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Windfall Gains: Your Guide – Shareholders


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We expect “windfall gains” to be one of the
key issues for UK-listed companies during this year’s AGM
season, an assumption supported by recent updates to shareholder
guidance which again highlighted this area. Despite this, the
phrase is still not well defined or understood by the market. While
the underlying concept is simple (that a relatively large number of
shares may have been granted under long-term incentive plan
(“LTIP”) awards made in early 2020 following significant
COVID-induced share price declines), it is much more challenging to
subsequently determine whether this has ultimately translated into
a so-called “windfall gain” and, if so, what if anything
should be done about it?

In addition to understanding the latest shareholder
perspectives, it is important that committees also reflect on the
potential management perspective, including the impact of COVID-19
on all remuneration outcomes over the period. A downward adjustment
to one LTIP award at vesting can feel unfair and inconsistent if
other elements of the package over the same period (including other
in-flight LTIP awards) have been negatively impacted by COVID-19,
without any adjustment.

In our view, a “formulaic” approach to
assessing windfall gains is unlikely to be appropriate, and
remuneration committees will need to use judgement. To support
committees in making an informed judgment, we have therefore
developed a framework of risk factors to take into account in
determining whether a windfall gain may have occurred. It includes
consideration of various factors related to the share price
trajectory (such as the magnitude, timing, relativity, and drivers
of share price recovery) as well as the broader remuneration
context over the period. We also provide reference points which
might be used if it is concluded that some adjustment should be
made. Throughout the process, it is important to take a balanced
approach, and to ensure appropriate engagement and communication
with all stakeholders.

In this guide, we consider the issue which has come to be known
in the UK-listed environment as “windfall gains”. We
explain what is specifically meant by the term in its current
usage, exploring how it rose to prominence in early 2020 as a
result of the equity market shock brought on by the COVID-19
pandemic. We look at the different stakeholder perspectives,
outlining both the evolution of shareholder guidance up to the most
recent releases, as well as considering the potential management

Finally, we then outline our suggested framework to assist
remuneration committees in determining whether a windfall gain may
have occurred and, if so, what type of adjustment might be made.
The guide will be most relevant for those companies that granted
their 2020 LTIP awards following a significant decline in the share
price without making an adjustment to the size of the awards and
instead deferring consideration of the impact until the point of

What is currently meant by the term “windfall

For anyone casually observing the world of executive
remuneration, where the potential regularly exists for the receipt
of multi-million pound payouts under incentive programmes, it may
seem that the opportunity for “windfall” pay-outs is a
common occurrence. But for those working in the field, the phrase
has come to represent a more specific set of circumstances related
to the number of LTIP shares granted following a material share
price decline.

Before we describe those specific circumstances, it is worth
remembering that it is now well-established best practice for
remuneration committees to consider, at the point of vesting of any
incentive award, whether the “formulaic” outcome is
appropriate based on a broad assessment of overall performance in
context. Where the formulaic outcome is not supported by this
assessment, shareholders expect awards to be subject to a
discretionary downward adjustment, and we have seen examples of
some companies making such adjustments in recent years. The
committee’s broad assessment should

consider whether the value being received by executives
“feels right” in the context of a range of contextual
factors, such as the underlying performance of the business, the
stakeholder “experience” over the period, and the
macroeconomic and trading environment. This process should
naturally capture, and adjust for, situations where a
“windfall”, conceived in the broadest sense of the term,
might have occurred. An example might be where large pay-outs were
due based on performance which had been significantly enhanced as a
result of a substantial and beneficial change in government policy,
which had not been anticipated when the targets were originally

While the phrase “windfall gain” could be thought of
as one aspect of this overall assessment, in current UK discourse
it is one with a very specific meaning related to the number of
LTIP shares which were originally granted in certain circumstances,
as set out below. It is this exact set of circumstances which we
are referring to in this note by the phrase “windfall

Where a company has experienced a significant fall in its share
price since the prior year’s LTIP grant, then if the next LTIP
award is made on the same percentage of salary basis it will result
in a material increase in the number of shares awarded to the
executive. Where the share price subsequently recovers, this could
create the potential for a so-called “windfall gain” as a
direct result of the increased number of LTIP shares which were
awarded at grant.

