Pension fund investors have called for a major rethink on executive pay to align it more closely with an organisation’s long-term performance.

The National Association of Pension Funds (NAPF), Hermes Equity Ownership Services (Hermes EOS), BT Pension Scheme, RPMI Railpen and USS Investment Management have published a discussion document setting out guidance on executive remuneration.

The report sets out four principles to encourage organisations to change their reward structures.

The four principles are:

  • Management should make a material long-term investment in shares of the businesses they manage. For example, shares granted to executive directors should ideally be owned for at least 10 years, whether or not the executive is still in post. This would encourage succession planning and reduce the need for golden hellos for new directors.
  • Pay should be aligned to long-term success and the desired corporate culture throughout an organisation. Pay awards and pensions arrangements should be consistent throughout the organisation and, if not, there should be a justifiable explanation.
  • Pay schemes should be simple, understandable for both investors and executives, and ensure that rewards reflect long-term returns to shareholders. For example, large awards should not be paid where returns to shareholders are below the cost of capital.
  • Remuneration committees should justify how their decisions will help deliver long-term business success. They should consider scaling back or eliminating awards where targets have been met by, for example, aggressive accounting or high leverage, or if the company has suffered reputational damage.

The NAPF and Hermes EOS will host a number of working seminars, bringing together remuneration committee chairs and shareowner representatives to discuss the four principles, refine the report, and compile an authoritative guide on organisations’ pay practices.

Joanne Segars, chief executive at the NAPF, said: “This is the next stage of a vital conversation with the business world about how it can rethink its approach to boardroom pay.

“We have become increasingly concerned by the complexity of many spiralling pay deals. We need to see change, and it is encouraging that many companies agree.

“Shareholders want a much simpler approach that nails boardroom pay to the long-term health of a business. Paying executives proportionally more in shares that are owned for a long time could help align pay with shareholder interests.

“Pay structures should go right to the heart of what a business is about, and should reflect its values and culture. We look forward to discussing these principles with the UK’s leading companies.”

Jennifer Walmsley, head of UK engagement at Hermes EOS, added: “Following meetings with FTSE 100 companies and many large pension schemes from the UK and overseas, it has become clear there is a growing desire to re-evaluate current remuneration arrangements and embrace a new approach.

“Flawed remuneration schemes can create inappropriate incentives with even the best-designed schemes potentially resulting in outcomes that do not match up to a deeper analysis of company performance.

“By publishing these principles we hope to encourage companies to reconsider their current remuneration arrangements to better align the interests of executives and shareholders, and ultimately enable companies to position themselves for future success.”