On 8 October 2024, the Investment Association (IA) published its much anticipated "Principles of Remuneration" (Principles) to guide remuneration committees over the 2025 AGM season.
In recent years, we have seen little substantive change to the Principles but following the IA's letter to the chairs of remuneration committees at the beginning of 2024, a more comprehensive re-write was expected. In the foreword to the new Principles, the IA notes that during the 2024 AGM season, it saw engagement between companies and shareholders over different proposals in terms of remuneration structure and quantum. The Principles are clearer and more concise than previous versions, noting the challenges companies face (particularly those with US operations) in attracting and retaining the best executives but acknowledging the expectations of shareholders for long-term value creation from their investments.
Below, we summarise the key aspects of the Principles, noting areas where the guidance shows a change of approach or emphasis to earlier versions. A quick comparison can also be found here.
1 What is the IA and what are its Principles of Remuneration?
The IA is the trade body for UK investment managers ranging from smaller UK specialist firms to those with a European or global reach. Its members collectively manage funds for many savers and institutions such as pension schemes and insurance companies. The Principles are aimed at helping remuneration committees make "informed and responsible decisions that are consistent with the long-term interests of the company and its shareholders". The focus is largely on executive pay, however, the remuneration of the wider work force will be relevant when applying the Principles.
2 Which companies are the Principles of Remuneration aimed at?
As in previous years, the Principles are expressed to be predominantly for companies with a main market listing but relevant to companies listed on other markets such as AIM. They were also expressed to apply to "other entities" but this has been replaced with a more specific reference to private companies. Although this isn't expanded upon, presumably the focus is on larger private companies.
3 Are the Principles of Remuneration rules or guidelines?
Historically, listed companies in the UK have taken note of the IA's Principles of Remuneration when devising their incentive arrangements as they have been seen as a standard for best practice that their largest shareholders will expect them to follow. The document published by the IA is called the "Principles of Remuneration" but takes the form of a series of short key principles that are followed by more detailed guidance. Neither the key principles nor the guidance have ever been strict rules that should be followed, but to a certain extent, they have been viewed by some stakeholders as such. In the foreword to the revised Principles, the IA emphasises that they are guidelines, rather than rules, that seek to "foster good practice, alignment with investor expectations and support a competitive market environment".
A table showing the key UK governance rules and regulations that have a focus on remuneration can be found here.
4 How have the Principles changed?
Fundamentally, the Principles have not changed a great deal - more striking is the difference in tone compared with previous versions. There is less focus on what remuneration committees "should" do and what shareholders will expect or want and greater emphasis on the need for companies to collaborate with shareholders in choosing a remuneration structure that is the most appropriate for its business and also helps the company deliver its strategy and create value for shareholders and other material stakeholders. The revised Principles acknowledge the pressures faced by UK listed companies that have a global reach (particularly when they have operations in the US) and their need to appeal to the best executives whilst being sensitive to the expectations of investors, the wider workforce and the public at large. The Principles are expressed as building on the relevant aspects of the UK Corporate Governance Code (the Code) and in a section headed "Long-term alignment between executives and shareholders", the guidance considers certain elements that are required by the Code relating to shareholding guidelines, malus and clawback and use of discretion.
5 How are the Principles structured?
Previously, the Principles took the form of 16 principles of remuneration under headings for remuneration policies, remuneration committees, structure and levels of remuneration. This has been simplified and there are now three "overarching" principles. Remuneration policies should:
- promote long-term value creation through transparent alignment with the board's agreed corporate strategy;
- support individual and corporate performance, encourage the sustainable long-term financial health of the business and promote sound risk management for the benefit of material stakeholders; and
- seek to deliver remuneration levels which are clearly linked to company performance.
The IA then identifies several factors that will help remuneration committees achieve the overarching objectives. Many of these factors reflect the previous principles, but they are more fluid and less specific than before. For example, there used to be a principle that required non-executive directors to generally serve on the remuneration committee for at least a year before chairing it (and this aligned with the requirements of the Code). Now, there is simply an expectation that, to make the best long-term decisions, the remuneration committee members (especially the chair) need "sufficient expertise and experience of the company to fully understand its strategy" and are expected to have "built effective relationships with other directors, management and shareholders". Note, however, that the requirements of the Code have not changed. The rest of the document sets out more detailed guidance to help remuneration committees apply the Principles and "ensure a proper level of shareholder protection".
