On 8 October 2024, the U.K. Investment Association (IA) published its Principles of Remuneration (the Principles) for the 2025 Annual General Meeting (AGM) season, setting out the IA’s expectations on executive remuneration structures.

The Principles are predominantly for companies with a main market listing but are also relevant to companies listed on other markets, such as AIM, or private companies (Companies).

The Principles build on the remuneration expectations set out in the U.K. Corporate Governance Code and should be read in conjunction with those expectations. They highlight best practices as to how Companies can incentivise executives appropriately and create long-term value for their shareholders, by, for example, linking executive remuneration to not only long-term performance, but also sustainable business models under the guise of Environmental, Social and Governance (ESG) factors. The IA notes that linking executive remuneration structures to such wider factors will “contribute to economic growth and increased prosperity for the wider economy. […] When aligned with long-term company success, remuneration serves to incentivise, reward and retain executive directors that generate value, thereby promoting growth in the UK”. The Principles further explain that “Executive pay practices have an impact on wider societal trends such as wealth disparity and public trust in business,” which investment managers are especially mindful of when voting on executive remuneration.

The IA’s Principles provide flexibility

The Principles offer greater flexibility and guidance to Companies to best suit their business models. They do not intend to prescribe any specific structure or quantum of remuneration; but rather, they are aimed at helping the remuneration committees (RemComs) to make informed and responsible decisions aligned with the long-term interests of shareholders. In particular, the IA encourages Companies to “adopt the remuneration structure most appropriate for their business, corporate strategy, and performance,” with a consideration as to how the latter aligns with the business objectives/models of the relevant Company.

Overarching Principles on remuneration policies comprise:

1. Promoting long-term value creation through transparent alignment with the board’s agreed corporate strategy;
2. Supporting individual and corporate performance, so as to facilitate the Company’s long-term financial health, and encouraging sound risk management for the benefit of material stakeholders; and
3. Delivering remuneration levels which are inextricably linked to the Company’s performance, supporting a clear link between pay and performance.

Where Companies deviate from the Principles, the IA expects them to provide a “suitably comprehensive explanation”. The IA suggests that the overarching Principles can be best met if RemComs “engage with their major shareholders to understand their views and provide clear explanations why the remuneration policy and approach is right for their business, company strategy and shareholders.”

Key Changes

1. Levels of Remuneration

The Principles confirm that remuneration levels should be aligned to the Company’s purpose, values, and strategic goals, “and how they help attract, retain and motivate talent”. Importantly, the use of benchmarking on its own is not encouraged as “it can lead to a ratchet effect in the market”. Instead, RemComs should take into account factors such as the workforce and pay ratios between the CEO and the average employee, as part of setting appropriate remuneration levels and structures. Variable remuneration plans should also be subject to shareholder consultation, where material, and otherwise capped. When appointing new executive directors, RemComs should also consider the salary of the predecessor. Where a new executive director is to be recruited on a higher salary, the Company should explain its decision and rationale for doing so to shareholders.

2. Pensions and benefits

The IA suggests that, like remuneration, pension contributions or payments in lieu of pension for executives should be aligned with those available to the majority of the workforce. No portion of variable pay should be pensionable. Additional benefits such as health and life insurance, should also be fully disclosed and explained. Relocation benefits should be fully disclosed on appointment for the benefit of shareholders, with provision for a limited period and a supporting explanation for any such entitlement.

3. Annual Bonus

When considering bonuses, any strategic Key Performance Indicators (KPIs) need to be disclosed by RemComs, with an overarching explanation as to how such KPIs relate to value creation. Notably, where material non-financial metrics such as ESG risks or principles are incorporated into the Company’s strategy, any targets or KPIs relating to ESG risks and opportunities can be included in the annual bonus structure, provided they are “robust, transparent, lead to demonstratable performance and ultimately […] linked to value creation.” Deferral periods for bonuses may be reduced if RemComs consider that the executive has satisfied shareholder guidelines and they still have “sufficient authority to exercise malus and claw-back provisions”. Performance should not be measured over less than one year.

4. Long-Term Incentives (LTIs) and Performance Share Plans (PSPs)

LTIs incentivise performance and long-term value creation within a Company. In line with the U.K. Corporate Governance Code, the IA suggests that the usual performance/vesting period and holding period should be five years or more. However, RemComs should have discretion to review the vesting outcomes of LTIs, ensuring they cohere with the underlying financial performance of the Company, as well as individual executive contribution. RemComs should have the ability to apply malus and/or claw-black provisions. Where broader factors such as ESG are incorporated into the Company’s strategy, they should feed into the design and assessment of any LTI awards to further incentivise performance and positive outcomes. ESG criteria should be elaborated to provide quantifiable performance outcomes.

PSPs should also be appropriately structured to reflect a Company’s long-term strategy. RemComs should explain KPIs and vesting conditions chosen for each award and how they will enhance shareholder value. Performance criteria should reflect the performance of the business as a whole and be applied consistently across the relevant periods. For example, if Total Shareholder Return (TSR) is used as a performance indicator or measure, the starting and finishing calculation values for TSR should be made by reference to an average share price over a defined time period and the beginning and end of the performance period. Where hybrid schemes are used involving restricted share plans, Companies should explain why a hybrid model is preferred over a single structure.

5. Dilution

As part of issuing guidance on the technical conditions attached to LTIs, the IA suggests that all LTI awards should be priced at the mid-market price of the Company’s shares at the time of grant, unless otherwise specified in the scheme rules, or agreed with shareholders. The issuance of new shares also dilutes existing shareholders, eroding value and impact on pensions. Appropriate dilution limits should therefore be set and complied with. Where ordinary shares are issued or treasury shares are re-issued under share schemes, they should not exceed 10% of the issued ordinary share capital in any rolling ten-year period.

However, exceptions may arise for recently listed high-growth Companies needing to incentivise their key employees with share-based awards. In such exceptional cases, the IA accepts that RemComs may seek shareholder approval for higher dilution limits, with the expectation that the Company will revert back to normal dilution limits over time.

Concluding remarks

Whilst the IA’s Principles offer flexibility proportionate to a Company’s business strategy, it does not expect significant derogation from the overarching Principles, and the U.K. Corporate Governance Code.

The Principles set out clear expectations around incentivisation, performance and value-creation, whilst encouraging Companies to engage in greater shareholder dialogue to better shape executive remuneration structures, including on financial and non-financial metrics such as ESG. Such dialogue is a welcome development to help Companies remain competitive both domestically and globally, particularly in terms of global talent attraction and retention.