Remuneration Committee Discretion

10 September 2020

by Angus Graham Senior Manager, PwC United Kingdom

Email +44 (0)7730 597024

Our recent poll shows that most remuneration committees intend to use discretion to determine 2020 annual bonus and LTIP outcomes - but what factors will they consider when making their assessments?

For many companies, coronavirus (COVID-19) has resulted in significant uncertainty in their short and long-term performance outlook.

Our recent poll of Heads of Rewards suggests that many Remuneration Committees intend to navigate this uncertainty through greater use of discretion over 2020 incentive outcomes.

Annual bonuses

For the 2020 annual bonus, just 10% of respondents intended to delay target setting until there is greater certainty over the FY20 outlook. This more than likely reflects the fact that most December year end companies had already set targets for the 2020 annual bonus at the start of the COVID-19 pandemic.

A clear majority (67%) intend to retain the existing targets set at the start of the year and to use discretion as required at the end of the year to determine the final outcome.

Other approaches would be to either amend targets in flight, or to reset them for a portion of the year (e.g. for H2). But just 11% of respondents intend to do either of these, primarily due to the challenges of setting targets in the midst of continued economic uncertainty and the possibility of “second waves”.

13% of respondents had already taken the decision to cancel the 2020 annual bonus in order to preserve cash.

 

What actions are you taking in respect of 2020 annual bonus targets?

LTIP grants

For 2020 long-term incentive plan (LTIP) grants, investors were quick to highlight the risk that, for grants based on low share prices, participants could benefit from windfall gains if share prices rebound over the vesting period.

Remuneration Committees had a choice:

  • Take action now - grant fewer shares to reflect the lower grant price;
  • Take action at the end of the vesting period - use discretion to reduce outcomes on vesting where windfall gains have been received; or
  • Continue to operate the LTIP as normal.

 

If you have granted a 2020 LTIP or decided what you are going to do for it, what actions are you taking to address windfall gains?

 

Again, a majority of respondents (51%) preferred to use discretion to assess whether windfall gains have been received at the end of the performance period, rather than taking any action now.

However, just 6% confirmed that the parameters to determine windfall gains at the end of the period have already been agreed by the Remuneration Committee, despite the fact that the Investment Association expects Remuneration Committees to set out the approach they will take and factors they will consider when judging if there has been a windfall gain from the LTIP grant in their next remuneration report.

2020 directors’ remuneration reports (DRRs)

Given the uncertainty that companies face, it is not surprising that many Remuneration Committees intend to use discretion when they determine the 2020 annual bonus and LTIP outcomes. This will allow Committees the benefit of making decisions on the basis of facts, rather than taking a pre-emptive approach.

However, historically the use of discretion has been a sensitive area with shareholders and it will be particularly important that 2020 DRRs set out clearly the factors that the Committee considered (or intends to consider, for 2020 LTIP grants) in making these decisions, and why they are considered appropriate. DRRs will set out the 2020 annual bonus outcome per the regulatory requirement, but they could also set out how the 2020 LTIP grant is tracking against any proposed windfall gains tests, to illustrate how the Committee’s discretionary assessment will work in practice.

When shareholders and proxy advisors assess these disclosures at 2021 AGMs, they will be looking for evidence that the Committee has considered a number of factors, including:

  • For annual bonuses: actual financial and share price performance, the company’s dividend policy, the remuneration of other employees during the year, and whether the company has made use of government funds such as the business rates relief or the Coronavirus Job Retention Scheme.
  • For 2020 LTIP grants: the grant price of the prior year awards, share price performance relative to the general market, and how share price performance compares to other metrics such as revenue, profit, returns over the same period.

The situation for 2021 AGMs is likely to be one of having had (or being in) a severe global recession, with significant increases in unemployment and a major strain on public finances from measures taken to mitigate the impact of the COVID-19 pandemic. Ultimately, Remuneration Committees will need to apply a common sense test to decisions, factoring in the differing perspectives of the many external observers.

by Angus Graham Senior Manager, PwC United Kingdom

Email +44 (0)7730 597024