Recent reforms in the UK market have led to less prescriptive executive remuneration principles that encourage companies to tailor structures to their business, strategy, and performance while consulting with shareholders.

By Mark Austin, Kendall Burnett, Sarah Gadd, James Inness, Anna Ngo, and Johannes Poon

On 8 October 2024, the Investment Association (IA) updated its Principles of Remuneration (and supporting guidance) (the IA Principles), which predominantly apply to UK-listed companies. UK proxy advisors refer to the IA Principles when setting voting guidelines for AGMs, and the revised edition is likely to impact next year’s AGM reporting season — particularly for companies seeking shareholder approval for a new director remuneration policy, whether as part of their usual three-year cycle or otherwise.

The revised IA Principles comprise three simplified, overarching principles focussing on:

  1. long-term value creation through aligning pay and corporate strategy;
  2. performance criteria that support the sustainable, long-term financial health of the business and sound risk management; and
  3. delivery of performance-linked remuneration.

These principles, and the accompanying guidance, are significantly more flexible and less prescriptive than previous iterations — and reflect the progressive market discussions on executive remuneration that have taken place in the UK in the last couple of years. The IA has made it clear that the revised IA Principles aim to allow flexibility whilst outlining “commonly accepted approaches” to executive pay. There is an emphasis on engaging proactively with shareholders to understand their views and expectations, where possible, throughout the revised IA Principles.

Key Changes

The key changes under the revised IA Principles include the following:

  • Dilution limits: the IA has removed the recommendation that only 5% of a company’s share capital should be subject to discretionary share plan awards in any rolling 10-year period, instead accepting that a 10% limit applying to both discretionary and all-employee schemes is sufficient. The IA also acknowledged that, for certain recently listed, high-growth companies, needing to incentivise their employees with share-based awards, a higher limit could be appropriate in exceptional cases — with an expectation that the company will align itself with normal dilution limits over time.
  • “Hybrid schemes”: the revised IA Principles acknowledge that “hybrid” arrangements — where executives receive a combination of performance-based awards and awards subject to service-based vesting only — can be appropriate, as is the case in the US. The IA notes that companies adopting these schemes typically have a significant US footprint and/or compete for global talent.
  • Deferral requirements: previously the IA Guidelines recommended that a proportion of any annual bonus in excess of 100% of base salary should be deferred. This has been replaced with a more fluid requirement to have a deferral policy in place which can allow for a less stringent approach to deferral, particularly for executives with large shareholdings in the company where adequate malus and clawback policies are in place.
  • Upwards discretion: the IA’s guidance on when a remuneration committee can exercise discretion over an executive’s reward now expressly states that upwards discretion is permitted to reward exceptional achievements or contributions not otherwise captured in performance metrics. Previously the guidance only referred to downward discretion leading to a practice in which UK companies felt constrained in their ability to reward outperformance.
  • Shareholding guidelines:the revised IA Principles now reflect that a director would usually meet the minimum director shareholding requirement by retaining the equivalent of one year’s LTIP award.
  • Change of control:the new IA Principles no longer expressly warn against the use of transaction bonuses or retention awards for executives. However, there will still be UK Takeover Code considerations — principally the need for transaction parties to navigate the UK Takeover Code prohibition of offer-related arrangements when agreeing management incentivisation arrangements in a takeover context.The IA has removed the previous guidance that time pro-rating should be applied to outstanding share awards on a change of control.

As referenced above, the updates to the 2024 principles come against the backdrop of once-in-a-generation reforms of the UK’s public equity markets. As explained in the IA’s annual letter to FTSE 350 remuneration committee chairs in February 2024, the IA delayed the publication of these updated principles to address the debate and diverse views on the competitiveness of remuneration in the UK and the impact of investor expectations on remuneration in the UK compared to other jurisdictions.

In updating the IA Principles, the IA has acknowledged that its members “want a competitive UK listing environment that attracts companies to list and operate in the UK” and that it is seeking to reflect investor views and allow for more flexibility in remuneration structures rather than create a one-size-fits-all approach to remuneration.

The IA still expects companies to comply with or explain divergences from the UK Corporate Governance Code and the IA Principles and to exercise caution over the design of remuneration structures generally — and in particular value creation plans. Consultation and transparency with shareholders is a key theme repeated throughout the new guidance. However, the new flexible guidance will be a welcomed development for many UK companies and their shareholders, looking to embrace more dynamic and competitive remuneration structures to attract and retain global talent, particularly those businesses with a significant US footprint.