volatile share price there is more chance of a high gain at exercise.  There is also more chance of a low downside in the share price, but because the pay-off cannot be less than zero (the option holder just would not exercise), this does not cancel out the extra value from the possibility of a high upside.

    Before we consider how different volatility assumptions affect the value of a share option, we need to find a workable definition of volatility.  To calculate the daily volatility, we look at the standard deviation of the logarithm of the ratio of each day’s share price to that of the previous day. We then multiple this daily volatility by the square root of the number of trading days in the year to get the annualised volatility, which is the measure used in valuing options. We take the natural logarithm because it results in a normal “bell curve” for compounding returns – which makes it possible, later in the valuation process, to model future outcomes randomly in our valuation model. A key assumption in share price forecasting is that returns are normally distributed.

    Not surprisingly, the value of a share option is highly sensitive to the assumption about share price volatility.  The graph below shows how the fair value of an option varies with volatility in a typical company. For clarity, we have expressed the fair value as a percentage of the face value of the shares under option.

    At 10% volatility, the fair value is 15% of the face value of the share. At 40% volatility, the fair value is 43% of the face value, with close to a straight line relationship in between.   The fair value per share is almost three times as much at 40% volatility as it is at 10% volatility.

    We can see that this variation matters when we make assumptions about likely future volatilities.    The reality is we do not know what the future volatility will be or how it will vary.  Most companies rely on the past as a predictor of the future.  If the company issues traded options, we can work out the implied volatility (ie the volatility assumed by market makers) but this will not apply for most smaller companies.

    The situation is even more difficult if we are dealing with a private company. The company is probably valued once a year for tax purposes or for internal share transfers.  The valuation methodology typically uses a profit multiple, or maybe a projection of future profits.  In this circumstance, there is no measurable “wiggle” in the share price.  The company has to estimate its volatility, for example by using an average of the observed volatilities of listed peer companies in its sector to provide a proxy.

    The table below shows how the volatility of one listed company’s shares has fluctuated, depending on the quarter over which it is measured.  The volatility varied by a factor of three, depending on the period chosen, ie Q1 2017 vs Q2 2015.  Neither historical period has a superior claim to representing the future.  There may be industry characteristics for 2017 which suggest that figure is a better predictor because it is more recent, but it depends largely on judgement.  As shown in the graph above, the volatility assumption has a crucial impact on the value of an option or performance share award.


    Depending on the purpose of valuation, the company has a lot of opportunity to choose volatility assumptions which suit its own purpose, provided it can persuade the interested parties, HMRC, shareholders or executives, that the final result is reasonable – one might say “fair”. This persuasion/ negotiation is more important than the mathematical result.  It could well be easier to take a rule of thumb of, say, 30% of face value (MM&K uses 30% of face value for share options in surveys and this is often talked about as a market norm) and agree with the relevant parties that that is a fair figure for the particular purpose in hand.  Unfortunately HMRC is currently insisting that a Black-Scholes or similar option-pricing model is used for valuation of growth shares and JSOP interests, which therefore requires the use of a volatility assumption, even though we have shown this is effectively arbitrary.

    Volatility is not the only assumption that introduces a large degree of imprecision.  We also have to decide the likely behaviour of participants in exercising their options – in order to determine the option life (grant to exercise period).  The graph below shows the impact of different option lives for the value of the option in a typical company.  This is yet another reason for agreeing a rule of thumb.

    For further information contact Harry McCreddie

  • November 26, 2018

    Changes announced in the Budget to the rules for entrepreneurs’ relief


    While there had been concerns whether entrepreneurs’ relief (which reduces the rate of capital gains tax for higher and additional rate taxpayers from 20% to 10% on the first £10 million of an individual’s qualifying lifetime gains) would be significantly reduced, or even abolished, in the Autumn budget, the Chancellor has confirmed that the relief will be retained, albeit with a couple of changes.

    Until 28 October 2018, entrepreneurs’ relief was available on the disposal of shares in a trading company (or shares in a parent company of a trading group) by an employee shareholder provided that throughout the period of one year ending with the date of disposal (the ‘qualifying holding period’):

    (a) the company is the individual’s ‘personal company’, and

    (b) the individual is an officer or employee of the company (or, if the company is the parent company of a trading group, of a group member).

    For a company to be a ‘personal company’, the individual is required to hold at least:

    • 5% of the issued ordinary share capital of the company and

    • 5% of the voting rights of the company.

