The end of LTIPs and bringing employees onto remuneration committees?

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While there is still some time to wait before the Government publishes its own proposals on directors’ pay in quoted companies, the House of Commons Business, Energy and Industrial Strategy Committee achieved headlines last week with its own proposals on the subject. The most eye-catching are proposals to phase out long-term incentive plans in their current form and to have employee representatives on their directors’ remuneration committees. A number of other general corporate governance proposals are made, but this Law-Now just focuses on the remuneration aspects of the report.

The overriding goal would be to achieve greater popular support of UK PLC’s pay processes for directors and the results that they deliver. The Committee sees current arrangements leading to unjustified high levels of remuneration and great friction not just with the public but also with investors.

End of LTIPs?

Long-term incentives (“LTIPs”) have been the main delivery vehicle of remuneration for some time now. In targeting LTIPs, it is not exactly clear what the Committee has in its sights. It would seem to be opposing not only the free share arrangements which have become known as LTIPs since the mid-90s, but also market value options for executives. The Committee favours replacing them with what it calls “deferred option” arrangements. These appear to be what many people call restricted shares or restricted stock units. They are also free share schemes but participants simply need to remain in employment to receive the shares rather than meet the additional corporate performance conditions which is a feature of LTIPs. In return for not needing to meet performance conditions, executives normally receive lower levels of award. Another committee recommended feature is that shares are received over 5 years rather than at the end of a 3 year period.

Restricted share plans were discussed by various investor bodies with approval last year and so the Committee’s support of them is not the introduction of a new idea, but its proposals that no new LTIPs are proposed after this year could, if the idea achieves quick momentum and particularly Government support, lead to a radical change in executive pay in the short to medium term. Although the Committee’s recommendation seems just to restrict companies adopting new LTIPs rather than require them to jettison existing schemes before they reach their expiry date (which is normally 10 years after adoption), if there is a general shift, companies may feel the need to understand restricted share plans, introduce them (probably with the need for shareholder approval) and probably change their remuneration policies to implement this change in very short order, which is one reason that change is likely to be slower rather than a sudden change. While several investors and investor bodies have reaffirmed their opposition to LTIPs, such is their near universal use at the moment that the silent majority is likely to prevail for some time yet while more thought goes into alternatives.

Employee representatives on remuneration committees

The second main proposal is an “optional “ proposal to put employee representatives on remuneration committees. The Committee wants the UK Corporate Governance Code changed to allow for this and expects “leading” companies to adopt this change in approach, although it will not be compulsory. It matches this with other proposals to involve employees more in the governance of companies. Again, this is not a new proposal, and what a representative would do (it seems unlikely a vote would be given or that this person would be a director) is unclear. It would certainly be as dramatic a change to the way that remuneration is discussed as a change from LTIPs discussed above. In remuneration committees, there is currently a debate between directors and their advisers who are well-versed in pay matters and all are generally comfortable in talking about remuneration levels. This would completely change and the need for education could make remuneration committees have similarity with pension trustee meetings and/or (negatively) lead to discussion taking place outside the committees.

Other proposals

  • More demanding and open bonus targets (and less performance-related pay generally)
  • Chairmen of remuneration committees should resign if more than 25% of shareholders disagree with their “proposals” (though it is not quite clear what this means, is this the annual remuneration report, the policy report or a specific share plan proposal, and is this resign as chairman of the remuneration committee or as a director altogether?)
  • If more than 25% of shareholders vote against the annual remuneration report, there is automatically a policy vote at the next AGM (at the moment, the threshold is 50%)
  • All FTSE 100 companies to publish workforce data broken down by gender, ethnicity and pay band; and the publication of pay ratios comparing the salary of the CEO and senior directors with the workforce.

The direction of travel here is clear. Whether the Government takes up some or all of these proposals, they are now gaining sufficient traction so that every remuneration committee should at least be thinking about whether their company is of a sufficient size and has the appropriate employee and investor base that they should be considering volunteering some changes and/or thinking about what some of the changes might involve for them. Some companies will be happy to embrace the changes. For others, either the end result or the cost of getting to the end result will be painful and costly.

Click here to see the Parliamentary Committee Report.