Executive Compensation Services: Are We Able To..? Assessing the Parameters of Discretion in Executive Pay

2020 was a devastating year for many companies, as the pandemic slashed revenues, particularly across travel, hospitality, entertainment, leisure, and non-food ‘bricks and mortar’ retail. In contrast, other sectors including on-line retail, home improvements and parts of the tech, medical supply and pharmaceuticals sectors have flourished. In this environment, management teams have faced unforeseeable and unprecedented challenges (and, in some cases, opportunities), and have been required to demonstrate resilience, adaptability and leadership.

As Remuneration Committees meet to review the outcomes for 2020 bonuses and 2018-20 LTIPs, and to set the terms of new awards, many will be faced with difficult decisions to deliver outcomes and set targets that are perceived by executives, shareholders and other interested parties to be fair and reasonable. In this context, discretion can be an important tool for the Remuneration Committee, albeit one which should be used carefully and responsibly taking into account the considerations set out below.

What is a discretion?

When Remuneration Committees make determinations about executive pay outcomes, they will usually be making routine “judgments” rather than exercising “discretion”.

The GC100 and Investor Group in their 2019 Directors’ Remuneration Reporting Guidance (the “GC100 Guidance”) discuss the distinction between judgment and discretion. They say: “In a number of areas, the remuneration committee is routinely asked to apply its judgment to what is appropriate within the bounds of the remuneration policy, or of a particular remuneration award or arrangement. This will not necessarily represent the exercise of “discretion” in the meaning of the Regulations [1].”

The July 2018 UK Corporate Governance Code (the “Code”) also helps differentiate between judgment and discretion. Provision 37 of the Code states “Remuneration schemes and policies should enable the use of discretion to override formulaic outcomes”.

The GC100 Guidance and the Code suggest that discretion is a determination that is not “routine” and may enable the Remuneration Committee to reach an alternative conclusion to the outcome which would otherwise have been determined using the normal criteria. The distinction is important because there is a specific regulatory obligation to disclose and explain an exercise of discretion, whereas a routine exercise of judgment may not require an exceptional reference in the Remuneration Report.

The Regulations require that Remuneration Committee Chairs disclose in their annual statement in the Directors’ Remuneration Report (“DRR”), “…any discretion which has been exercised in the award of directors’ remuneration.” Additional disclosures relating to the exercise of discretion in respect of an award are required in the notes to the Single Total Figure Table.

Circumstances in which discretion may be exercised

Circumstances in which it may be appropriate for the Remuneration Committee to exercise discretion could include the following:

• where, during the performance period, an exceptional event causes existing performance conditions to require amendment;
• determining the extent of any malus and clawback application to an award;
• where the Committee determines a need to override a formula-based or criteria-based incentive outcome; and
• where there is a need to apply a special treatment to one or more participants which is outside established practice; for example a discretion to treat a leaver or joiner differently from normal practice (although still within the bounds of the Directors’ Remuneration Policy (the “Policy”)).

Which factors will be relevant in exercising discretion?

The plan documentation and the Policy may provide a non-exhaustive list of permitted exercises of discretion. This can be helpful in building confidence regarding the parameters of the discretion, and important in ensuring the incentive value is not undermined. From a legal perspective, the Remuneration Committee must also be careful not to exercise discretion irrationally or capriciously and must respect the implied duty of trust and confidence to the participant. By giving examples of allowed uses of discretion, the Remuneration Committee is helping to manage these legal risks.

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