    Changes effective from 29 October 2018

    The first change to entrepreneurs’ relief is that, with effect from 29 October 2018, a company only qualifies as a ‘personal company’ if, in addition to the requirements relating to share capital and voting rights, the individual is also beneficially entitled to at least:

    • 5% of the company’s distributable profits, and

    • 5% of its assets available for distribution to equity holders on a winding up.

    How does this change affect employee incentives?

    There is no immediate effect on EMI Option holders, including holders of EMI Options over ‘growth shares’ (i.e. a special class of shares which gives the holder the right to share in the growth in value of the company in excess of a pre-determined hurdle). EMI Option holders continue to enjoy the benefits of entrepreneurs’ relief on the disposal of their qualifying shares.

    However, other employee shareholders who typically only hold 5% or more of a class of ‘growth shares’ with voting rights will be adversely affected. With effect from 29 October 2018, their rate of capital gains tax on disposal of their shares will increase from 10% to 20%, because they will not meet the two additional requirements of having a beneficial entitlement to 5% of the company’s assets and distributable profits.

    These changes have been brought in to counter incentive structures that the Government considers to be tax avoidance, where the incentive arrangement has been designed to comply with the letter but not the spirit of the conditions for entrepreneurs’ relief.

    Changes effective from 6 April 2019

    The second change to the entrepreneurs’ relief is that, for disposals on or after 6 April 2019, the ‘qualifying holding period’ (see above) has been increased from one year to two years.

    In other words,  entrepreneurs’ relief will only be available on the disposal of shares in a trading company (or shares in a parent company of a trading group) by an employee shareholder provided that throughout the period of two years ending with the date of disposal (the ‘qualifying holding period’):

    (a) the company is the individual’s ‘personal company’ and

    (b) the individual is an officer or employee of the company (or, if the company is the parent company of a trading group, of a group member).

    How does this change affect employee incentives?

    Practically speaking, this extension to two years is unlikely to have much impact on the majority of employee shareholders (who are otherwise eligible for entrepreneurs’ relief including EMI Option holders). The press release suggests that 95% of disposals already meet the two year qualifying holding period.  To qualify for the relief, an EMI Option holder must not dispose of the shares acquired through the option until at least two years after the option grant date.

    Dilution protection

    Legislation will also be introduced from 6 April 2019 to protect an individual’s entrepreneurs’ relief entitlement up to the point that the individual’s shareholding is diluted below the 5% qualifying requirement as a result of funds raised for commercial purposes by the issue of new shares.

    A new provision will apply where a company has issued shares for cash consideration for genuine commercial purposes, which has caused an individual’s shareholding to fall below the 5% personal company threshold. If gains on share disposals prior to the issue would have qualified for entrepreneurs’ relief, individuals may elect to be treated as having sold and reacquired their shares at market value immediately prior to the dilution, giving rise to a chargeable gain on which they can claim entrepreneurs’ relief.

    There will also be a provision for a second election to defer the gain until an actual disposal of (or of interests in) the shares or securities.

    For further information contact Michael Landon

  • November 26, 2018

    Largest AIM companies stick with UK Corporate Governance Code

    AIM companies are required to adopt a recognised corporate governance code – which one do they choose? One of the main attractions of listing on the AIM market is the reduced regulatory requirements compared to a main market listing, but do the biggest AIM companies take advantage of this, or do they stick with the UK Corporate Governance Code?

    This summer we saw a number of significant changes in light of the UK Government’s wider corporate governance agenda. Alongside the introduction of a new UK Corporate Governance Code and an updated QCA Corporate Governance Code, the amendment to AIM Rule 26 requires all AIM companies to select a corporate governance code.

    Under this rule, as of 28 September 2018, every AIM quoted company must state on its website which recognised corporate governance code it has decided to apply and to explain how it complies with that code. They also need to provide an explanation of any departures from that code.

    Many AIM quoted companies previously stated that they complied with the UK Corporate Governance Code or QCA Code “so far as appropriate for a company of this size” or something similar, i.e. that they do not comply in full (a qualified compliance statement). Such terminology is no longer acceptable and substantive disclosure is expected.

    MM&K has investigated the corporate governance statements of the 20 largest AIM quoted companies (by market capitalisation).

