Are you paying your executives for retention or value creation?

Shareholder disquiet on executive pay has had an impact on the regulators. The Financial Reporting Council (FRC) has issued an update to the UK Corporate Governance Code designed to strengthen the focus of companies and investors on the long term. The main implications for executive pay are:

• Remuneration policies must be designed with the long term success of the company in mind
• Part of the remuneration package should be deferred and be at the risk of ‘malus’

Linking Reward to sustainability

In many organisations, Executive Pay has been driven by the need to attract, retain and motivate. This has been blamed for the upward spiral of executive pay with seemingly no corresponding improvement in corporate or individual performance. Companies must now align executive remuneration with sustainable value creation. The FRC state that performance conditions including non-financial metrics used in remuneration design should be relevant stretching and designed to promote long term success.

In our blog ‘are your long term incentives long enough?’ we introduced linking reward to non-financial performance measures. Sustainability isn’t just about reducing carbon emissions, it redefines success from short term financials to management of financial, social and environmental risks. A sustainability model might look through the 3 lenses of the profit, people and planet and may include governance and ethics, diversity, customer satisfaction, safety, environmental stewardship, employee engagement, education and socio-economic value as measures of success.

Deferred remuneration       

The requirement to defer bonuses or long term incentives and have those subject to withholding or claw back is an extension of arrangements already in place for Banks. It gives the remuneration committee the power to withhold or reduce the amount of deferred pay to reflect an individual’s performance and the company’s subsequent financial performance. The aim is to encourage longer term corporate performance and behaviours.

Directors will be required, as now, to hold significant numbers of shares and to hold them for a period after vesting or exercise (including for a period after leaving the company). There should be a minimum deferment or vesting period of three years for shares granted, other forms of deferred remuneration to be paid, or options exercisable. Grants under long term incentive schemes should be phased.

‘Comply or explain’

Whilst the definition of long term and the appropriate deferment period will vary across companies The Code is sending a clear message that the focus of executive pay should be to reward long term sustainability.

The basis of the Code is ‘comply or explain’ so Remuneration Committees must:

• Understand the timeframes and how long term value is created
• Determine the financial and non-financial performance measures that are appropriate
• Decide the balance between fixed and performance related, immediate and deferred compensation.
• Ensure that the design features of the remuneration package meet The Codes requirements regarding deferment and malus
• Engage with shareholders and be transparent

The effective date of the revised regulations is for accounting periods beginning on or after 1 October 2014. 

Please get in touch if you’d like some further advice on getting more value from your Executive pay - 020 3457 0894

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