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Executive pay continues to attract criticism, and has long been a contentious issue for investors and in wider society. In this updated RI Expert Briefing we take a deep-dive into executive pay, how it works, how it is calculated, and what our approach to it is.

Executive Remuneration

Neville White Neville White Head of RI Policy & Research
RI expert briefings

Executive Remuneration

Neville White


Head of RI Policy & Research

Executive Remuneration

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Executive pay continues to attract criticism, and has long been a contentious issue for investors and in wider society. In this updated RI Expert Briefing we take a deep-dive into executive pay, how it works, how it is calculated, and what our approach to it is. 

how are company executives normally rewarded?

In the UK executive directors are normally rewarded via a package of short and long-term incentives that are designed to pay out in the event of the company achieving certain strategic targets. In the main, an executive might hope to receive a base salary, a short-term annual bonus and share awards under one or more long-term incentive plans. Executives also accrue a pension pot and are often contractually entitled to company benefits. Incentives are most often expressed as a percentage of base salary. A typical pay profile of a mid-tier FTSE100 Chief Executive is set out below:

Therefore, subject to performance the chief Executive above may potentially earn up to 640% base salary, with a further 30% in pension contributions. On average, base salary only makes up around 16% of the total executive package, with the largest portions contributed by short-term bonus (22%) and long-term awards (56%). Pension and benefits make up 6%.

what does a typical package look like?

Best practice now mandates that all awards are performance tested prior to pay out. In the main short-term annual bonus is linked to personal and corporate objectives. Long-term awards measure company performance over a period of three years.

what does a typical long-term incentive plan look like?

Companies may employ a range of schemes, but these fall into two groups: an award of ‘free shares’ (often known as Performance Share Plans (PSP) or Long Term Incentive Plans (LTIP), or Options, a financial instrument providing the opportunity, but not the obligation, to buy at a price set by the Remuneration Committee at a discount to the market price.

Typically these schemes operate over a ten year period, with annual grants measured over three years. If performance has been met after that time, the shares are said to “vest”: if not they lapse. With Option schemes, the performance period is again three years, and the executive has up to a further seven years to exercise the option. If after three years performance has been met, the shares vest: if not they lapse. However, if at the time of vesting the option to buy price is more than the market price they are said to be “under water” and have no value. Following pressure from investors the vesting period is increasingly set at three years with a further two year holding period.  Option schemes are increasingly rare in the UK owing to the difficulty in assessing their value.

how is performance measured?

Companies are expected to adopt performance hurdles that are appropriate to the business, are stretching and align with shareholder interests. The most usual metrics employed are a combination of Total Shareholder Return (measured against a comparable peer group or index) or EPS (earnings per share).

Companies may also choose additional or alternative hurdles such as return on capital employed (ROCE), free cash flow, sustainability indicators (typically in extractive industries) or Net Asset Value (relevant real estate). The Remuneration Committee is responsible for setting the policy criteria and monitoring delivery. It is considered best practice for each scheme to employ at least two performance hurdles. 

is it easy for shareholders to assess value?

No. A frequent criticism of contemporary executive pay is its complexity and lack of transparency; most schemes demand a level of technical expertise that eludes the majority, whilst the performance conditions attached are not easy to interpret in terms of their direct link to growing and sustaining long-term shareholder value.  Quite often we see schemes pay out when performance does not appear to warrant it! Recent reforms have required companies to set out a ‘single figure’ of pay received in the year; but this is not necessarily the same as the amount awarded.

has this contributed to excessive pay?

The opaque nature of long-term incentives has, in our view, contributed to the ratcheting of pay over time. The median pay for Chief Executives among the FTSE100 is now 117 times higher than the average full time employee; this equates to a median package of £3.46m based on an average salary of £29,574. The mean pay ratio between the CEO and their employees is now 114.1 times. We believe strongly in fair and appropriate levels of pay, however it is hard to justify the very significant levels of executive pay that now dominate.

Are there some very significant outliers?

Yes. Despite intense scrutiny, some companies continue to pay very excessive levels of variable pay, often owing to the poor design of the incentive scheme. In 2018, seven FTSE100 companies paid their CEO in excess of £5m, and five, more than £9m. 

how are shareholders able to vote on pay?

In the UK, companies were first required to have an advisory vote on executive remuneration in 2006. This follows publication of the Remuneration Report as part of the Annual Report cycle. The Remuneration Report is backward looking, reviews what has been paid, and seeks shareholder approval on an annual, advisory basis.