    11 of these companies have adopted the UK Corporate Governance Code, eight have chosen to comply with the QCA Code and one, Burford Capital, reports against the Guernsey Finance Sector Code of Corporate Governance. Research by the QCA itself into the practice of all AIM listed companies (over 900 companies) shows that 89% have adopted the QCA Code rather than the UK Corporate Governance Code. It is clear that the dominance of the UK Corporate Governance Code among the top AIM quoted companies is a feature of company size.

    In terms of level of detail, the corporate governance statements are generally similar. Companies following the UK Corporate Governance Code give a broad explanation of how they comply with its five main principles under the following headings:

    1. Leadership

    2. Effectiveness

    3. Accountability

    4. Remuneration

    5. Relations with shareholders

    Those following the QCA Code provide a broad explanation of how they comply with its 10 principles, which are:

    1. Establish a strategy and business model which promote long-term value for shareholders;

    2. Seek to understand and meet shareholders’ needs and expectations

    3. Take into account wider stakeholder and social responsibilities and their implications for long-term success

    4. Embed effective risk management, considering both opportunities and threats, throughout the organisation

    5. Maintain the board as a well-functioning, balanced team led by the chairman

    6. Ensure that, between them, the directors have the necessary up-to-date experience, skills and capabilities

    7. Evaluate board performance based on clear and relevant objectives, seeking continuous improvement

    8. Promote a corporate culture that is based on ethical values and behaviours

    9. Maintain governance structures and processes that are fit for purpose and support good decision-making by the board

    10. Communicate how the company is governed and is performing by maintaining a dialogue with shareholders and other relevant stakeholders

    The majority of companies make references in their website statement to their Annual Report, for example by providing a link to the Remuneration Report for further details on the committee’s activities. Several also point the reader towards the corporate governance statement in their Annual Report.

    At the beginning of their statement, some companies clarify whether they believe they have complied fully with the code. For example, Fevertree Drinks plc’s statement includes “Given our stage of development there are certain provisions of the Code which we do not feel are appropriate for the Group at this point in time and therefore do not fully comply, further details on which are set out below”. However, only five companies include a statement similar to Fevertree’s, with a further four proclaiming they have not departed from the code in any way. For example, Secure Income REIT plc state “As of 6 September 2018 the Board does not consider there to be any areas relevant to the Company where it does not comply with The Code”. The remaining 11 companies are less explicit on departures from their chosen code.

    The five companies referred to above are clear in explaining how and why they have not complied; a common departure was from provision B.1.2 of the UK Corporate Governance Code, which states that, except for smaller companies, at least half the board, excluding the chairman, should comprise non-executive directors determined by the board to be independent. The reason typically given is that despite non-compliance, the board has an appropriate balance of skills, knowledge and experience to enable it to discharge its duties and responsibilities effectively.

    Another trend is the inclusion of an introduction outlining the company’s beliefs and philosophy surrounding corporate governance. ASOS plc, for example, included the following one by the Chairman:

    “For ASOS Plc, ‘Doing the Right Thing’ is pivotal to every part of the business model and good corporate governance is a key part of this. As an AIM listed company with a significant market capitalisation, we recognise the need for ensuring that an effective governance framework is in place to give our external investor community and our employees and suppliers, the confidence that the business is effectively run”.

    Seven companies divulge their corporate governance philosophy (in six cases it is in the form of a chairman’s introduction).

    Hurricane Energy plc provides an interesting example of switching from the QCA to the UK Corporate Governance Code. In 2017, the Board decided to change due to the company’s size (Hurricane’s market capitalisation rose from under £65m at the start of 2016 to a peak of over £800m in 2017). Still, company size is not the only factor in deciding which code to follow, both Boohoo Group plc and RWS Holdings plc follow the QCA Code and have larger market capitalisations than Hurricane (£1.3bn and £2.4bn respectively).

    The requirement of AIM Rule 26 is very recent. The test of any code and disclosure under it is whether it provides shareholders with the information they need to exercise their stewardship or make decisions on their own behalf in the case of beneficial shareholders. We would expect shareholders to assess over the coming year whether companies are providing this information and to influence companies to change code if necessary. It will be interesting to see if the higher “outcome focus” rather than procedural focus in the QCA Code will lead some shareholders to prefer the AIM companies they invest in to use the QCA Code.

