- May 28, 2020
A recent report sponsored by the Investment Association said that the IA is strongly in favour of wider employee share ownership. But is now a good time to adopt a new employee share plan?
A recent report, published by The Social Market Foundation (“the SMF”), in February 2020 was entitled “Strengthening employee share ownership in the UK”. This report was both supported and funded by the Investment Association.
The SMF is an independent British political public policy think-tank based in Westminster, London. It is allegedly one of the ‘Top 12 Think Tanks in Britain’.
The Report is a lengthy tome and it assesses the potential for employee share ownership to reduce inequality, tackle the UK’s supposed productivity problems, improve financial resilience and increase the employees’ voice within companies.
There is, says the report, a growing amount of evidence that employee ownership enhances long-term performance within companies, it improves employee commitment and it helps staff retention. A poll of workers in larger companies found that 68 per cent liked the idea of holding shares in the companies they worked for, while 58 per cent agreed that it would make them more motivated.
Britain’s institutional investors are seemingly warming to the idea that companies should be set targets to increase employee share ownership.
The SMF has urged the government to set a target for large listed companies. This could either be a percentage of share capital owned by staff or a percentage of the workforce owning shares. A target of 10 per cent of the company owned by staff “might capture the public imagination”, it said.
There needed to be “a sea change in attitudes to employee ownership”, the SMF has said, including giving employee shareholders a bigger say than outside shareholders in running the company.
Whilst the IA said it was strongly in favour of employee ownership it declined (sensibly) to comment on the 10 per cent target proposed.
For our part, we do strongly support wider employee share ownership in many listed companies and even in some privately owned ones. However, we do not advocate any sort of league table, nor the need to have any sort of target for large listed companies. We certainly do not favour employee shareholders having a bigger say than outside shareholders in how a company should be run.
Companies in the UK have a wide choice of tax-approved employee share plans that they may consider adopting. These include Savings Related Share Option Schemes (“Sharesave” or “SAYE” Schemes), Share Incentive Plans (or “SIPs”), Company Share Option Plans (or “CSOPs”) and Enterprise Management Incentives (or “EMIs”) for smaller companies.
It seems a shame, therefore, that so few companies in the UK have any sort of wider share ownership plan to provide their employees with an opportunity to acquire shares in their employing company. The statistics suggest that just over 13,000 out of 1.4 million firms operate tax-advantaged employee share ownership plans. The SMF estimates that just 1.9 million workers have a stake in the business they work for and about 10 per cent of employees in companies with more than 500 workers have some shares.
One of the big dangers associated with employee share plans is the risk that employees may become disincentivised if the value of their shares goes down. It is important in this connection to educate employees on the financial risk to them of investing in shares and in particular of potentially having all their eggs in the one basket.
As far as the employing company is concerned, it will need to understand the various different types of employee share plan that are available to them to implement and decide which type of plan is right for them and their workforce. Most of the tax-advantaged plans that are available are option based plans and, to that extent, while the employee is holding options, they are not benefitting from any dividends that are being declared on the company’s shares.
Having said that, employees often prefer the option-based plan structure because they feel protected, while holding options, from a fall in the company’s share price.
One might argue that putting in a new employee-wide share scheme just after there has been significant turmoil in financial markets is not the best time to do so, as employees will be worried about the concept of investing in shares generally and the reliability of their employer’s shares in particular. We would argue, on the other hand, that now would be a very good time to consider putting in a new employee share plan. To some extent one may be able to communicate that a lower share price provides a potentially attractive buying opportunity, although of course employers must be careful not to be seen to be providing any sort of financial advice.
Education and communication will be key. If communicated well, a new employee share plan should be seen as an attractive perk to employees, particularly those who are invited to participate for the first time. It can also be communicated (and structured) in a way of expressing a sort of thank you and appreciation to employees for bearing with and continuing to work hard for the company through difficult times.
MM&K is very well experienced at advising companies on the different types of employee wide plans that are available in the UK market as well as on a more global basis. We would be pleased to have an initial discussion with any of our clients about the pros and cons of putting in an employee wide share plan, and the various different types of plan that are typically being used, on a completely non-committal basis.