6 What is the role of the remuneration committee and the wider board?
The IA considers that the non-executive directors, and particularly the remuneration committee, should oversee executive remuneration but the entire board needs to be engaged in remuneration decisions. As well as having the necessary levels of expertise and experience, they should have access to independent advice to help them make informed decisions and engage with shareholders and other material stakeholders. Remuneration committees are encouraged to disclose the key decisions they make in relation to remuneration and the reasons for them.
7 When should shareholders be consulted?
The Principles previously said that companies should listen and respond to feedback from shareholders on remuneration proposals and expressed concern that shareholder consultation was being treated as a validation exercise by some remuneration committees. The new Principles make the point that the purpose of shareholder consultation is "not to seek approval or endorsement but to understand the views and expectations of shareholders" and place emphasis on constructive dialogue between companies and their shareholders to "foster a mutual understanding and trust". There is a greater sense of taking shareholders on the journey to developing remuneration policy rather than waiting for them to vote against a remuneration resolution and finding out why. Companies are particularly encouraged to consult shareholders before introducing new incentive plans, substantially changing performance metrics or materially increasing remuneration levels.
8 How should shareholders be consulted?
Early dialogue with shareholders is encouraged and once the consultation process has ended, the IA believes that it is best practice for the remuneration committee to send a "wrap-up" letter to the shareholders they approached, summarising the finalised proposals and the reasons for them. Whilst these communications can remain confidential, companies are also encouraged to disclose in their annual remuneration report how the consultation process was carried out, the number of shareholders consulted, the outcomes, the main feedback and the company's response to it.
9 What limits should there be on the levels of executive pay?
The levels of executive remuneration can be a thorny issue and although for some years now, the IA has not mandated a particular limit on executive pay, it has previously warned against the damage caused by excessive and undeserved remuneration. Although this issue remains, the new Principles take a slightly different tone, recognising the challenges that companies operating in certain markets (such as the US) or competing for talent globally, can face. Nevertheless, remuneration committees need to disclose potential pay levels and explain how they "align with the company's purpose, values, and strategic goals, and how they help attract, retain and motivate talent". In particular, the IA remains critical of companies using benchmarking alone to justify pay levels, and remuneration committees are expected to disclose the identity and constituents of peer groups used for this purpose. Remuneration committees are also encouraged to consider pay across the workforce when setting executive pay.
10 How should you view the different components of executive pay?
The Principles consider each element of executive pay separately, looking at fixed remuneration (base pay, pensions and benefits) and variable remuneration (bonus and long-term incentives). The new guidance sets out the IA's views on the most common forms of long-term incentive more clearly than before but recognises that some companies favour "hybrid" arrangements where some awards are subject to performance conditions and others are not.
The new guidance also includes a statement that "variable remuneration plans should be capped, with increases fully justified to shareholders and subject to consultation, where material". In practice such a cap is not very common under 'standard' long-term incentive plans (unless in relation to exceptional, 'one off' grants). It is more common (and arguably appropriately so) under value creation plans.
11 What do the Principles say about basic pay?
The Principles continue to note that investors expect an executive's base salary to properly reflect their responsibilities, experience and the nature of the role. Maximum increases in basic salary should be in line with those awarded to the wider workforce in their area unless there are exceptional circumstances that warrant higher increases (these might be a change in role or responsibility) in which case shareholders would expect clear justification for them. Consideration needs to be given to the fact that an increase (even a relatively modest one) in basic pay can have a knock-on impact on levels of variable remuneration, for example, where bonus or long-term incentive awards are expressed as a multiple of basic pay.
When a company appoints a new director at a salary that is higher than they received in their previous role, shareholders would expect this to be explained. On the other hand, if they receive a lower salary, shareholders expect future increases to be linked to performance in the role and spread over several years (with the approach disclosed to shareholders).
12 What do the Principles say about annual bonuses?
Annual bonuses are acknowledged as an important part of the remuneration package helping to incentivise and reward executives. However, the guidance stresses that shareholders expect bonuses to be paid for achieving "robust, quantifiable targets that reflect the company's performance and implementation of the strategy". Remuneration committees are expected to disclose the reason for choosing performance measures and explain how they relate to value creation. They are also expected to explain how the bonus payout reflects the experience of other stakeholders, such as payments to shareholders, the workforce, customer experience and wider sustainability risks and opportunities.
