Major UK pension funds and NAPF set out five principles of executive remuneration

The investors avoid prescribing any specific structures or measures

A group of leading UK pension funds and trade body the National Association of Pension Funds (NAPF) have launched a set of five principles on executive remuneration.

The principles (see below) have been produced by Hermes Equity Ownership Services, the BT Pension Scheme, RPMI Railpen Investments and Universities Superannuation Scheme (USS) alongside the NAPF.

The investors avoid prescribing any specific structures or measures, saying: “Instead we expect companies to articulate clearly to shareholders how their pay policies meet these principles in a manner which is most appropriate for their specific situation.”

“We strongly believe that the time is right for companies and investors to fundamentally rethink their approach to executive remuneration,” they say, adding there’s a “significant appetite” amongst companies to more closely align pay with the interests of their long-term owners.

The principles have grown out of a report launched at the start of 2013 called “Remuneration Principles for building and reinforcing long-term business success”. Since then, the investors have held discussions with the chairs and remuneration committee chairs of almost half of FTSE 100 companies, along with executives responsible for reward, remuneration consultants and other institutional investors.

They acknowledge that “each company is unique” and that it is for boards to determine which specific pay structures will work best for their company’s executives and to communicate intelligently their reasoning to investors.

The new pay principles are part of what the NAPF calls “more robust expectations” for corporate accountability – adding they represent significant changes to its latest Corporate Governance Policy and Voting Guidelines published today.

The guidance also puts greater emphasis on corporate reporting of extra-financial factors and “strongly encourages” investors to use their full range of powers.Joanne Segars, NAPF Chief Executive, said: “This year, we are more strongly encouraging companies to identify and engage with their long-term investors, rather than those on their register who are more interested in short-term trading.”

The Principles:
1. Remuneration committees should expect executives to make a “material long-term investment” in their companies.
Supporting comment: “The best form of alignment between executives and shareholders is the ownership of shares over the long-term. The meaning of “long-term” will differ from company to company but three years, the most commonly used time period for long- term awards, is often not long enough.”

2. Pay should be aligned to long-term success and the desired corporate culture.
Comment: While we do not believe that well-structured remuneration is a panacea we do believe that it is a vital indication of and contributor to the desired culture, values and ethos of a company.

3. Pay schemes should be clear, understandable for both investors and executives, and ensure that executive rewards reflect long-term returns to shareholders.

Comment: “The desire of some investors to encourage improved company performance by focusing on metrics and targets rather than behaviour and outcomes is at least in part responsible for the increased complexity we have seen in remuneration schemes in recent years.”

4. Remuneration committees should use the discretion afforded them by shareholders to ensure that awards properly reflect business performance.

Comment: “We support committees that take a holistic approach to performance rather than applying simplistic mechanistic formulae.”

5. Companies and investors should have regular discussions on strategy and long-term performance.

Comment: “We believe it is also vitally important that investors are aware of their responsibilities under the Stewardship Code to engage with companies on a full range of issues.”