- May 28, 2020
Oil and gas on a knife-edge – remuneration might have to break the mould to retain talent throughout this current crisis
The market price of oil balances the scales between success and failure for companies operating in the sector. Boards keep a close watch on the break-even price.
The average break-even price in the US was estimated recently to be between $48 and $54 per barrel (with the caveat that a sustained price of less than $40 per barrel would have a devastating effect on the US industry). On the other hand, Saudi Arabia can make money at $20 per barrel but operators in Russia need $40. In the North Sea, where production costs are high, close observers of the industry have commented that at $60 to $70 per barrel life is comfortable but at $40 to $50 projects are at risk.
At the time of writing, the market price of a barrel of Brent crude is about $36 and the West Texas Intermediate price per barrel is about $34. A recent survey published by the Oil & Gas Council indicates that nearly 90% of respondents think that, over the next 12 months, the market price of oil will be in the range $20 to $50 per barrel. If that is right, the industry, globally, faces a prolonged period of belt-tightening.
Africa, where there have been a number of discoveries, is seen as a source of opportunities. Companies looking to reposition their business models through energy transition and diversification can see opportunities to acquire gas assets on the continent. But Africa has been hit hard by COVID-19 and there are other challenges. It was reported recently, that all drilling activity in Angola, the continent’s second-largest oil producer, has been halted. Our clients operating in Africa have first-hand experience of difficulties arising from:
• inconsistent regulatory environments and inadequate infrastructure
• renegotiation of financial terms
• delays to licence applications and renewals.
Closer to home, in the North Sea, decarbonisation (which involves developing robust ESG policies and practices), automation and increased investment in digitalisation are key focuses for the future. For our North Sea clients, decommissioning costs are a major challenge. There is also some concern about a dearth of private equity exit strategies. Private equity has made significant investments in North Sea and UKCS E&P companies. PE firms, particularly infrastructure funds, have also invested in mid-stream companies, some of which have been divested by bigger operators as part of their A & D policies. Their lower risk profile and cash flows make them attractive to long-term investors.
The current state of the oil and gas industry points to a strategy of cost cutting, consolidation and collaboration. Conserving cash resources is the priority – for all firms but particularly for the small and mid-size players, whose balance sheets are not so strong as those of the large firms.
Those companies, which eventually emerge successfully from this latest crisis to affect the industry, will need to have retained their executive talent. They will also need to ensure that remuneration policy and practice can and does recognise executives’ contribution to that success in a way which can be justified in terms of the outcome for shareholders and other stakeholders and the economics of the business. We are seeing more examples of companies breaking the mould by amending their remuneration policies and practices to deliver a greater proportion of remuneration in shares or share options, for executives and non-executives – and, in some cases abandoning annual cash bonuses.
In the meantime, if the number of acquisitions and divestments in the oil and gas sector increases, as forecast, companies operating long-term incentive plans and plan participants, will want to be certain of their position under the plan rules in the event of termination of employment or a change in control of the company. And, the deal on exit for executives managing private-equity-backed companies, agreed at the time the PE firm makes its investment, will be a key consideration for those executives. It may be difficult (and may be impossible, in practice) to renegotiate at a later date.
MM&K advises extensively on directors’ and executives’ remuneration policy and practice in the oil and gas sector internationally and is a leading independent adviser on remuneration to PE firms and their portfolio companies. In addition, MM&K is authorised and regulated by the Financial Conduct Authority for the provision of corporate finance advice.
- May 28, 2020
Revisit NED remuneration policy to conserve cash and increase alignment
Traditionally, UK NEDs have been paid an annual cash fee, supplemented, in some cases, by additional cash for chairing or being a member of a Board committee. Participation by NEDs in annual bonus plans and performance-related share options or LTIs is opposed by investors and good corporate governance guidance. Some investors have gone even further and have written to companies to inform them that they will vote against share option proposals for executive directors, too.
