The Investment Association: Covid-19 guidance on executive pay

On 8 April, the IA wrote to the FTSE 350 chairs on a number of corporate governance issues in light of the Covid-19 pandemic. The letter contained little detail on executive pay noting simply that executive pay should be linked to company performance and take account of the shareholder experience, not just financial performance. Since then, many companies have announced Covid-19-related changes to their executive pay arrangements, mostly in the form of voluntary salary reductions and bonus waivers. Companies’ approach to valuable long-term incentive awards has to date been less clear.

The IA has now issued guidance on how it expects remuneration committees to address difficult decisions on executive pay. The guidance asks remuneration committees to "sensitively balance" the need to incentivise executives at a time when they are being asked to show significant leadership and resilience while being mindful of the effect the pandemic is having on shareholders, employees and other stakeholders.

Embarking on that balancing act, remuneration committees may find the IA’s guidance helpful. It should be read with the caveat that it is by no means comprehensive and its recommendations may not be appropriate for all listed companies given the different degrees to which companies are affected by the pandemic. The key points are:

• Adjusting bonus outcomes for FY2019 - Where a company has suspended or cancelled a dividend, the IA expects this to be reflected in annual bonuses – either through downward discretion in the bonus pay-out (where payments have not yet been made), or through the application of malus to deferred bonuses. To the extent this is not possible, the IA expects bonus outcomes for FY2020 to reflect any suspension or cancellation of dividends. The IA does not mention the use of clawback as an alternative.
• Adjusting in-flight performance conditions – The IA generally does not expect remuneration committees to adjust performance conditions for the impact of Covid-19. Nevertheless the IA notes that, where company performance and shareholder experience is not commensurate with executive pay outcomes, the use of discretion by the remuneration committee may be appropriate. However, it should only be used following appropriate shareholder engagement and the reasons for the adjustment should be fully disclosed.
• Windfall gains – For companies that have already granted awards in 2020, and where such awards have been based on a lower than normal share price, the IA accepts that no adjustment is needed to the size of the grant if the share price fall is solely related to Covid-19. However, according to the IA, remuneration committees need to look at the market and share price response during the performance period to ensure that windfall gains do not arise when awards vest. Use of discretion to reduce vesting outcomes in these circumstances is likely to be expected. In addition, remuneration committees will need to explain in the next remuneration report how they will approach the issue and the factors they will take into account. If there is longer-term share price underperformance, long-term incentive awards should be scaled back.
• Setting performance conditions and grant levels – The IA accepts that it is difficult for remuneration committees to grant long-term incentive awards at this time, including setting meaningful three-year performance conditions and determining appropriate grant levels. Three possible options are suggested:

1. Granting awards as normal and setting grant size and performance conditions now.
2. Granting awards as normal and setting grant size now, but delay setting performance conditions for up to six months.
3. Delaying awards for up to six months of the normal grant date. 
   
   Companies should explain the approach taken to shareholders and be prepared to use discretionary powers to adjust pay outcomes to ensure they reflect company and executive performance as well as shareholder and stakeholder experience.

• Adjusting pay outcomes for companies furloughing employees or seeking additional capital - If a company has sought to raise additional capital from shareholders, or required government support, including furloughing employees, shareholders expect this to be reflected in executive pay outcomes. Remuneration committees should be mindful of the wider employee context, and failure to do so may have significant reputational consequences. Shareholders also expect that, if companies are asking employees to take a temporary pay cut, the same approach should apply to executives.
• New remuneration policies - Companies who are due to seek shareholder approval for a new remuneration policy this year should carry on as planned. The IA does not expect companies to rewrite their remuneration policies at this time, but remuneration committees should be mindful of the current environment in deciding whether to implement any proposed increases in variable pay.

Despite leaving a number of questions unanswered, listed companies and their remuneration committees will undoubtedly welcome the IA’s guidance on these difficult issues. It is still too early to talk about emerging market practice in this area and the continued scrutiny from investors, proxy advisers and the media will put additional pressure on remuneration committees to do the right thing.