Walker Review – Employee incentives in support of sustainable performance

United Kingdom

The Walker review of corporate governance in the UK financial services sector, published on 16 July 2009, has made a number of draft recommendations on remuneration.

While specifically directed at the financial services sector, there will undoubtedly be pressure for certain proposals to become part of mainstream corporate governance for all quoted companies. The Walker review can be accessed here.

Our financial services team will be commenting on the other aspects of the Walker review as part of their Regulatory Reform Report, which will be published shortly.


Generally, the Walker review repeats and supports all of the conclusions on remuneration drawn by earlier UK reviews (e.g. the Turner review of UK and international banking regulation published earlier this year) and international reviews, as well as the FSA’s own draft Handbook rule and code of practice on remuneration, all of which say that remuneration practices should not create or reward excessive risk.

Following publication of the FSA’s draft code of practice on remuneration, we produced a Remuneration Checklist for companies, which can be found here.

This article does not cover aspects of the review which repeat the principles already set out in the FSA’s draft code of practice on remuneration and approaches agreed at an international level already, but focuses on where the Walker review goes further or is more explicit.

The key issues on remuneration raised in the Walker review are as follows:

  • Extended role of the remuneration committee

The remuneration committee should not just look at remuneration (and risk) for directors. It should look as closely at the remuneration of anyone who over the last year was or might be expected to earn as much or more than the median amount earned or to be earned by the executive directors (called the “high end” executive group). In addition, it should have oversight of remuneration policy on a group-wide basis, with a particular emphasis on how risk is taken into account. However, it is not expected to be involved in setting the specific remuneration of employees below the board level and the high end executive group.

Many remuneration committees already include some considerations of what is happening within the wider group anyway, but the need to identify all potential high end executives and to determine in each case their total compensation package is likely to increase the remuneration committee’s workload substantially.

  • Disclosure of “high end” remuneration

There should now be disclosure by UK listed banking and finance institutions of the remuneration of employees in the “high end” executive group in bands, stating the total number falling within each band but without individuals being identified.

There has already been much discussion in this area over the years, which has some precedent in the United States. The remuneration of Katie Couric, an American broadcaster, was not disclosed as she was not a member of the board of the relevant listed company, so this kind of provision requiring the disclosure of senior employee pay is sometimes known as a “Katie Couric” clause. Bob Diamond at Barclays is also rumoured not to have joined the board for some time so that his remuneration did not need to be publicly disclosed.

These disclosures are likely to produce headlines, but at the moment not much additional work for companies. However, could they be the prelude to individual disclosures in due course?

FSA-authorised UK subsidiaries of major non-UK financial institutions are also proposed to have reporting requirements imposed on them – although it is proposed that the detail of these be agreed between the FSA and the relevant company on a case-by-case basis.

  • A proper balance between elements of variable remuneration

The proposal is that at least half of variable remuneration should be in the form of long-term incentives and should only vest with performance conditions. Fifty per cent of this amount should vest after three years, with the balance (although not subject to further performance conditions) vesting at the end of five years.

The other half of the variable remuneration may be paid by reference to performance within a single year, but only one third may be paid out at the end of that year. The balance must be deferred so that the full bonus is not paid out until the end of year 3.

Using deferred payments will enable a company to withhold or cancel payment – rather than having to claw it back from the executive if the performance on which the award was based turns out to have been overstated or if the executive subsequently leaves.

The long-term proposals are the most surprising. A five year retention period for 25% of the overall intended variable remuneration for a year will be seen by many as too long and the long deferral period for the annual bonus will also raise some eyebrows. Walker accepts that his proposals may cause basic salaries and other non-variable remuneration to rise (and cautions remuneration committees to ensure this upward pressure does not become excessive), but clearly thinks that the protection offered by the deferral is worth it.

The Walker review goes further than the FSA code in terms of pressing for a five year retention period and it will be interesting to see if the FSA adopts this proposal or treats it as aspirational, i.e. not one that needs to be included in the code (where non-compliance would be more serious).

If anything, it had been hoped that the FSA’s code would be less prescriptive in terms of deferral of bonuses and timing of payments, leaving it to the market and companies to work out appropriate deferral periods. After the Walker review, this now looks a forlorn conclusion, but that will not stop continued lobbying on this.