To illustrate this with an example, assume an executive on a
salary of £500,000 is granted an LTIP award annually at a
level of 100% of salary (i.e. a “face value” of
£500,000 is awarded each year, converted into a number of
shares to be granted at the prevailing share price at the point of
grant). For the award in the prior year, assume the share price was
£20 and therefore 25,000 shares were awarded (£500,000
of award value divided by £20 per share). Then assume the
share price fell by 40% to £12 per share in advance of the
next grant. Without any adjustment, the number of shares awarded
would increase by 67% to 41,667 (£500,000 / £12).


Although the same monetary value has been awarded, it is the
significant increase in the number of shares granted which creates
the potential, in the eyes of shareholders, for a future
“windfall gain”.

Impact of the COVID-19 pandemic and evolution of shareholder

Shareholders have been cognisant of this issue for a number of
years. In fact, reference to the “windfall gains” risk
has been explicit in the Investment Association’s Principles of
Remuneration for over ten years. In our experience, however, it has
historically rarely been a major area of investor focus, outside of
those individual companies which had experienced exceptional and
sustained periods of share price decline. This changed almost
overnight following the onset of the COVID-19 pandemic.

Cast your mind back to early 2020….

Given the significant shock to equity markets in response to the
impact of the pandemic on the macroeconomic outlook, a large number
of companies experienced a rapid and material decline in their
share price at that time. While the extent of the impact was sector
dependent, across the FTSE All Share, the average level of annual
share price decline to mid-March 2020 was 26%, with over a quarter
of the market experiencing falls in excess of 40%.

In an immediate response to the pandemic (in late April 2020),
the Investment Association (“IA”) issued new guidance
around executive pay, which included addressing this issue. The
guidance noted that for awards which had already been granted in
2020 following the share price declines:

“It is important for the Remuneration Committee to confirm
that they will look at the general market and share price response
over the performance period to ensure that windfall gains will not
be received on vesting. Shareholders will expect the Committee to
use their discretion to reduce vesting outcomes where windfall
gains have been received.”

The above guidance was relevant for a large number of December
year-end companies where awards had been granted. For those who had
not yet granted awards in 2020, the IA guidance
“discouraged” remuneration committees from granting at
the normal award level, and instead advised committees to
“consider reducing” the award level. In practice, a
substantial majority of companies granting after April 2020
continued to make awards at the normal level, but typically
disclosed that they were aware of the investor view and
committed to review the outcome at vesting (and included provisions
in their award documentation to ensure this could be

Fast forward to 2023… shareholders provide a timely

Most awards made in 2020 will be due to vest in 2023. In their
recent letter to remuneration committee chairs, the Investment
Association provided a timely reminder that this remains a key area
of shareholder focus:

“In 2023, many Remuneration Committees will be making those
vesting decisions, assessing executive’s performance against
performance measures of long-term incentive grants made in 2020.
These 2020 grants were made in the midst of the pandemic following
significant share price falls, so a greater number of shares were
granted compared to previous years. To ensure that participants do
not benefit from being granted significantly more shares, it is
important that Remuneration Committees consider if vesting outcomes
need to be reduced. Committees should clearly articulate to
shareholders how they have considered the impact of any potential
windfall gains when determining vesting outcomes and why any
reduction is appropriate. If the Committee has decided not to
adjust for windfall gains it should explain and disclose its
rationale for doing so.”

Other prominent institutions have issued similar guidance on
this issue (LGIM). While the proxy advisors, most notably ISS, have
not issued any updated guidance on the windfall gains issue, we
understand that their thinking is broadly aligned with that
described above.

To view the full article click here

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.


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