To say that executive pay has been under the microscope recently would be an understatement. Rachel Reeves, then-chair of the Business, Energy and Industrial Strategy Committee, went so far as to say that excessive executive pay threatens “to undermine the foundations of our business culture and our society”.
It is unsurprising, therefore, that the UK's Corporate Governance Code now includes significant detail on the issues companies should be thinking about when looking to set executive remuneration.
The latest version of the Code came into force for accounting periods beginning on or after 1 January 2019. One specific change concerned pension contributions for executives. Although omitted from the consultation, the Code was amended to require companies to take steps to align the rate of pension contributions that are available to staff more generally. In other words, although pension contributions for executives can still be greater on a pound-for-pound basis, on the basis that they are calculated by reference to a higher salary to start with, the percentage rate of pension contributions should be the same across the workforce.
The Investment Association picked up the baton and has sought to increase pressure on companies in this area. Earlier this year the Investment Association’s Institutional Voting Information Service, which provides corporate governance research to investors, decided that it would apply its highest warning category to companies that had not aligned pension contributions for newly-appointed directors. The Institutional Voting Information Service drew the distinction between new and existing directors on the basis that existing directors may have contractual rights to a higher level of pension contributions. That said, where existing directors were entitled to a rate of contributions in excess of 25% this led to a medium risk warning from the Institutional Voting Information Service. The Investment Association concluded that alignment of pension contributions is an issue of “fairness”.
Parliament has been active in this area as well, with management from leading banks summoned to appear before a select committee hearing in June to explain their approach to executive pension contributions in light of the revised Code and the approach taken by the Investment Association.
Pension contributions clearly form an important element of remuneration for all employees and can be a key tool to retain and incentivise staff. However, isolating the rate of pension contributions from the question of wider executive remuneration is ill-thought-out.
The government’s policy in the past decade has been to restrict tax relief for pensions – both through reductions in the annual allowance (the amount of pensions savings one can build up tax free on a year-by-year basis) and the lifetime allowance (the overall cap on lifetime pensions savings). The annual allowance for executives (assuming that they earn more than £210,000 per annum) is now £10,000, which is significantly down from a high of £245,000. The lifetime allowance now stands at £1.03 million, which is almost half what it was previously.
As a result of the reductions in tax allowances it is simply no longer tax efficient for companies to pay pension contributions for high earners, with most top executives opting to receive an additional cash sum in lieu of pension contributions.
The fact is that most executive 'pension contributions' are never paid into a pension scheme. They are simply paid as a cash supplement and taxed in the same way as normal salary. Given this, if one is serious about properly assessing executives' total pay it is futile to focus solely on pensions.
Instead remuneration committees, and those seeking to analyse the issue of executive remuneration more generally, need to consider what executives are paid in the round, taking into account salary, bonuses, share options, and pension contributions as a single package. While there may well be justification for aligning pension contributions across a workforce, focusing in on this one issue is unlikely to facilitate proper consideration of the pay disparity between executives and other staff. Instead it could result in certain companies and individual executives being made scapegoats while others continue to maintain a greater differential in pay between executives and the general workforce.
Alasdair Smith is a managing associate in the pensions team at Linklaters
