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Article | Executive Pay Memo – UK

Is the UK approach to executive pay broken?

By Jane O'Reilly , Paul Townsend and Dr Richard Belfield | November 23, 2023

There has been much debate in recent months about the competitiveness of the UK as a place for businesses to list and thrive, with executive pay being a small but important and emotive part of this debate.
Compensation Strategy & Design|Executive Compensation|Ukupne nagrade

It is imperative that UK companies can compete for talent globally in order to succeed, drive growth and maximise the meaningful contribution that our largest companies make to the UK economy. Ultimately, the Remuneration Committee has delegated authority to determine a Company’s approach to remuneration for executives, considering wider workforce pay, while acting in the best interests of the Company and its shareholders. Of course, the challenging macro-economic backdrop and cost of living crisis cannot be ignored, but being able to attract and retain the best executive talent is a critical input to growing the UK capital markets.

The results from our recent webinar attended by over 200 companies evidenced that the structure and competitiveness of executive pay in the UK is a live issue.

Such is the acuteness of this issue, the Capital Markets Industry Taskforce (CMIT) has been established, comprising CEOs, Chairs, and industry leaders, to maximise the impact of capital markets reform ensuring the UK is a place for businesses to “start, grow, scale and stay”. While pay is just one small aspect of this debate, it is part of a wider discussion on ensuring the governance environment in the UK does not prohibit competitiveness.

Yesterday, CMIT published an open letter titled “Resetting the UK’s approach to corporate governance” with 48 supporting signatories comprising prominent business leaders. This follows the Policy update from the Financial Reporting Council (FRC) on 7 November and the remit letter sent to the FRC by the Secretary of State for Business & Trade yesterday stating that “Proportionality of any new requirements is essential, and it is also important to look actively at where rules and guidance are no longer proportionate and can be removed or streamlined.”

The CMIT letter sets out a number of recommendations for how a recalibrated governance and stewardship regime could be applied in the UK to ensure that it actively contributes to economic growth and international competitiveness. We have set out an overview of CMIT’s main recommendations and have provided our views on the issues underpinning the debate and a potential way forward below. It is no coincidence that, while our thinking has been entirely separate from CMIT, there are many overlapping themes. This would suggest that there are some clear practical changes that can be made that would benefit companies operating in the UK making it a competitive place to do business. Importantly, the letter recognises that this is not about boundless increases to pay levels but rather giving Boards the ability to make decisions on pay in line with how other strategic matters are approached. A level playing field for UK companies globally is one of the underpinning principles.

CMIT suggests a reset and updated issuer and investor covenant:

  • Formation of new investor and issuer forum – comprised of representatives from companies and investors to improve the engagement between Boards and their shareholders. The purpose of this forum would be to identify challenges and issues with the opportunity to work together to develop practical solutions.
  • Issuers – ultimately Boards are accountable to shareholders, and they should have the ability to exercise their judgement as appropriate acting in the best interests of the Company. This may include deviation from the “conventional” application of governance standards where in the long-term interests of the Company, with appropriate explanation provided. They should explain how their chosen strategy discharges their duties, including the role that remuneration plays in this. Boards should demonstrate accountability – for example, if a Board member is not performing this should not be deemed “routine retirement”. The annual re-election of Directors is supported.
  • Investors – the governance and fund management functions should be fully integrated with primacy given to the portfolio managers. While CMIT advocate global consistency in application of principles, where this differs investors should make clear why this is the case. Equity owning investors should commit to best practice on engagement. Voting against without meaningful dialogue and / or outsourcing to proxy agencies without the ability to take back decisions is discouraged.

They also suggest a series of practical interventions:

  • The 20% voting threshold on a resolution as set out in the Corporate Governance Code should be removed. In addition, the Investment Association’s Public Register should be discontinued.
  • Companies should genuinely have the ability to apply the Corporate Governance Code principles in their best interests. Moving from a “comply or explain” to “apply or explain” basis is suggested so that an alternative explanation would be categorised as compliance affording more flexibility.
  • The 10% and 5% dilution limits in the Investment Association’s Principles of Remuneration applying to share schemes and executive share schemes respectively should be raised or removed. CMIT states that these limits are outdated and restrict companies (particularly those that are growing quickly) using shares effectively as part of their remuneration strategy.
  • Removal of “automatic” 50% discount from the Investment Association’s Principles when moving from a Performance Share Plan to a Restricted Share Plan.

So, what exactly is the problem?

The role of executive pay in an organisation should not be under-estimated; it can be a powerful tool to drive performance, foster alignment, create accountability and communicate priorities to a Company’s stakeholders. Rightly, there is significant scrutiny, but we question whether this has gone too far.

Quantum – How much is too much?

This is a question that is impossible to answer but it is clear there has been an unrelenting focus on restraining pay when actual levels in the FTSE 100 and FTSE 250 have not demonstrated a continuous upward trajectory over the past ten years as demonstrated in the charts below.