Previously, the guidance noted the increasing use of non-financial performance targets (such as strategic or personal objectives) and stated that shareholders would expect financial metrics to comprise the significant majority of the overall bonus. Although this wording does not feature in the latest guidance (which even contemplates a bonus being payable for non-financial performance alone), the underlying message remains that such targets need to be explained and pay outcomes justified. For example, if management of ESG risks is incorporated into the company's strategy, targets relating to the management of ESG risks can be included in the annual bonus provided they are "robust, transparent, lead to demonstrable performance" and ultimately linked to value creation.
As with the previous guidance, deferral into shares to help achieve a minimum shareholding target (with malus and clawback) is seen as a way of aligning the interests of executives with shareholders. However, there is no longer the expectation that a specific portion of the bonus should be deferred into shares where the bonus opportunity is more than 100% of salary. Instead the guidance states that if the director has met the minimum shareholding target, shareholders might support a lower level of deferral (as long as the committee has sufficient malus and clawback powers in respect of the bonus).
13 What are the different ways in which long term incentive plans can be structured?
There are many ways in which a long-term incentive plan (LTIP) can be structured and, as in previous years, the Principles do not express a preference for any particular form. Instead, the guidance highlights issues relevant to all LTIPs and particular features of the most commonly used arrangements.
- Equity rather than cash based: Generally speaking, the guidance states that shareholders prefer equity based LTIPs rather than those delivering cash (other than to pay tax liabilities). The same applies to any dividend equivalents payable on shares that have vested under an LTIP award.
- Type of award: The Principles note that common forms of LTIP award are those made under performance share plans (PSPs), restricted share plans (RSPs), hybrid plans (a mixture of PSPs and RSPs) and value creation plans (VCPs).
- Size of award: While it has long been considered best market practice to limit the size of LTIP awards granted to executives each year, the guidance does not recommend a maximum percentage of salary to be used and leaves this for remuneration committees to decide. However, there is an expectation that RSP awards will be granted at lower levels (specifically 50%) than awards under PSPs. The guidance suggests that award size should be calculated by reference to the mid-market price of the shares on grant.
- Performance criteria: PSP awards should be subject to "challenging and transparent performance conditions that reflect the company's strategic objectives" and the performance of the business as a whole. The new guidance states that, if total shareholder return is used, the share price used to calculate it should be an average over "an appropriate and well-defined period of time" at the start and finish of the performance period. This is a slight change from the previous version of the guidance that specified that any period of averaging should be short. Awards under RSPs are not granted subject to performance criteria however, the use of minimum performance "underpins" is supported by shareholders to ensure that awards do not vest where the company has significantly underperformed. ESG performance conditions should be included if the management of these risks and opportunities are important for long-term sustainability and success of the business but need to be both "quantifiable and appropriately stretching". Although the wording has changed in the new guidance, it capturesa the sentiment in the previous version that ESG targets should not reward "business as usual" activities.
- Dilution limits: Share plan rules should provide that no more than 10% of a company's issued share capital should be issued under all a company's share plans over a 10-year rolling period. This is a long-standing dilution limit under the IA guidelines, but notably, the previous dilution limit that mandated 5% cap for executive plans has gone. Further, the new guidance recognises that a dilution limit in excess of 10% may be appropriate in exceptional cases, for example in high-growth, newly-listed companies. Otherwise, the guidance emphasises a use of "appropriate" dilution limits for the company. Treasury shares remain caught by the dilution limit.
- Normal performance/vesting periods: In line with the UK Corporate Governance Code, the Principles state that the "normal" performance or vesting period for awards should be at least 3 years, with a further holding period of 2 years.
- Timing of grant: Awards for executive directors (other than under all-employee plans) should normally be granted within 42 days of the announcement of the company's results or exceptional events that may affect the share price. It is interesting that the new guidance limits the 42-day window in this way – previously it applied to all awards granted under all plans.
- Retesting or repricing of awards: The guidance continues to note that shareholders do not support the retesting of performance conditions or repricing of awards as this has the effect of undermining the link between pay and performance and reduces alignment of the executives with shareholders. An exception to this could be where there are one-off events affecting the company but even then, the remuneration committee should engage with shareholders before making any changes.