These are not normal times. CFOs are keeping an even closer than normal eye on cash. Companies of all sizes have had to adapt their business models to help them emerge successfully from a crisis with an uncertain future. Their remuneration policies and practices, if they have not done so already, will also need to adapt.
There are well-publicised examples of CEOs agreeing to take a salary cut. Many of their non-executive colleagues will have done the same. Compared with executive remuneration, however, NED fees represent a significantly lower drain on a company’s cash. Nonetheless, research done following the 2019 AGM season shows that the median fee for a FTSE100 Chair was in excess of £400,000. In the FTSE30, the median was more than £650,000. The corresponding amounts for NEDs were broadly in the range £70,000 to £90,000. Additional fees for committee membership could easily add £10,000 to £20,000; more for the committee Chair. So, the cash outlay for NED fees can be significant. For smaller companies, in particular, conserving cash, by whatever means, is their top priority.
Agreeing to take a temporary cut in salary or fees is an immediate response to an immediate problem. But what about the longer-term shape of NED remuneration?
Non-executive directors of US public companies receive annual restricted stock unit awards in addition to an annual cash retainer. Walmart NEDs receive annual stock grants worth $175,000 in addition to an annual cash retainer of $90,000. NEDs at Apple receive annual RSU awards worth $250,000 plus an annual retainer of $100,000.
Ten years ago, International Corporate Governance Network (ICGN) guidance recognised that properly structured equity-based compensation for NEDs, which is not performance-related, creates an immediate alignment with investors. Current Investment Association (IA) guidance, whilst also opposing share awards linked to share price or corporate performance, encourages share ownership by NEDs. Echoing the earlier ICGN guidance, current IA guidelines state remuneration committees should be free to select remuneration structures which are appropriate for their specific businesses.
Recently, MM&K has been working with clients which, having a pressing need to conserve cash, have sought to adapt their NED remuneration policies to substitute cash fees wholly or mainly with share awards. Calls for restricted share awards, of which a nil-priced option, not subject to any performance conditions on vesting, is a form, are gaining ground, even if the arguments are not yet fully accepted by all investors. Earlier this month, Lloyds Bank plc was successful in gaining shareholders’ approval for a deferred (restricted) share plan but the majority in favour was only 64%.
In our 2020 Chair and Non-executive director survey report, “Life in the Boardroom”, which is on sale now (contact us if you would like to purchase a copy), 53% of respondents reported that the demands on NEDs’ time are increasing. That is likely to lead to upward pressure on costs (because either more NEDs will be needed or existing NEDs will have to bear a greater load and will need to be compensated accordingly).
Introducing share awards for NEDs could help to conserve cash and create alignment with shareholders but raises a number of issues in light of current governance guidance and practice. Operating within a strong governance framework is important for all companies. Proposals to make such a change to remuneration policy require careful thought, not least in connection with the terms of the awards and to make the case to shareholders that the policy is in the best interests of the company. Flexibility will be required on all sides and engagement with shareholders will be an essential element of the process.
For further information or if you would like to discuss points or issues raised in this article, please contact Paul Norris.
- May 28, 2020
Deferred Share Plans get over the first major hurdle (just about…)
Without doubt, it is always difficult being an early adopter and trying something new.
Those in new areas of the economy talk about being at the “bleeding edge” rather than the leading edge when it comes to changing things. As we explored in a recent Article, the adoption in the UK of a Deferred Share Plan (also known as a Restricted Share Plan) by listed businesses for their Executives would certainly seem to fall into this category.
On May 21st 2020, Lloyds Banking Group (“Lloyds”) took that plunge with its proposed move from a Performance Share Plan (often dubbed a “PSP” or sometimes confusingly “LTIP”) to a Deferred Share Plan.
The resolution regarding this was passed by the shareholders but with a majority of only 64%.
This is likely to make an interesting dilemma for those Remuneration Committees considering a change in approach to long term incentives.
