CORPORATE GOVERNANCE AND REMUNERATION  - AN ABI PERSPECTIVE ON 2003 AND THE OUTLOOK FOR 2004

 

 

Key issues

 

Compliance with the Combined Code has continued to grow, but fewer companies are getting a clean bill of health from our Institutional Voting Information Service(IVIS), largely because of the introduction of voting on remuneration reports.

 

IVIS has monitored 686 companies so far in 2003. Of these 86 have been given a red-topped report indicating serious concern. The main causes for a red-top were the remuneration report (32), combined code issues such as independence of non-executive directors or composition of the remuneration and audit committees (30), and failure to comply with guidelines in new or amended remuneration schemes which were put to a separate vote (13).

 

A striking feature of the year has been the large increase in companies receiving an amber top. This category indicates a significant breach of best practice, although one requiring careful shareholder consideration because of the presence of mitigating circumstances, plausible explanation, or commitments made as a result of pressure from ABI members.

 

Amber tops now constitute just over 20 per cent of the overall total while blue tops have come down from around 82 per cent to 65 per cent. The proportion of red tops is very little changed.

 

The results show that, thanks largely to the introduction of voting on remuneration reports, there are now a larger number of cases requiring careful consideration by investors because of circumstances that are not straightforward. This is reflected in a wider range of voting results at annual meetings.

 

Remuneration

 

Overall, most red-tops are still awarded because of concerns over remuneration. Some 10 per cent of new share incentive schemes receive a red-top. The largest problems relate to performance targets, but members are still worried by breaches of dilution limits, attempts to re-price options and retesting arrangements, which allow executives a second chance to receive an award if they fail to meet the performance hurdle at the first attempt.

 

Some 70 per cent of new option schemes still allow for re-testing. Shareholders increasingly believe this is inappropriate now that annual grants are commonplace and the ABI remuneration guidelines have been tightened to reflect this view.

 

During the year the ABI reviewed 124 executive pay proposals from companies and, in consultation with its members, regularly recommended changes before the schemes were finalised. We are grateful to companies which agreed to modify their proposals and we continue to encourage them to consult in advance on new schemes or significant changes to existing schemes. This reduces the risk of public conflict when proposals are published.

 

Following pressure from investors, service contracts have been reduced and three quarters of companies now restrict their contracts to one year or less. The total rises to around 80 per cent if companies are included that confine new directors to one year contracts.

 

One year contracts have been established as best practice. Shareholders see no justification for compensation in cases where they are reduced to this level.

 

Guideline revision

 

ABI has completed its annual revision of its remuneration guidelines which are now on our website. The wording on re-testing has been tightened as mentioned above. So has the wording on American-style options issued without performance conditions.

 

The ABI has given careful consideration to the new government regulations, designed to help companies manage their capital efficiently by buying back their shares and then re-issuing them. Our new remuneration guidelines make clear that the use of such shares to satisfy option schemes should be kept within the overall dilution limit, which is kept at a generous level of 10 per cent.

 

The new remuneration guidelines include tighter wording of the joint ABI/NAPF paper on contracts and severance, for example with regard to the inspection of contracts. The paper makes it clear that contracts should be properly thought through when they are written in order to prevent awkward situations arising later.

 

Separately the ABI board has endorsed a paper on voting policy. This stresses our belief that institutional shareholders should make considered use of their votes as part of the engagement process with companies. Institutions should make clients aware of voting policy. The paper encourages ABI members to monitor demand from retail customers for information about how votes are cast.

 

We have not made any further modification to our guidelines on corporate social responsibility. However, we continue to monitor compliance and are pleased at the improved standards demonstrated by larger companies in the second year of operation of these guidelines. In 2004 we intend to focus on increasing awareness of the connection between the management of social responsibility risks and the financial performance of companies.

 

Combined Code

 

ABI strongly supports the Combined Code and has welcomed the new version introduced in the wake of the Higgs report. Members believe that, properly applied, high standards of governance reduce risk and enhance the quality of long term earnings. This helps companies to deliver value to long term investors such as the insurance industry and its customers.

 

Monitoring by IVIS shows continued progress by companies towards compliance with the Combined Code. Some 55 per cent of FTSE 100 companies and 44 per cent of AllShare companies now claim to be fully compliant. In both cases this is a sharp and welcome increase on 2002 levels.

 

It is also clear from the figures that, contrary to comments from some corporate observers, shareholders do not take a rigid view of compliance. Comply-or-explain is working. It is not a question of comply-or-else. We look forward to further incremental improvement with the introduction of the new Higgs Code.

 

ABI has maintained its programme of engagement with companies at the behest of members. During the past year we have engaged with 12 companies on governance issues other than remuneration. Members also engage regularly on a bilateral basis.

 

Because of the time lag with which the new Higgs Code comes into force, companies will still only be required to report under the old code in next year’s reporting season. IVIS will therefore continue to monitor behaviour under the existing code for the time being. But we encourage companies to start complying early with the new Higgs Code and will give credit to those that conscientiously seek to do so.

 

ABI members stand by their obligation to consider carefully explanations given by companies for deviation from specific provisions of the code. However, they also believe the operation of the Code will be enhanced if companies take care to offer reasoned explanations of why the code provision should not apply to them in their particular circumstances. The better the quality of explanation, the more likely shareholders are to accept it.

Notes

 

1.            Enquiries to:

         Alan Leaman    020 7216 7440 (Mobile: 07957 482330)

         Lucy Butler        020 7216 7411 (Mobile: 07712 841184)

 

2.            The ABI is the trade association for Britain’s insurance industry. Its more than 400 member companies provide over 94% of the insurance business in the UK. It represents insurance companies to the Government, and to the regulatory and other agencies, and is an influential voice on public policy and financial services issues. ABI member companies hold more than a fifth of all investments traded on the London Stock Exchange, on behalf of millions of pensioners and savers.

 

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