In our experience, most UK companies are able to offer broadly competitive levels of pay versus UK peers. However, those that are truly global can consistently struggle to attract and retain the best global talent. This challenge can often be perceived as being isolated at executive director level, when it is also felt in the reporting levels immediately below. Pay for senior executives has consequently become compressed as it is often limited by the levels of executive director pay which are pegged to UK norms, rather than the markets in which global companies operate and compete for talent. This not only creates recruitment barriers, but also makes managing internal succession planning more challenging.

Our analysis, presented below, indicates that, on a target total remuneration basis, US and European pay markets have experienced greater growth than the FTSE 100, with the second highest paid Director in the S&P 400 (which is a more comparable index to the FTSE 100 in terms of size), experiencing the highest growth in percentage terms since 2017. This creates significant pay competitiveness and compression issues, especially if companies have a significant US presence.

When we analyse the absolute figures which are presented below, we observe that the second highest paid Director in the S&P 400, which as an index has a median market cap smaller than the FTSE 100, has a median target remuneration opportunity that is close to that of a FTSE 100 CEO. Taking all the data points in totality, it is clear that for the truly global UK organisations there is a fast-evolving pay competitiveness and compression issue.

“Comply or else”

Over the past 10 years there have been a number of design features introduced with the ultimate aim of aligning the interests of executives and shareholders, thereby promoting responsible behaviour (e.g. bonus deferral, LTIP holding periods, post-employment shareholding guidelines, malus and clawback) such that there is a perception that companies must “comply or else” rather than be given the opportunity to explain why non-compliance might be appropriate. Some of these design features have been as a response to “bad apples” while others have been pushed by vocal investors. Whilst some interventions have rightly addressed inequity, such as pension provision, others have unnecessarily reduced the perceived value of incentive pay.

For example, once a shareholding guideline is achieved, what purpose does deferring annual bonus or applying holding periods serve? This layering of requirements creates churn in underlying share ownership, increases administration and reduces the perceived value of incentive pay. We therefore challenge whether the dogmatic expectation for “best practice” features is working and would instead support a return to a principles-based approach where the circumstances of each company and its executives are the primary driver for governance decisions.

Shareholder vs. Remuneration Committee power

A frequent comment we hear in Board rooms is that it is challenging for the Remuneration Committee to fully exercise the authority delegated to it by shareholders and that, although investment managers may fully support the executive team, their governance colleagues take issue with any deviation in executive pay practice from UK market norms. While the Executive Remuneration Working Group started the debate back in 2015, the approach to pay has become increasingly homogenous over recent years with c. 75% of FTSE 100 companies now adopting the same variable pay structure – bonus plus performance shares – at the most senior levels (from 42% in 2013).

In addition, there is an increasing asymmetry regarding how a Remuneration Committee can exercise its power, for example, significant pushback when discretion is exercised positively. Our analysis of the use of upwards and downwards discretion among FTSE 350 companies over the past two years reveals that, whilst the use of discretion is still unusual – around 16-17% p.a. on annual bonus and around 10% p.a. on LTI – there is an even split of upwards and downwards discretion in respect of adjusting LTI outcomes (49% and 51% respectively), whereas there is a much higher prevalence of the use of downwards discretion (85%) compared to upwards discretion (15%) in respect of the annual bonus. This has resulted in an environment which affords companies and Remuneration Committees little flexibility to exercise good judgement and respond to the dynamic market for executive talent and changes in the context in which an organisation’s performance is being assessed.

And what might be the solution?

In exercising their remit today, Remuneration Committees are required to balance the combined requirements of legislation, corporate governance guidelines, and the diverse views of investors (from governance and fund managers) and proxy agencies, whilst developing remuneration arrangements which are competitive and attractive in the context of the markets in which the company competes for talent. There is a lack of consensus such that, for some Committees, it is no longer possible to satisfy all the varying perspectives on executive pay.

We believe there are two areas for change.

How companies approach executive pay

Principles based approach – A simpler, principles led approach would provide a more effective and adaptable construct within which Committees can operate. Trust is needed to let Committees exercise their authority appropriately without the need to “comply or else” with a complex set of granular requirements.

For many UK companies, the current framework does not inhibit a Remuneration Committee’s ability to offer competitive pay, but it does inhibit a Committee’s ability to shape the remuneration framework in a manner best suited to a company and its stakeholders.

WTW’s global executive compensation guiding principles is a conceptual framework for how best to navigate the nuances of pay for senior executives. Below we present the four overarching principles of the framework alongside how the UK landscape could evolve to better support UK capital markets.