Whilst those outside the listed arena may consider 64% to be well above the “50.1%” required, it is likely be to seen by those closely involved as, at best, a cautious acceptance that the Deferred Shares may be a suitable plan – and certainly something that will remain highly scrutinised.
Importantly, by having more than 20% of shareholders dissent against the proposal, Lloyds will now be put on the Investment Association (“IA”)’s Public Register and will have to provide an “Update Statement” within six months of the vote, setting out an update on the views received from shareholders and any actions taken.
Whilst some companies will already have their changes to long term incentive plans in place and therefore we may see a few more Deferred Share Plans put to shareholders, it is most likely that the majority of Remuneration Committees will adopt a “wait and see” approach once all the smoke has cleared following the Update Statement. Given that this may not be issued until November, it does indicate that an uptake in using Deferred Shares may not come until 2021 (and late into that year at that).
Whilst understandable, we would encourage Remuneration Committee not to wait just because market conditions are not fully favourable now.
Whilst Deferred Shares will not be the right solution for every organisation, if, following careful review, they are considered to be the best approach then it is well within IA guidelines for a Remuneration Committee to choose a “non-market” approach to incentivisation if that is what it believes would be best for the business. Indeed, in our recent conversation with Andrew Ninian (the IA’s Corporate Governance Director), he reiterated that this should always be the approach that any Remuneration Committee should take to Executive Reward.
For further information about the issues raised in this article or to discuss any questions you may have, please contact Stuart James.
Our previous Article on Deferred Shares can be found here.
- May 28, 2020
Coming out of a downturn strong (and how long-term incentives will be key to doing that)
One of the things that we have seen time and time again, as advisors to a wide range of companies across many sectors, is that future success after a downturn is not measured by how you weathered the initial storm, but how you came out the other side.
Frequently, success is measured by costs saved or margins retained. Little or no thought is given to the “people” aspect of the downturn. In the worst cases, the prevailing attitude from management is that the workforce must be alright as “at least they have kept their jobs”.
Whilst it may be true that in the immediate aftermath there is a gratefulness for employment, this does not automatically translate into perpetual gratitude. Many workers will remember and retain the words, actions and behaviours of management during the more difficult moments and use them as the reason and motivation for moving on.
In addition, perceived poor treatment during this period can have the effect of demotivating the best people in the workforce. This is an important point as, no matter their role, it is these people who are the real engine of a business. These are the people who are usually focused on the success of the company (not their own advancement) and are willing to go the extra mile to help it get places. The people who get their colleagues to deliver more and will often sacrifice their own time to put more energy into the success of the business.
We would always recommend two steps for any business who wants to not only retain their best people but also make sure they can start to help delivering growth as soon as possible.
Firstly, the business should conduct its own “people audit” as part of its plans to get back to growth. Even where decisions have been made genuinely for the benefit of the business as a whole, messages and intentions can be lost in the speed of change as recovery measures are put in place.
Secondly, in order to further tie-in the interests of both the key individuals and the wider workforce to those of the owners and managers, we would recommend introducing some form of long-term incentive. This may be cash or equity, it may be for a bespoke group or the entire workforce and it may come with all manner of performance conditions attached.
Research has shown that the inclusion of any long-term incentive plan improves retention by up to one third – a crucial factor when competitors start to look at your workforce in order to help rebuild their business.
In addition, “paper based” long term incentives, which require no upfront cash cost by the business, can be an effective way to reward and remunerate. Performance conditions mean that the workforce is only rewarded if results are delivered.
Whilst there are costs associated with setting up these types of plan, the return over the medium to long-term is likely to far outweigh these – in terms of both performance and retention.
For further information about the issues raised in this article or to discuss any questions you may have, please contact Stuart James.
- April 30, 2020
Share and share option plan reporting for 2019/20
If your company operates a share or share option plan for employees or directors (including non-executive directors) you will need to report any awards by filing electronically with HMRC (as well as reporting the adoption of the plan if it is the first year in which awards have been made).
In addition, if employees or Directors (again including NEDs) have personally acquired shares in the business this may also need to be reported.
