EIB Insight: Poaching global talent – can UK listed companies finally be competitive on pay?

What are the IA principles of remuneration?

The IA is the key proxy firm in the UK through its Institutional Voting Information Service (IVIS). As such, the views of the IA are carefully considered by remuneration committees of main market companies in the UK (and often also AIM-listed companies). The IA regularly publishes its latest concerns for listed company incentive arrangements in its principles of remuneration and so, together with the ‘comply or explain’ approach now required under UK corporate governance, the IA heavily influences market practice.

Technically, the principles of remuneration are guidance, not rules, but you’ll need good reasons to stray away from the norm and having your shareholders on side will be critical.

What has changed?

The recently updated principles of remuneration follow a letter that was sent to FTSE 350 companies’ Remuneration Committee Chairs in February 2024, which outlined how investors will engage with investee companies on executive pay in the 2025 AGM season. The letter set out the IA’s intention to update their principles of remuneration to reflect evolving views and practice on quantum of awards and the use of hybrid plans in order for the UK to remain a competitive market.

This article provides a summary of the changes made by the simplified new guidance.

Tailored incentives to suit each company – really??

The updated guidance continues to encourage flexibility in remuneration with emphasis on the importance of the right incentives for each “unique” company.

In this spirit and following feedback from the FTSE 350 in September 2023, the new guidance suggests that companies curry shareholder favour to less usual incentive approaches by identifying where these are being proposed in order to compete for talent from other markets, such as the US. In addition, in a potential softening towards value creation plans (VCPs) and hybrid schemes, the guidance asks for additional explanation for shareholders where companies consider such incentive structures to be appropriate.

Nonetheless, the IA’s previously overt scepticism to such alternative incentive arrangements does seem to remain in the background: the guidance sets out minimum expectations and expresses a preference for “simplicity” in incentive arrangements (the inference being that VCPs and hybrid schemes do not provide this). It will be interesting to see how this translates to actual change in remuneration practices this year.

Special awards? Think again…

The IA warns that special awards should only be used in exceptional circumstances and the guidance now includes a list of principles that companies should adhere to when considering special awards or ex-gratia payments.

This is in line with the IA’s continued support for market aversion to “excessive rewards for mediocre results” and “wealth disparity” in the context of executive pay, and the new guidance again draws out the necessity for “public trust in business”. An example given is that benchmarking alone in order to increase pay levels is not considered acceptable since it would encourage a ratchet effect in the market.

However, it is worth noting that the new guidance around special awards is markedly less directly critical and prohibitive than the previous guidance, which stated that “a need for special grants…indicates poor planning by the Remuneration Committee”.

Will NED share ownership become market practice?

The IA continues to state its expectation that NEDs should hold company shares. The difference in the new guidance is that the IA acknowledges that NED participation in share option or performance-related pay schemes is not permitted by the UK Corporate Governance Code, and seems to draw a distinction between such incentives and the acquisition of shares at market price as part of the NED fee.

It seems likely that this renewed emphasis might be due to so few companies requiring NEDs to hold shares due to the apparent mismatch with the UK Corporate Governance Code. Whether companies accept the proposed nuance and make any real change in this respect in the 2025 AGM season is questionable, especially considering that companies’ remuneration policies are unlikely to currently permit such equity grants to NEDs and so specific shareholder approval would be required in the absence of a new remuneration policy being tabled for shareholder vote in 2025.

Will there be a comeback for subsidiary growth share grants? Mmm…

The IA have removed a provision from the previous version of the guidance that noted that shareholders generally consider it undesirable for share-based incentives to be granted over shares in a joint venture company or subsidiary company.

It will be interesting to monitor whether this gives birth to a fresh round of tax-favourable growth share grants over subsidiary companies with an automatic flip-up on certain corporate events. The long-awaited autumn budget will likely play a part here given that growth shares will undoubtedly become less popular if capital gains tax rates increase.

Acceptance of accelerated vesting? Not likely.

The prohibition on automatic acceleration of vesting on a change of control and stringent vesting testing for leavers is no longer contained within the new guidance. It might be that this signals a change of approach. However, we feel the more likely reason is an acknowledgement that market practice on these points now reflects the previous guidance from the IA and so, in line with the aim of simplifying the IA principles of remuneration, such provisions have been removed from the guidance for the time being.

Shareholder listening is crucial

The new guidance places great emphasis on shareholder “engagement” and understanding shareholder views through maintaining “constructive dialogue”. This builds on the previous guidance which openly criticised companies for using shareholder consultation as a validation exercise only.

The message here echoes comments previously made by the IA where they verbally encouraged companies to “pick up the phone” to them and major shareholders to discuss any significant or non-market remuneration proposals before remuneration policies go to shareholder vote. This goes beyond simply writing to communicate such proposals: companies must instead ensure that the IA/shareholders are properly appraised of such proposals and able to engage meaningfully.

The new guidance now specifically mentions the importance of early engagement and providing sufficient information on the proposals and approach to remuneration strategy, as well as disclosing the outcomes of the consultation.

Broadened scope of guidance – private companies take note!

In its introductory statement, the IA notes that the new guidance is also relevant to companies listed on markets such as AIM or private companies. This is despite the guidance historically being aimed at companies with a main market listing for obvious reasons.

It is possible that the IA is hoping investors in private companies will take on board the principles of remuneration when negotiating funding round terms (maybe) or that companies hoping to move up from AIM to the main market will voluntarily seek shareholder approval for their incentive arrangements or take the principles of remuneration into account when considering their remuneration strategies (as many AIM companies do).

However, Two Birds considers that this is more likely a nod to the PISCES consultation, which outlines proposals to open up the UK markets to certain private companies (and which, incidentally, may cause significant issues for private company incentives taxation). At the time of writing, we are awaiting the outcome of the 2024 autumn budget and any early indicators from the new government as to whether this initiative will proceed.

Your trusted adviser

If you are considering your remuneration arrangements ahead of the 2025 AGM season, please contact Sarah Ferguson or Laura O’Flynn at Bird & Bird LLP via: [email protected] or [email protected], and we will be happy to discuss your proposals in light of the new IA principles of remuneration.