In addition from 2014, companies were required to put a binding vote to shareholders on Remuneration Policy. The vote has to be held at least every three years, and seeks approval of the various elements of pay and any increases to the individual elements, such as bonus. Any change to Policy between the triennial vote needs shareholder approval. This applies to all companies listed on the premium market, but not to AIM.

In theory these reforms, as well as empowering shareholders were designed to constrict the escalation of pay on an annual basis. Most companies first sought a binding vote on Policy in 2014, which means 2017, 2020 and 2023 are ‘Policy’ years for a large number of UK companies.

Therefore, subject to performance the chief Executive above may potentially earn up to 640% base salary, with a further 30% in pension contributions. On average, base salary only makes up around 16% of the total executive package, with the largest portions contributed by short-term bonus (22%) and long-term awards (56%). Pension and benefits make up 6%. 

If a Remuneration Report is voted down in a non-policy year, the company is required to return with a new vote on Policy.  The failure of a Remuneration Policy vote requires a company to either maintain the old Policy or return at a General Meeting seeking approval for a new revised Policy.

Share incentive plans, which last for 10 years, are subject to different rules requiring a binding vote on the plan’s expiry in order to commence a new one.

how often do investors oppose remuneration?

The Investment Association maintains a public register of ‘significant votes’ which is taken to mean opposition in excess of 20%. In 2018, only one UK Remuneration Policy was voted down, and a further 15 attracted over 20% opposition. The advisory vote on the Remuneration Report saw five voted down, and a further 42 having more than 20% oppose. 

What about overseas?

Each territory applies different rules and putting executive pay to a shareholder vote remains quite rare. The US Say on Pay regime allows shareholders to vote on the frequency of a vote, and at an advisory level on pay itself. In some parts of Europe, remuneration policy or directors fees are put to vote, but there is no EU wide requirement as such. In Asia, voting on pay is rare, and is not generally accepted in Japan. Even in mature Asian markets such as Singapore, shareholders may only be asked to vote on the level of aggregate fees, rather than the individual elements.

what does EdenTree look for in deciding how to vote?

Our published Corporate Governance Policy sets out in detail what we look for in deciding how to vote. In essence we take the view that remuneration should be sufficient to recruit, retain and motivate without being excessive, and should not reward undue risk. Overall in assessing each pay proposal we look for the quality of disclosure so as to allow an informed view, whether performance hurdles appear stretching and the potential for excess. In general terms, annual and long-term awards that exceed 300% salary per annum will trigger an ‘excess assessment’. This does not mean we would automatically support pay awards up to 300% salary, but that additional scrutiny is applied in these cases.

Factors that contribute towards opposing remuneration include below market consensus performance criteria; criteria linked wholly to share price appreciation; factors generally outside of a director’s control (such as commodity price movements); and long-term incentive schemes that are tiered towards, and reward excessively for, median performance.

In circumstances where we view the structure of pay to be particularly egregious we may choose to oppose the Chairman (or members) of the Remuneration Committee, and we expect all companies to exercise ‘malus’ and ‘clawback’ in the event of material issues arising that should make awards forfeit.

are there any other contentious elements of pay?

Most directors are entitled to corporate benefits such as a car, health insurance etc. We ensure these appear reasonable in aggregate, and may oppose where they are not.

There is increasing focus on pension payments. These are most often paid as a cash amount expressed as a percentage of salary. The Investment Association (IA) has issued guidance that these payments should be in line with employees as a whole, and should not be used to increase remuneration. Our Policy states pension should not normally exceed 20% of base salary, and where it is materially above this, we will oppose.

How much action does EdenTree take?

The majority of resolutions put to shareholders are routine and non-contentious; that is why the level of opposition is small. In 2018, the last full year of voting, we opposed/abstained 7% of resolutions in the UK and 16% overseas. This hides the fact that we opposed 48% of all remuneration ballots in 2018, and 86% of all FTSE100 remuneration ballots that we own. Remuneration was 45% of all UK action taken, followed by Board directors (27%).

Whilst we view active voting to be a vital part of overall stewardship, resolutions are seldom voted down in the UK owing to the disparate nature of share ownership. Nevertheless, we feel it is important to clients as part of our active responsibility to vote our shares and to oppose proposals that fail to meet our stringent standards. Over time, the market has moved closer to where we believe these standards should be set across a raft of governance proposals including auditor tenure, director contract notice periods and in seeking to rein in excessive levels of remuneration.