    For further information contact Harry McCreddie or Margarita Skripina

  • November 25, 2018

    Remuneration Consultants Group (“RCG”) Recruitment of New Chairman

    The Remuneration Consultants Group comprises the 11 UK consultancies that advise the remuneration committees of larger companies. The RCG manages the voluntary Code of Conduct (‘the Code’) that sets out the role of executive remuneration consultants and the professional standards by which they advise their clients. It was formed following the Walker Report in November 2009.

    The Board is looking to appoint an independent Chair to replace the current chairman who is stepping down after 8 years in the role. The Chair provides strategic direction to the Board – gained by prior experience as a senior NED able to demonstrate a clear understanding of the operation of remuneration committees (ideally as Chair of such a committee at a FTSE350 company). The time commitment is in the region of 10 days each year.

    In addition to attending Board meetings, the Chairman will be required to lead the Board in the review of the Code and of its effectiveness which may include interviews with representatives of institutional shareholders and chairs of remuneration committees on an annual basis. The Chair is responsible for leading on the appropriate communication strategy for of the Code. To date this has included occasional press interviews.

    The appointment will normally be for an initial term of three years commencing on or shortly following 1 January 2019.  Fees are currently £40,000 for this role.

    To obtain full details of the role and how to apply, please contact Damien Knight

  • October 30, 2018

    Changes announced in the Budget to the rules for entrepreneurs’ relief and their impact on employee incentives

    Entrepreneurs’ relief reduces the rate of capital gains tax from 20% to 10% on the first £10 million of an individual’s qualifying lifetime gains. It is available on the disposal of shares in a trading company (or shares in a parent company of a trading group) by an employee shareholder provided that throughout the period of one year* (see below) ending with the date of disposal:

    (a) the company is the individual’s ‘personal company’ and

    (b) the individual is an officer or employee of the company (or, if the company is the parent company of a trading group, of a group member).

    Until 28 October 2018, for a company to be a ‘personal company’, the individual was required to hold at least:

    • 5% of the issued ordinary share capital of the company and

    • 5% of the voting rights of the company.

    Changes effective from 29 October 2018

    With effect from 29 October 2018, a company will qualify as a ‘personal company’ if, in addition to the requirements relating to share capital and voting rights, the individual is also beneficially entitled to at least:

    • 5% of the company’s distributable profits and

    • 5% of its assets available for distribution to equity holders on a winding up.

    How does this change affect employee incentives?

    There is no immediate effect on EMI Option holders, including holders of EMI Options over ‘growth shares’ (i.e. a special class of shares which gives the holder the right to share in the growth in value of the company in excess of a pre-determined hurdle). EMI Option holders continue to enjoy the benefits of entrepreneurs’ relief on the disposal of their qualifying shares.

    However, other employee shareholders who typically only hold 5% or more of a class of ‘growth shares’ with voting rights will be affected as, with effect from 29 October 2018, their rate of capital gains tax on disposal of their shares will increase from 10% to 20%, because they will not meet the other two requirements re having a beneficial entitlement to 5% of the company’s assets or distributable profits.

    These changes have been brought in to counter incentive structures that the Government considers to be tax avoidance, where the incentive arrangement has been designed to comply with the letter but not the spirit of the conditions for entrepreneurs’ relief.

    Note also that the Government has announced proposals to introduce new legislation, applicable to disposals after 5 April 2019, increasing from one to two years the holding period that must be met. This change will affect holders of EMI options, who after 5 April 2019 will need to have held their EMI options (or shares) for at least two years before their disposal for Entrepreneur’s Relief to be available.

    * Also for disposals after 5 April 2019 the requirements that need to be met throughout the period of one year* ending with the date of disposal (referred to in the Introduction above) will need to be met for a period of two years ending with the date of disposal.

    For further information contact Stuart James

  • October 24, 2018

    Are chief executives overpaid?

    In October 2018, Deborah Hargreaves published a new book, under the title “Are Chief Executives Overpaid?”. The question, of course, is rhetorical.

    Hargreaves is an ex Guardian business editor and FT journalist who has made it her life’s work to attack fat cat pay, which she believes is having a corrosive effect on the cohesion of our society and is putting liberal capitalism at risk.

    Hargreaves has been most effective at creating visibility in this area, although I suspect she fans the flames of discord rather than dampening them down. She was the original Director of the High Pay Commission in 2009 which was founded and funded by Compass, the centre-left pressure group, aligned with the Labour Party.  Compass’ mission was to get the Labour Party re-elected, and they figured that dissent over executive pay was a good lever for winning votes.  Mirroring the name of an existing official body, the Low Pay Commission, was a clever ploy.  It gave the High Pay Commission immediate credibility and a quasi-official status.