WTW’s global executive compensation guiding principles, a conceptual framework
WTW’s executive compensation principles Evolving the UK approach
Purpose: Executive remuneration programs should support the overall purpose, mission, strategy and objectives of the organization and its stakeholders.
  • Increased acceptance of alternative vehicles (e.g., options) or portfolio of vehicles (e.g., performance & restricted shares) to align pay with strategy. The merits of hybrid approaches are gaining some traction in the market, however we would advocate further acceptance of other hybrid plans (i.e., options and restricted shares mix) depending on the company’s strategy, talent challenges, geographic spread and risk profile
  • Increased acceptance of flexible dilution limits based on company-specific factors (e.g., lifecycle or industry)
  • Greater consistency in global proxy guidance, as the prescriptive nature of UK guidance means many UK global companies feel that they are at a competitive disadvantage
Alignment: Executive compensation should help foster a commonality of interest between management and stakeholders, as well as between various organizational levels, business units and geographies.
  • As restrictions on Board level pay has led to pay compression and misalignment of pay across the top cadre:
    • Ability to set salary at appropriate level, including larger than workforce increases where set at a lower level initially without significant challenge
    • Move away from ‘automatic’ pushback on bonus opportunities over 200% of salary
    • Give companies flexibility to make increases where needed rather than having to focus on one area at a time
Accountability: Reflects the role of executive compensation as one of the key accountability structures in most organizations - by which objectives are established and performance is measured, assessed and rewarded.
  • Greater acceptance of upwards discretion, which is often regarded as a ‘one-way street’
  • Recategorization of what is considered a ‘low’ vote – see section 2
Engagement: Refers to executive compensation’s key roles in attracting, motivating and retaining a company’s management team.
  • Increase the perceived value of executive pay by implementing a common-sense approach to governance restraints, i.e. shareholding policy should be set taking into account a number of factors including existing shareholding and the circumstances of the individual and Company (for example, bonus deferral may not be mandatory if an individual already has a significant holding)

How executive pay is governed

  1. Shareholder responsibility – we hear of conflicting views between investment and governance teams. The focus of investment teams tends to be commercial and therefore they are highly sensitive to factors that can impact company competitiveness. In contrast, governance teams tend to focus on the views of a wider range of stakeholders with a lesser focus on factors that can drive business results. It is imperative that these two “sides” are joined up and that issuer companies receive investor feedback that appropriately balances the views of both sides.
  2. Voting agencies – we fully understand that there needs to be an objective way of assessing a Company’s approach to pay to ensure a fair assessment. However, we call for a level playing field across geographies to ensure that no individual country is at a competitive disadvantage. Whilst there are clear differences in stakeholder views between listing locations, mid- and large-cap companies tend to have an international or global footprint and many key investors that subscribe to proxy research are also global. For these reasons, the extent of local influence on these companies is materially lower than at times in the past, and thus there is now a more pressing need for a level playing field globally. We are of the view that the current diversity in proxy voting policies across regions has the unintended and arbitrary side-effect of reducing the competitiveness in some geographies. Previous research we have published: Is executive pay a factor in the decline of London share listings? has examined the differences in proxy voting guidance between jurisdictions.
  3. Comply or explain basis of the Code – the reality is that companies feel that the Code is applied on a “comply or else” basis. In our view, there must be genuine room for companies to adopt an approach other than the default through thorough explanation based on their unique circumstances.
  4. “Acceptable” levels of voting – setting the “acceptable” level of vote at an arbitrary 80%+ can create unwarranted and unhelpful attention. Around 50% of current FTSE 350 companies have been included in the IA Public Register since its inception and it is difficult to believe that all these companies have made irresponsible decisions on executive pay. Over the past 10 years, between 0.4% and 1.6% of the current FTSE 350 have lost the vote on a remuneration-related resolution in any given year. As this “acceptable” level of voting is only applicable to resolutions for UK-listed companies, global companies that are subject to the UK regime may feel that their pay arrangements are subject to a disproportionate focus compared to their peers.

    According to the Office of National Statistics, the percentage of the UK stock market owned by overseas investors has increased from 41.2% in 2010 to 56.3% in 2020. This, in our view, demonstrates that Remuneration Committees are required to navigate an increasingly divergent set of views. Given this reality, and the fact that there are no comparable requirements in other jurisdictions, we would advocate removing this “acceptable” level of shareholder support entirely. Remuneration Committees should be empowered to decide what an acceptable level of support is based on their own unique circumstances and shareholder register, as is stated in GC 100 guidance published in 2019. Given the sometimes boiler plate nature of how organisations respond to a low vote, we would argue that allowing Committee flexibility to determine what constitutes a low vote would lead to more meaningful shareholder engagement outcomes.

So, what’s next?

There is no “one size fits all” answer and tweaking the high-friction areas is unlikely to effect the change needed in the system. We are strongly of the view that with effective design and governance processes in place, appropriate pay levels will generally result and inappropriate outcomes can be readily addressed. There needs to be an increase in trust afforded to Remuneration Committees to do the right thing by a Company’s wider stakeholders.

We therefore fully support the move to a principles led approach and believe that this would result in the UK being an attractive place for businesses to start, grow and thrive.


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