Finally, if you have an existing share or share option scheme for employees but have made no awards in the year, a NIL return will still be required to be sent to HMRC to avoid penalties and fines.
All reporting for the tax year ending 5 April 2020 must be done through the HMRC Employment Related Securities (ERS) online service. This is for both tax advantaged and non-tax advantaged plans. Registration is required, even where a company already operates the PAYE for employers online service.
All annual returns must be filed by 6 July 2020.
Any share or share options transactions in any group entity involving employees or office holders will need to be reported online on an Employment Related Securities return. In addition to acquisitions or grants, the form also covers the position where shares / options have been sold, lapsed or cancelled due to someone leaving the organisation.
For approved schemes, there is also a self-certification process under which all EMI, CSOPs, SIPs and SAYEs must submit a declaration to HMRC that the criteria for qualification have been met. Self-certification only needs to be done once, therefore only new schemes which commenced operation in 2019/20 need to be completed by 6 July 2020. Failure to register the scheme within the ERS online service could mean the tax benefits of the approved scheme will be lost.
It can take up to a week to register a scheme on the ERS online service, so we recommend registering sooner rather than later to ensure any technical issues can be resolved without any delay before the deadline.
For further information about the issues raised in this article or to discuss any questions you may have, please contact Stuart James.
- April 30, 2020
Why UK listed companies are now considering replacing their LTIPs with Restricted Stock Plans
Back in November last year, the Investment Association (the “IA”) came out with these dramatic words:
“Alternative remuneration structures – We encourage all Remuneration Committees to evaluate their remuneration structures to ensure that they are appropriately aligned with the implementation of the company’s strategy.
In recent years, there has been a growing debate on the benefits of various long-term incentive structures. For many years, Long Term Incentive Plans have been introduced by companies and generally accepted by shareholders. However, IA members are increasingly of the view that the traditional Long-Term Incentive Schemes are not working as effectively as they could for all companies and can sometimes drive outcomes which can cause concerns for shareholders such as increasing grant levels or volatile and significant vesting outcomes.”
Research from the Purposeful Company has recently shown that there is a growing body of investors who are willing to consider alternative remuneration structures, if the Remuneration Committee can argue the strategic benefits of adopting such schemes. Following the Purposeful Company report, IA members commit to working with other stakeholders to look at the circumstances in which such schemes may be more widely implemented in the UK market. If needed the IA, will look to review the Principles of Remuneration as soon as possible after next year’s AGM season to reflect on any developments or changing expectations.”
These comments from the IA followed soon after the publication by the Purposeful Company of its Study on “Deferred Shares”. The Purposeful Company was established in 2015 with the support of the Bank of England to identify changes to policy and practice to help transform British business with purposeful companies committed to creating long term value through serving the needs of society.
The reference to “Deferred Shares” is really a reference to Restricted Stock (or Share) Plans. Under these types of plans, executives are simply granted a right to receive a number of shares in their employing company in three or five years’ time and provided the executive is still employed by that company at the end of the vesting period, he or she will receive that number of shares (subject to any tax and social security deductions that may be applicable) at that time. They will typically also receive the value of any dividends declared on their restricted shares over the course of the deferral or restricted period.
In effect the only performance criterion that will apply to a restricted share award is the continued employment of the award recipient throughout the vesting period.
These types of plans are already quite common in the US where they are typically structured and referred to as “RSUs” or Restricted Stock Units.
In The Purposeful Company’s Key Findings Report, it made (inter alia) the following statements:
• There is widespread support amongst investors and companies for greater adoption of deferred share models than we see in the market today.
• Overall the consensus is that such plans might be appropriate for 25% of companies or more, as opposed to the c. 5% that we see in practice today.
• Investors and companies generally see behavioural and practical benefits from a move to deferred shares, including long-term alignment and encouraging long-term behaviour, as well as greater simplicity and spending less time on executive pay and target setting. The academic evidence largely supports these views.
