Achieving excellence: remuneration reporting

The CGIUKI policy team and judges of the Excellence in Governance Awards identify examples of corporate reporting good practice in FTSE 350 companies

It is critical to get remuneration reporting right. Not only is it a topic of particular public interest, but it also comes with the inherent risk that shareholders could vote against the report unless there is assurance that their interests and those of the executives are aligned.

Obviously compliance with the law is a prerequisite; in this case the Companies Act 2006. The vast majority of reporting in the period up to the end of July 2014 must also act in accordance with the new Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013, which are being implemented for the first time and are very prescriptive. Although most companies will have had the benefit of the guidance produced by the GC100 and Investor Group, there was sympathy from judges for those 30 September year-end companies who were the guinea-pigs for the rest of the market.

From policy to outcome

Linking remuneration policy to strategy and then connecting strategy and results to outcomes is a critical issue for many companies. In the months leading up to the publication of the first reports, a number of companies struggled with creating a policy which covered their existing pay arrangements. Where no changes have been proposed to arrangements less likely to be agreed today, these reports look a little out of step with current fashion. Generally, the feedback from most investors is that they would be inclined to support pay policies that are clearly and explicitly linked to the strategy of the company, the only exception being where potential rewards were egregious.

Some companies handle this very well, others less so. Companies that do succeed in connecting pay and strategy in their policy report fail to do so in their implementation report, and vice versa. Investors are keen to see policy that aligns pay with strategic targets. They want pay outcomes in the implementation report to reflect achievement of those targets and to show the results obtained. Investors also expect thought to be given to how the remuneration policy is used to create and maintain the desired culture throughout the organisation. Examples of good practice include:

  • Dairy Crest offers a clear connection between policy, targets and outcomes and a good discussion on company performance. There is also an overview of priorities and approach for the year ahead. Its disclosure on recruitment and termination policies is well written, with some interesting information on outside appointments.
  • The Smith and Nephew chairman’s letter features comprehensive explanations tied to strategy.
  • Standard Life provides a useful description of targets and how these join to its strategy.
  • The Thomas Cook chairman’s letter is excellent and emphasises the company’s significant turnaround. A table explains how KPIs are hooked to remuneration schemes – aligning pay with growth – and an enlightening section on the approach to external appointments.
  • WS Atkins includes a helpful section on buyouts and a table on termination scenarios.

Setting targets

Obviously the targets associated with any remuneration policy are critical. Investors will expect companies to explain their targets, albeit within reasonable limits. Perhaps more important – yet less frequently included – is to say why they are appropriate. Companies should consider how achievement of their targets will deliver company strategy. They should also evidence that these are stretch targets.

Investors expect thought to be given to potential unintended consequences of any chosen target, for example where they might encourage negative behaviours such as mis-selling. They also like to see the steps that can be taken to mitigate any such risks. Examples of good practice include:

  • Dairy Crest has an informative section on why particular performance measures have been chosen.
  • GlaxoSmithKline tracks performance very clearly.
  • The letter from Lonmin’s Remuneration Committee Chairman is particularly insightful, reflecting on performance over the year, linking to payouts and describing how the committee treated joiners and leavers. Graphs demonstrate the impact of results on pay and the connection between pay and strategy.
  • Smith and Nephew’s explanation of its 2013 performance includes practical graphics and charts in respect of policy and target summaries.
  • Standard Life has an interesting discussion on performance and achievements.
  • Thomas Cook’s table on executive performance over the year was innovative and helpful.

Judgement and discretion

Some remuneration policies are rather woolly in the areas of judgement and discretion. The former is the assessment made by the remuneration committee on whether a target (usually non-financial) has been achieved. The latter is where a company has chosen to do something other than apply the outcome generated by simple application of the policy. Not all companies appear to understand the distinction, and in one or two cases the terms are used interchangeably.

On the use of judgement, unless the decision is obvious, the report should state why the remuneration committee believes that the target has been achieved. Discretion needs to be distinct in the policy where there should be examples of the circumstances in which it may be applied.

In the implementation report, it should be clear how, why and where discretion has been applied. Good examples include steps taken in acknowledgement of the external and internal economic environment, or those taken to discourage any unwanted behaviours driven by a chosen target. This is an emotive issue. The purpose of discretion is to encourage fair pay outcomes. However, there is a perception among some investors that companies propose the exercise of discretion in order to increase pay. Some companies feel that investors will only approve the downward exercise of discretion.

There are a number of companies which had to issue clarification statements over the course of the year. In many cases this happened because their proposed policy did not give investors sufficient information on how proposed discretion might be used.

A similar issue arises when changes have been made to pay arrangements. There should be clear explanation of the reasons for changing elements of the pay schemes and why other options were not adopted. If they are outside the scope of the policy new authority must be obtained from shareholders. Again, fairness is the key. Examples of good practice include:

  • Lonmin gives an informative explanation of the different markets in which the company is engaged and the impact that these have on pay arrangements. The table of advisers was particularly strong, detailing by whom they are appointed, and there was a good overview of committee discretion.
  • WS Atkins features analysis of the assessment of performance for annual bonus as well as insights into the following year’s strategic measures. There is also an interesting link to the HR section of the annual report for broader workforce pay.

Investor engagement

It is a fact of life that remuneration is one of the perennial issues in discussions between issuers and investors. Both sides would probably prefer that it was not. Some remuneration reports have evidence of timely, open and constructive engagement with investors, including some information about the discussions. Examples of good practice include:

  • GlaxoSmithKline includes a focus on shareholder engagement.
  • The WS Atkins report provides excellent details of its engagement with ISS.

FTSE 100

WINNER

Smith and Nephew plc

SHORTLISTED

GlaxoSmithKline plc
Rio Tinto plc
Standard Life plc

FTSE 250

WINNER

Lonmin plc

SHORTLISTED

Dairy Crest plc
Thomas Cook plc
W S Atkins plc

Peter Swabey is Policy and Research Director at The Chartered Governance Institute UK & Ireland

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