    In 2012, Hargreaves set up The High Pay Centre (the HPC), its successor organisation.  She describes it as an independent think tank, not aligned with any political party, although its spiritual affiliation to the Labour party is evident.

    Hargreaves has very firm beliefs on executive remuneration.  She believes it is a manifestation of human greed and is escalating far beyond the pay of the average worker and in a way that bears no relation to company performance.  Current pay differentials are essentially unfair. Chief executives are not worth anything like the amounts they are paid.  She is more sympathetic to entrepreneurs who are people creating wealth through their energy and ideas.  But “captains of industry” are essentially bureaucrats – they administer a system someone else has created. This refusal to believe they add so much more value than the average worker leads Hargreaves to use such ploys as “a captain of industry in the UK take 129 times the annual income of someone on average wages” and the more dramatic statement that before the end of the first week in January they will have “notched up” more income than the average annual wage.

    In keeping with those beliefs, Hargreaves’ language is heavily value-laden.  Executives “pocket” their pay. She talks about “late-stage capitalism”. Remuneration governance is a “religious cult”.  Thatcherism was intended to free the “supposed” entrepreneurial spirits in people.

    In her criticism of the conspiracy of excessive executive pay Hargreaves takes a swipe at pretty much everyone. US business schools take a lot of stick – principal-agent theory “doing the rounds of US business schools”.  Head-hunters are a “coterie” drawing from the same pool of usual suspects.  Institutional shareholders are too self-interested to act as effective policemen for executive excess. They provide “weak oversight”.  Government crumbles in the face of corporate UK and US. Remuneration committees are afraid of the executives. Former civil servants (in nationalised industries) were “pitched into the premier pay league”.  Remuneration consultants, the “high priests of the religion”, work to create high pay through benchmarking, chasing the upper quartile and opaque and complex incentive design.  Tony Blair and New Labour sought a cosy relationship with big business. Even Joe Public comes in for criticism: “The modern economy has succeeded in turning peoples’ needs (the basic material goods required to achieve a secure standard of living) into wants which are never-ending.”  The puritanical nature of these views indicate an aversion to people earning “loads-a-money” and a desire to produce any argument as to why they do not deserve it.

    You can feel sympathy for Hargreaves’ view point.  But what disturbs me is her careless use of statistics to support her case and the willingness of business editors and politicians of all parties to accept these statistics without question.  One notorious piece of earlier HPC “research” served up again by Hargreaves is the report of October 2014, Performance-related pay is nothing of the sort, produced for HPC by the now defunct Incomes Data Services. This was an appalling piece of sophistry: a fishing expedition which showed no real understanding of statistics or maths.  It was full of errors, but one notorious example will suffice here.  IDS plotted executive bonuses against company profit for 350 companies on one chart.  They showed there was virtually no correlation between profits and bonuses on their graph, and their conclusion was there was no relationship between pay and performance. But this was just nonsense maths. I will demonstrate why. Let us say you paid a CEO a share of profits in his or her company and nothing else, there will be a 100% correlation between his or her bonus and his or her performance.  If you accept profit as the measure of performance, his or her pay is perfectly related to performance.  Now If you do the same thing for CEOs in five companies – all paid on a profit share, but with a different profit percentage, the correlation for each company is still 100%, but the overall picture become blurred and the overall correlation falls dramatically.  Graphically, the points are all over the place because the percentage share varies by company.

    In fact IDS did this exercise not for five, but for 350 companies, the FTSE 100 and FTSE 250 combined, again making the assumption that profit was a good performance measure. Not surprisingly they found the correlation to be vanishingly small for the sample as a whole.  Does this mean that bonuses bore no relation to profit for these companies?  Of course not: you have to look at the correlation company by company, not the market as a whole– but that is what the IDS study concluded.  They then went on to do the same thing with long-term incentives and relative TSR.  Same conclusion: no relationship to performance.  At the report launch meeting, John Plender, the FT financial journalist sighed with relief “I always suspected this was the case” and heads all around the room nodded.  Since then the canard has been repeated time and again.  David Davis, the right wing Tory MP wrote an essay for the High Pay Centre in which he said “CEO pay has massively outpaced anything with which it can even remotely be correlated”.

