Paying for the long-term - Alternative models of pay


Sophie Johnson, Corporate Governance Analyst

4 May 2018

  • We were pleased to welcome over one hundred clients to our annual investment conference last week. Topics discussed ranged from equity lifecycle investing, through how Environmental, Social and Governance (ESG) research can help credit fund managers assess risk and value, to how a multi asset approach is well suited for generating retirement income. But a clear theme running through much of the day was the increasing influence of a ‘responsible’ approach to investing. Asked at the start of day the importance they placed on a manager’s ESG credentials when allocating capital, 72% of our audience said it was ‘important’ or ‘very important’. Only 3% thought the subject ‘a fad’. Wind forward to the same question at the end of day and the numbers had moved to 81% and 1%! Had a handful of sceptics left after afternoon tea or had we struck a chord with our debate? Either way, this chimed with the message from our key note speaker, Rasmus Ankerson, who urged companies to think differently if they want to maintain success. Complacency is the enemy within he says; if it ain’t broke, break it! 
  • Our most successful conference yet? Probably. Will we change the format for next year? I know what Rasmus would say… 
  • Like many other investors, we are concerned about the alignment of pay in the UK with long-term, sustainable investment performance. We have some concerns that long-term incentive plans (LTIPs) are not always effective, can be confusing and complex for both executives and investors, and can lead to perverse outcomes. As such, we are open-minded about considering and approving alternative models of pay.
  • Our View
  • Fundamentally, we believe remuneration committees are best placed to decide on the most appropriate pay structure for their company. Engagement with investors is important to help inform the board, but it is not a replacement for good, sensible decision-making and discretion. For this reason, we will hold remuneration committees directly accountable for pay structures and pay decisions.
  • We are mindful of the difficulties facing some companies in setting long-term performance targets, particularly smaller companies or those in more cyclical sectors. We are also cognisant of the difficulties companies and investors face when trying to set and discuss future theoretical performance targets and payout scenarios.
  • Therefore we accept that in some cases, it may be suitable for alternative models of pay to replace traditional LTIPs. These could be in the form of Restricted Share Awards (RSAs) or Deferred Bonus Plans. We are however cautious of approving schemes introduced to mitigate the fact that long-term incentive plans have not recently paid out. Companies seeking to introduce alternative pay models must provide a clear rationale for doing so.
  • Ultimately, pay must be tied to sustainable long-term performance and must be simple and easy to understand.
  • Our proposals 
  • Below we set out our expectations for alternative models of pay:

Like many other investors, we are concerned about the alignment of pay in the UK with long-term, sustainable investment performance. We have some concerns that long-term incentive plans (LTIPs) are not always effective, can be confusing and complex for both executives and investors, and can lead to perverse outcomes. As such, we are open-minded about considering and approving alternative models of pay.

Our View
Fundamentally, we believe remuneration committees are best placed to decide on the most appropriate pay structure for their company. Engagement with investors is important to help inform the board, but it is not a replacement for good, sensible decision-making and discretion. For this reason, we will hold remuneration committees directly accountable for pay structures and pay decisions.

We are mindful of the difficulties facing some companies in setting long-term performance targets, particularly smaller companies or those in more cyclical sectors. We are also cognisant of the difficulties companies and investors face when trying to set and discuss future theoretical performance targets and payout scenarios.

Therefore we accept that in some cases, it may be suitable for alternative models of pay to replace traditional LTIPs. These could be in the form of Restricted Share Awards (RSAs) or Deferred Bonus Plans. We are however cautious of approving schemes introduced to mitigate the fact that long-term incentive plans have not recently paid out. Companies seeking to introduce alternative pay models must provide a clear rationale for doing so.

Ultimately, pay must be tied to sustainable long-term performance and must be simple and easy to understand.

Our proposals
Below we set out our expectations for alternative models of pay:

• Simplicity

Our preference is for one single straightforward long-term plan to be proposed, and not the combination of numerous different performance and non-performance based awards.

• Performance underpin

To somewhat mitigate the lack of performance conditions, we would ask companies to implement a financial underpin. The goal would be to reduce the award in the event of significant underperformance.

• Performance on grant

We would be supportive of plans that apply performance on grant, either as an alternative or an addition to the performance underpin.

• Reduction in quantum

Due to the greater certainty involved in granting RSAs, we would expect a minimum of a 50% reduction in the total value of an award against current LTIP values.

• Holding periods

We would also expect a prolonged vesting and/or holding period to be added before shares are released.

• Discretion

Mathematical pay models do not lead to good outcomes. We believe many of the historic issues with pay could have been averted with the use of appropriate discretion.

• Post-retirement holding periods

We believe that by requiring executives to hold shares postretirement or post-departure this encourages long-term thinking and can prevent the need for excessive buy-out awards.

Conclusion
Provided a company can show sufficient rationale for the adoption of an alternative model, such as an RSA or deferred bonus over a traditional LTIP plan, we are open to supporting them. We would require a company to demonstrate that they have sufficiently addressed the risks of granting a share award with a more certain outcome by reducing the size and implementing an underpin in order to reduce the awards in the event of underperformance. Alternatively companies could apply performance on grant to reduce the size of the initial award.

 The views expressed are the author’s own and do not constitute investment advice.