Ellason lens on… LGIM’s UK Principles of Executive Pay for 2023

Mon 24, October

LGIM has recently issued an updated version of its UK Principles of Executive Pay, to guide companies as they make pay decisions ahead of the 2023 AGM season. The key tenets of the Principles remain similar to previous years, but there are some significant updates, particularly regarding the use of ESG in incentives, as well as guidance on how to navigate the current economic environment.

Key additions to the Principles include:

Executive Director salaries and cost-of-living increases

Where companies have awarded significant pay increases to lower paid workers to help with the cost-of-living crisis, remuneration committees should exercise caution if they plan to use the average workforce increase when setting executive salaries. Consideration should be given to the impact of a similar % increase on the total £ pay for an executive once the impact on incentive opportunities is taken into consideration.

Addressing ‘windfall gains’

Where companies have previously stated that they will adjust vesting outcomes for LTIP awards granted when share prices were low (e.g. during the pandemic), LGIM expects to see a clear explanation of the Remuneration Committee’s decision-making process and will vote against the remuneration report if it does not believe this process has been sufficiently thorough or transparent.

ESG measures
LGIM has created prescriptive environmental guidelines for companies in the following sectors, which it believes have the greatest impact on climate change: autos, apparel, aviation, banks, cement, chemicals, food, insurance, mining, oil & gas, REITs, steel, technology, telecoms and utilities.

In the immediate term, LGIM states that these companies should link part of their long-term incentive to delivering on climate mitigation goals, ideally via SBTi-approved (or equivalent) transition plans to achieve net zero by 2050. For new remuneration policies approved from 2025 onwards, at least 20% of the LTIP (or a distinct underpin for restricted stock awards) should be based on climate targets linked to net zero targets (scope 1-3), subject to third party verification.

LGIM’s more general ESG recommendations include the use of diversity targets in sectors that struggle to recruit female talent and the avoidance of employee engagement metrics. LGIM prefers employee retention measures (where appropriate), as it believes that employee engagement is something a well-governed company should be doing anyway.

Restricted stock

The vesting of restricted stock awards should now be subject to meeting a threshold level of financial performance that is pre-disclosed; and, for companies in those sectors with the greatest impact on climate change, to meeting pre-disclosed climate transition targets (from 2025).

Ellason commentary: In the current economic environment, executive salary increases and the treatment of windfall gains are likely to be the most contentious voting issues of the 2023 AGM season, and LGIM’s additional guidance provides helpful clarity on how to approach these considerations for fixed and variable pay for executives. Our forthcoming Ellason Lens on the issue of windfall gains will also aim to provide further clarification in this area.

LGIM now joins Cevian and Allianz in treating ESG as a red-line voting issue (at least for companies in certain sectors). While companies should certainly be aware of LGIM’s recommendations when considering how (and whether) to incorporate ESG into their incentives, it is important that any measures introduced are specific, tangible and relevant to the company’s wider strategy. LGIM’s guidance is more prescriptive than most and some shareholders remain cautious about the use of ESG unless the targets set can be meaningful, robust and measurable to avoid the perception of ‘greenwashing’.

LGIM’s call for restricted share awards to be subject to specific financial targets is rare among investors; the majority remain comfortable with Remuneration Committees taking a more holistic, discretionary view on whether or not awards should vest, provided that the company has a compelling rationale for the use of restricted stock in the first place.

Please do not hesitate to contact any of the Ellason team should you wish to discuss this issue further.