- Windfall gains: If grants are made at a time when the company's share price is unusually low, this can lead to awards being larger than usual which, in turn, can cause windfall gains. Although remuneration committees should continue to have a discretion to review vesting outcomes, the guidance notes that shareholders would prefer an exercise of discretion on grant, to combat unexpected windfalls. When granting awards, remuneration committees should take into account the potential pay-out levels for target and maximum performance, as well as the probability of the award vesting.
- No cliff edge vesting: Rather than "cliff-edge" vesting, awards subject to performance conditions should vest on a sliding scale. This reflects the Code, however, market practice in this area has not necessarily moved. The guidance states that there should be no vesting below median performance, and an award should only vest in full where there has been "stretching performance" that "reflects exceptional and sustainable value creation".
- Buy-out awards on recruitment: When recruiting new executives, companies will often wish to compensate them for any awards they have forfeited with their previous employer. The guidance states that shareholders recognise this, but remuneration committees should ensure that replacement awards are subject to similar terms and reflect the present value, vesting and performance expectations of the awards given up.
- Leavers: Only good leavers (usually those leaving for retirement, death, disability, ill health, redundancy or a change of control of their employer) should be able to keep their awards. These should be subject to the original performance and vesting conditions with pro-rating for the time served. In contrast, other leavers should usually forfeit all their unvested and deferred awards.
- Malus and clawback: The Code states that variable remuneration should be subject to malus (reduced before it is paid) and clawback (recovered after payment) where it transpires that it was inappropriate to pay it or it was based on inaccurate information. Neither the Code nor the IA Principles specify the circumstances in which malus and clawback should apply, however, the Principles state that they should be clearly communicated to executives (who should agree to them) and they should be consistent across contracts, the remuneration policy as well as bonus and share plan rules. Some companies choose to have a "malus and clawback policy" in place.
- Employee benefit trusts: Many companies use employee benefit trusts (EBTs – note that the IA refers to them as employee share ownership trusts or "ESOTs") to help with the delivery of their long-term incentive plans. However, the IA guidance expects remuneration committees to limit the number of the company's shares an EBT can hold to 5% of the issued ordinary share capital of the company. Shareholders also expect remuneration committees to ensure that EBTs are not used as an anti-takeover device.
- Shareholder approval of plans: LTIPS (excluding all-employee plans) should have a limited life of 10 years unless renewed by shareholders.
14 What do the Principles say about hybrid plans?
The revised Principles recognise that some companies, particularly those with a significant US presence, have implemented what are known as "hybrid" plans. These are LTIPs under which a combination of awards can be granted, typically with a performance share and a restricted share element. The guidance in respect of standalone PSPs and RSPs would apply to each element of hybrid schemes, with the RSP element discounted to reflect the fact that performance conditions do not need to be met. The vesting period for a hybrid scheme is expected to be 5 years with no accelerated vesting or early release of shares (note that some US plans permit annual vesting of restricted share awards). This reflects the expected vesting period for restricted share awards and the combined vesting and holding period for performance share awards, but it isn't clear whether the performance share element is also expected to have a longer vesting period of 5 rather than 3 years. Remuneration committees are expected to explain why a hybrid plan is more appropriate for the company's executives than a single structure and the rationale behind the discount chosen.
15 What do the Principles say about value creation plans?
VCPs are a form of incentive arrangement where executives receive a proportion of value created above a threshold level of return. The guidelines note that such plans aim to align executive remuneration with ambitious goals and value creation but they also risk creating significant pay outs and dilution for existing shareholders. VCPs are also seen as less flexible if circumstances change. If a remuneration committee is considering implementing a VCP, the guidance state that they need to engage with stakeholders at an early stage to discuss these concerns. Shareholders expect there to be a monetary cap on the amount that can be paid out under a VCP award, and the new guidance sets out key issues that remuneration committees need to consider. One of these is that a VCP should only reward "exceptional performance that creates substantial and sustainable value for shareholders and material stakeholders over at least a five-year period".
16 What do the Principles say about the remuneration of non-executive directors?
As in previous years, the new Principles note the importance of ensuring that independent non-executive directors (NEDs) receive fair remuneration for their contribution to the board. Remuneration committees should disclose the time that NEDs are expected to commit, and their fee should reflect this. Although a proportion of the fee can be paid in shares bought at market rates, in line with the Code, NEDs should not participate in share option or performance related pay arrangements as this would impact on their independence.
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