The Report also commented: “Investors highlighted two behavioural impacts above all others. Most investors believe that changing to deferred shares will encourage executives to take decisions in the long-term interests of the business and to execute strategy more effectively because they will not be distracted by LTIP targets.” Furthermore, they also highlighted a more practical benefit of these types of plans, they avoided the difficulties of long-term target setting.
The situation we now find ourselves in and which a large number of companies are struggling to deal with, is highlighting, more than ever before, just how difficult long-term target setting can be. For many companies in these worrying economic times, it will be practically impossible to say now, or even in the next three months, what are the right three year performance metrics that they should apply to their planned upcoming award of performance shares.
It is interesting in this context that the IA have just published another missive, this time about the effects of COVID-19 on executive remuneration policies. In this they say:
“There are concerns from companies and shareholders over the ability to set meaningful three-year targets at the current time and questions over the appropriate grant size given the share price reaction to COVID-19. In particular, Committees should be considering if it is appropriate to make LTIP grants at the current time and whether given the current market environment it might be more appropriate to postpone the current LTIP grant. Members believe that there are a number of options depending on the individual circumstances of the company:
1) Grant on the normal timeline setting performance conditions and grant size at the current time.
2) Grant on the normal timeline setting the grant size now but committing to set performance conditions within the next six months.
3) Delaying the grant to allow the committee to more fully assess the appropriate performance conditions and grant size. In such circumstances Committees should aim to make the grant within six months of the normal grant date.”
We are surprised that the IA is not suggesting a fourth option: to replace the current LTIP (presumably a Performance Share Plan) with a new Restricted Stock Plan and make awards under the new plan as soon as possible after shareholders’ approval for such a plan is obtained.
Perhaps one of the biggest questions around the concept of Restricted Share Plans is at what level should awards of deferred shares be made?
Again referring to the Key Findings Report of the Purposeful Company it had the following to say: “Investors and companies were broadly in agreement. Half of investors said they would require a discount of at least 50% in grant level, compared with the previous LTIP, to support a restricted share plan. Around half of companies also felt that this was appropriate. However, nearly 40% of companies said a discount less than 50% was required to make restricted shares attractive to executives (with responses evenly distributed between a 25% and 40% discount). Equally, 43% of investors said they would consider a lower discount than 50%.”
This provides very useful contextual background, and if asked to comment as a generality, MM&K would suggest that it would be appropriate that Restricted Stock Awards be made annually at around 60% of current Performance Share Plan Award levels.
So what is the experience of companies that have adopted Restricted Share Plans? For the most part they feel they are working well. However, they did acknowledge that they all encountered problems in getting agreement from shareholders at the time they were being implemented and that some proxy advisers challenged them purely on the grounds that they were “non-standard” and they were not able to tick the boxes which expected them to see long term performance metrics.
We hope and, in some ways, expect that the current economic climate will change investor attitudes towards these types of plans. In any event, any company considering going down this route will need to engage with its principal shareholders at an early stage and the remuneration committee will need also to put together a convincing argument that a new long term incentive structure of this kind is right for the company and all its stakeholders. MM&K would be pleased to assist any company considering a new plan of this kind.
- April 30, 2020
Now cash is the only KPI, there is an opportunity to rethink executive incentives
There is now a singular concentration on conserving corporate cash.
The Bank of England has issued a statement, falling barely short of an instruction, that banks should withhold dividend payments. Some, but not all, have complied. This is a crucial week for UK plc, as a number of the UK’s largest companies announce their results and dividends. BP and Shell are among them. Some analysts estimate that these two companies account for almost 25% of FTSE 100 dividend payments yet to be made based on last year’s performance. The boards of both companies face a difficult decision on dividend payments. The imperative of conserving cash in the company, at a time when the oil and gas sector is suffering the effects of a low commodity price, has to be balanced against the importance of their dividends to the economy, particularly pension funds. At the time of writing, BP has maintained its first quarter dividend; Shell’s announcement is due on 30 April.
Last weekend, it was reported that the total UK company pension deficit of about £136bn is expected to increase by up to £500m. Industry insiders believe that the Pension Protection Fund can withstand this increase but that company levies to the fund are predicted to rise, placing more strain on company cash flows.