  • Directors and “high end” earners should maintain a shareholding commitment

The expectation is that, over time, shares with a value equal to annual remuneration should be acquired and held by executive directors and high end executives. This goes beyond the current generally expected level of shareholding by executive directors equal to their annual basic salary.

  • Remuneration committees should liase with risk committees

Elsewhere in the report, the Walker review recommends the establishment of a board risk committee, separate from the audit committee, to advise the board on current risk exposures and future risk strategy. The review recommends that the remuneration committee should liaise with the board risk committee to check risk assessments of relevant remuneration policies, in particular the risk adjustments to be applied to performance conditions.

Again, this is not likely to be difficult and indeed may even relieve the remuneration committee of work it would otherwise not be qualified to do. However, a further set of cross-committee meetings will now have to occur, with resolution of any differences to be decided by the chairman and all the non-executive directors.

  • Consequences of shareholder dissent over the directors’ remuneration report

Listed companies must have an advisory vote each year on their remuneration report. However, if the report is not approved there are no legal consequences and the company is not obliged to change its current or future arrangements. The Walker review considered whether a vote against the report itself should have greater impact, but concluded it should not.

However, it does suggest that, if the report is not approved by 75% or more of the total votes cast at the meeting, then the chairman of the remuneration committee should stand for re-election in the following year irrespective of his or her normal appointment cycle. This reflects a recent proposal put forward by the Institutional Shareholders Committee (“ISC”), which is comprised of the Association of British Insurers, the National Association of Pension Funds and the Investment Managers’ Association.

  • Remuneration of chairman and non-executive directors

The Walker review sees no need for any change in structure of their remuneration, but does acknowledge that it will inevitably have to increase as more time is required to be devoted to the role on the basis of Walker’s own recommendations – in particular, that the chairman of the financial institution should probably commit at least two-thirds of his time to the role and that the non-executive directors of a major bank board should commit at least 30-36 days a year.

  • Pensions

More and more attention has been focused in recent years on the value of final salary pension schemes, but, until the recent case of Sir Fred Goodwin, there was not that much attention on companies’ capacity to increase the value of pension pots dramatically by the exercise of discretion on departure. Investors felt caught out by this and there was a perceived corporate governance deficit in this area.

The proposal is that no executive director or high end executive who leaves early should have an automatic right to retire on a full pension by taking into account extra years of service, although boards should retain the flexibility to allow top-up in certain circumstances.

In addition, the remuneration report should expressly state whether there is a discretion to allow enhanced pension benefits, as well as whether that discretion has been used.

  • Remuneration consultants

Finally, the review notes that a group of the main remuneration consultants has published a draft code of conduct (which is included as an annex to the review). Walker recommends that the consultants should form a professional body with ownership of the code of conduct.

The draft code provides reassurance about the independence of the advice provided, integrity of data and comparators supplied etc and is designed to prevent remuneration consultants exacerbating pay rises and minimise conflicts of interest. The remuneration committee should only engage remuneration consultants who have committed to abide by the code.

One debate that has been around for some time is whether the remuneration committee should always have access to independent advice to the extent of appointing independent advisers each time. The review, however, does not address that question.

The future?

There is now a period of consultation on the points raised in this report until 1 October 2009, with a final version of the proposals being issued in November. We will be submitting comments – if you would like to submit any feedback via us, please let us know.

Quite how this consultation dovetails with expected final proposals from the FSA on remuneration (which is expected later this month or in early August and are to take effect in November) is not yet clear. It would clearly make sense for overlap to be co-ordinated both within the UK and internationally. The FSA has indicated that it intends to keep to its previously announced timetable. However, it is hoped that the FSA proposals are if necessary delayed until a consensus is reached or at least the consultation period is closed, otherwise this would make a mockery of the Walker consultation process on remuneration.

Finally, while the recommendations are specifically for large listed financial institutions, the FRC will be considering to what extent Walker’s recommendations should be applied to quoted companies generally. With the Combined Code currently being separately being reviewed, it is likely that many of the Walker recommendations will be incorporated for all companies and become mainstream corporate governance practice – in effect making “Walker” a second Higgs report.

Not all recommendations will be relevant outside the financial sector – for example, the degree of risk in non-financial companies is very different and emerges in a much shorter timescale. It is also unusual for executives in these companies to be paid more than executive board members. However, proposals like greater pensions disclosure and a greater shareholding commitment and recommendations on the use of remuneration consultants are clearly of wider application and all companies should interest themselves in these proposals.