    Rachel Reeves, chair of the Commons BEIS select committee told the Mail on Sunday the committee is going after the fat cats again later this Autumn.  Their April 2017 report said “executive pay is increasing at a rate that vastly exceeds increases for ordinary employees and which seemingly is at odds with the value created in the company”.  This statement is wrong on both counts – Minerva (formerly Manifest) data shows that, since 2010, CEO salary increases have fallen to a level much in line with the 2%-3% increases in the general workforce and this is has been the case for the past eight or so years.  What have gone up are the earnings from long-term incentives but this is precisely due to share price increases and consequent shareholder returns ie “the value created in the company”.

    Does this inaccurate propaganda matter?  Well yes it does.  It becomes accepted as fact and it affects Government policy and inflames public disenchantment with business.

    Hargreaves takes another swipe at non-executive boards, who she thinks are not doing their jobs effectively. Then she adds “ remuneration committee members are well-paid too.  Average pay for a remuneration committee member was £441,383 in 2015 (remember they are part-time jobs), 16 times the average for a UK employee”. This suspiciously precise figure is in fact dangerous rubbish.  The proxy agency Minerva produced an analysis for the MM&K Chairman and Non-Executive Director survey covering 2015.  The average total fees for a FTSE 100 NED was £115,386 (median £94,000).

    These figures are accepted by journalists and politicians simply because they want to believe them.

    This is from Margaret Hefferman in the FT on 1 October 2018:

    “Hargreaves amasses devastating data to prove that performance-related pay massively outpaces all rational measures, and that rewarding failure is routine”.

    Powerful stuff, except it is not true.  People want to believe it because they resent the pay for top executives in a way they do not, for example, resent pay for international football stars (Ronaldo and Messi each earn about £40m gross per annum at Real Madrid).

    Hargreaves devotes quite a lot of the book to arguing that companies introducing performance related pay fail to understand human motivation.  Executives do not need all this money.  But this misses the point. By blaming executive greed, Hargreaves’s book does not follow through on the real economic issue, which is low pay for the average worker. She blames low wage growth on low investment which in turn she blames on executive incentives with a short-term focus.  She would rather pay the money directly to the workers than increase investment.  She claims to believe in free markets, but doesn’t like it when the market decides some people are worth a lot of money and pays them accordingly.  This jars with her puritanical viewpoint.  Hargreaves ends her book with a menu of actions that could be taken to pull down the share of wealth taken out by top executives:

    • Put up top taxes for executives and corporations.  Block loopholes.

    • Publish tax returns on-line like Sweden does (the “shaming” approach).

    • Move corporate focus away from achieving returns for shareholders towards achieving benefits for stakeholders, especially workers so as to create a new corporate ethos. She (wrongly) claims that the legislation for requiring the delivery of benefits to wider stakeholders already exists in Section 172 of the Companies Act.  (In fact Section 172 requires boards to have due regard for the interests of these other groups, but shareholder interests clearly have primacy.)

    • Give the workers a say in bosses’ pay – by a worker representative on the remuneration committee or board (“to inject some common sense”) or even by having a worker’s vote on the remuneration policy.

    • Improve companies’ consultation with workers.  Introduce a structure of councils.

    • Give the FRC the power to investigate and prosecute company directors for poor corporate governance. Create new statutory bodies in the UK and US focused purely on corporate governance, with new enforceable guidelines.

    • Phase out LTIPs.

    • Make any bonuses a pure profit share only.

    • Pay cash only – no shares.  Executives should buy their own shares.

    • Have a binding vote once the non-binding vote falls below 75%.

    • Reduce salaries to a reasonable level – all stakeholders to decide what is “reasonable”.

    She summarises by saying “a critique of the self-serving justification is often attacked for relying on the wrong data, a misunderstanding of the way companies work and plain old envy.  But if capitalism is not seen to be fair by much of the public there will be moves for something more drastic to replace it.  It is time for the business sector to listen to the moderate voices for reform or reap the consequences of growing inequality, anti-business sentiment and possibly more dramatic clashes. If it does not rise to the challenge, the fundamental trust that makes a liberal market democracy function could be damaged beyond repair.

    In fact there are only a few companies with the excessive pay arrangements this book is railing against.  Hargreaves’ proposals would result in a regime which would restrict legitimate reward and damage companies generally, without helping in any way to address the key problem, which is low wages.

    For further information contact