In addition, there are numerous examples of directors taking salary cuts. A High Pay Centre study shows that 25 of the UK’s top 100 companies have taken a 20% pay cut in line with pay for furloughed workers. Some CEOs have taken bigger cuts. Long-term incentive awards have been scrapped or put on hold; remuneration committees have been wrestling with decisions about bonus awards for the past financial year and bonus targets for the current one. Executive pay is not significant in relation to the value of the biggest companies but cutting it shows solidarity with the cuts enforced on the, sometimes, large numbers of employees whose costs are significant to a company, however large, which has seen its business fall away as a result of the pandemic.
Cuts in CEOs’ pay increase the, already high, level of attention on executive remuneration and it is unlikely, perhaps, that executive pay will ever get out of the fire. However, the current situation provides an opportunity to re-evaluate some of the accepted norms about incentive plan design, which might help to lower the temperature.
In the run-up to the current crisis, executive pay has been criticised, including by government, for being too complex and too high, with many arguments for and against. Executive incentives (both bonuses and long-term incentives (“LTIs”), attacked for neither aligning executives’ and shareholders’ interests nor linking pay to performance, have been singled out for particular criticism.
Annual bonuses tend to be based on a range of financial measures, usually a form of profit or profit/return measure, and personal performance measures, likely (but not exclusively) to be qualitative. ESG factors are now seen (rightly) to be an essential focus for boards. Remuneration committees are strongly encouraged to introduce ESG measures into their executive incentive plans. Many bonus plans now include ESG targets but the introduction of another set of performance criteria does not help to limit complexity.
LTI design has evolved to the point where companies are now encouraged by shareholder guidance to adopt plans which their remuneration committees believe are right for the company and support its culture, remuneration philosophy and business strategy. However, relative TSR and EPS continue to feature high on the list of performance measures. Arguments in favour of replacing traditional LTIs with restricted share schemes (about which there is a separate article in this Newsletter) are gaining ground but restricted share plan proposals are still treated with suspicion by some shareholders.
On 27 April, the IA published guidance for UK listed companies on shareholder expectations regarding the operation of executive incentive plans as a result of COVID-19. Surprisingly, the IA guidance makes no reference to restricted shares. A summary of the key points in this guidance is as follows:
• Companies which have cancelled dividends are expected to consider how this should be reflected in remuneration policy; including use of discretion and malus
• Remuneration committees are not expected to amend performance conditions for annual bonuses or “in-flight” LTIs
• No adjustment to grant size for 31 December year-end companies if share price fall is wholly related to COVID-19; but remuneration committees are expected to take action to avoid windfall gains
• In relation to LTI grant size and performance criteria for new grants, remuneration committees must:
– decide whether to make or to defer awards; the guidance sets out a number of options
– explain their actions and how they will avoid windfall gains and ensure outcomes reflect executive performance and the experience of shareholders and other stakeholders, including employees
– making maximum awards after a substantial share price fall is discouraged
– performance conditions may be set up to six months after the award date; the performance measurement period should be at least three years but, if performance measurement periods are reduced, award sizes should be reduced accordingly
• Any additional capital raised or government support sought should be taken into account in outcomes for executives; the guidance warns of serious reputational ramifications if pay and conditions of the wider workforce are not taken into account
• Companies which have spent time consulting shareholders on a new remuneration policy to be put to their forthcoming AGM will not be expected to rewrite that policy; but committees should consider if any proposed increases in variable pay for 2020 are appropriate
• Committees must balance the need to incentivise executives when management are being asked to show resilience and leadership and to ensure that executive pay takes account of the interests of shareholders and other stakeholders, including employees.
LTIs and bonuses are likely to be part of executive remuneration packages throughout and after the current COVID-19 crisis. They serve a number of purposes. Bonuses increase the focus on key performance measures and actions so as to enhance business performance. They also enable companies to increase the value and competitiveness of remuneration in a way that is justified by company performance or to reduce costs when company performance is poor. Equity-settled LTIs align executives with shareholders.
The current reality is that cash is the only KPI. For the present, many companies are in survival mode and cash is fundamental to their survival. In better (normal?) times, cash (not TSR, EPS or, even, a year’s profit) is essential for sustainability and growth. A company’s ability (or its potential ability) to generate cash goes directly to its worth. Cash and cash-flows determine a company’s ability to:
• reinvest in the future of the business and fulfil its commitments to the community and the environment
• pay suppliers
• provide returns to shareholders and increase market value
• pay down debt
• pay executives and the wider workforce.
Cash, therefore, is crucial to developing and maintaining a sustainable business, not just in these unusual times but in better times, too, whatever the market or wider economy is doing.
Incentive policies based on the sources, generation, conservation and uses of cash would provide an opportunity to focus executives on a constant factor, essential to creating value and sustainability in any business. Requirements for remuneration committees to take account of ESG factors, act fairly in relation to the wider workforce and other stakeholders and engage with shareholders to explain their proposals and decisions would continue to be just as relevant and important as they are now.
For further information or to discuss this article, please contact Paul Norris.
- April 29, 2020
COVID-19 and its impact on pay in the UK’s Private Equity / Venture Capital Industry
As with all parts of the financial system, this virus pandemic has created huge challenges for private equity and venture capital fund managers, management teams and employees of investee companies, as well as for institutional investors. PE and VC fund management teams are working tirelessly to guide and support their portfolio companies.
From our conversations with our Private Equity friends and clients, for the most part their biggest concern at this time is for their investee companies. Of course, they are not able to visit them and this has created issues. Interaction with the businesses they invest in is crucial for PE and VC fund managers in helping them to make critical investment decisions; to what extent do they need help, whether in terms of advice, regular communication or a new injection of funding?
In our survey published in October last year, a significant majority of participating firms were expecting to increase the size of their investment teams in 2020. Our perception is that, for most firms, new recruitment of investment professionals has been put on hold.
Institutional investors are also very concerned, understandably, about the effects of the pandemic on their fund investments. They are requiring regular information flow, as well as regular financial updates. Hence the need for more IR and finance roles in the industry. We hear that there is some activity in the PE and VC recruitment arena – a number of firms are needing to bolster their finance and their investor relations functions at this time to help deal with this extra workload.
From what we are hearing in the market, very few new deals are happening at present. Those that are in train are for the most part being delayed and in many cases valuations are being reassessed.
There is, however, no sign as yet that any firms are looking to let go of any of their investment team members. It is all hands on deck for most firms, albeit largely firefighting (in their portfolio companies) rather than trying to find new deals.
This will come later. It will take some time before a sense of stability will return to the deal doing process and before valuations can be looked at and agreed in a reliable manner. This may not happen until Q4. But once this starts to happen, we are sure that there will be many interesting opportunities for PE houses to find and acquire new investments at attractive prices.
The fact that there is so much dry powder in the industry means that for the large majority of fund managers, they will need to retain all their existing talent and in due course they will need to recruit new talent. They will need more people to execute the new deals that surely will come through, as well as to help look after their existing portfolio of wounded investments which will take some time to recover from this economic bombshell.
We would expect that bonus levels for the current year for below partner level grades are most likely to be at around the same level as they were for 2019. Firms will need to reward their investment teams who will in most cases be having to work extremely hard throughout these difficult months.
2020 will be a tough year for many PE and VC investment professionals. We expect that the partners in these firms will recognise this and will realise that they will need to reward them accordingly. Otherwise we suspect that the more adventurous and the most talented of them will look elsewhere.
- April 21, 2020
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To all our clients and contacts: we know things are tough for businesses right now.
Many of you will have done all you can to set your business up to deal with the lockdown and will now be thinking about what needs to be done to help ensure your business emerges successfully from this difficult period.
We want to help.
MM&K has been going for more than 45 years. In that time, we have supported our clients throughout a number of significant economic downturns and have seen what needs to happen to come out stronger.
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