Executive and Board Remuneration in Finland

Executive and Board Remuneration in Finland Increased demand for transparency and fit for purpose June 2017

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Contents Chapter 1 About the report 5 Practical considerations 5 Chapter 2 Executive summary 7 Chapter 3 Global trends 9 Simplification and transparency 10 Global benchmarking 11 Remuneration design 11 Chapter 4 Board and management team diversity 13 Gender diversity 13 Nationality diversity 15 Chapter 5 Board remuneration and committees 17 Board 17 Committees 17 Chapter 6 CEO and management team remuneration 19 CEO and management team total compensation 19 Short-term incentives (STIs) 22 Long-term incentives (LTIs) 25 Pension plans 28 Chapter 7 Regulatory perspective 29 Chapter 8 Sustainability 33 Investor pressure to link executive compensation to long-term sustainability 33 Is the concern over excessive executive pay justified? 33 Chapter 9 Taxation 35 Changes in Finnish taxation 35 Taxation of start-up companies employee share schemes 37 Chapter 10 Our team 39 Executive Remuneration in Finland 2017 3

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CHAPTER 1 About the report Welcome to our second EY Executive Remuneration report produced in Finland, put together by our local People Advisory Services professionals in collaboration with EY s Global network. In this report, we aim to give you a comprehensive overview of the contemporary debates and developments in executive remuneration, contrasting local and global findings. From a holistic perspective, we provide you with selected insights into how concepts such as gender diversity, nationality, sustainability, regulation, and compliance, come into play in executive remuneration strategies. In this spirit, we invite you to read the report and consider how executive remuneration can bear a valuable impact upon your business opening up new opportunities to achieve growth, innovation and success in the near and longerterm future. Should any of the contents and viewpoints presented in this report provoke ideas or questions, please do not hesitate to contact us for further discussion. For more information on our services and know-how, please visit our website at ey.com/fi. Practical considerations We have based our studies on publicly available data on all companies listed on the OMX, Helsinki s main list stock exchange, in the years 2015-2016. Moreover, we have structured our analysis using identical size classification as the OMX Helsinki (large capital, mid-size capital and small capital companies). We excluded companies listed on First North from our analysis as they generally disclose only limited data on remuneration. Lastly, we have included benefits in kind in the base salary figures since many of the studied companies do not disclose these figures separately. Also, as Finnish listed companies typically report salary costs for the management team as a total sum, we calculated the average levels per management member for each company, and drew the median levels from these values. Our methodology also takes into account possible zero values. Sincerely, Mikko Nikunen Partner People Advisory Services Hannu Tyyskä Senior Manager People Advisory Services Executive Remuneration in Finland 2017 5

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CHAPTER 2 Executive summary Executive remuneration is still a hot topic both in Finland and abroad. People demand more transparency in executive remuneration while rewards continue to make headlines. At the same time, remuneration and especially incentives are seen as a means to steer executive performance, driving company performance, and to align executives and shareholders interests. Because executive pay is considered to bear a large impact on company performance and economy, executive remuneration becomes increasingly regulated. Regulations affecting executive pay include the Finnish Corporate Governance Code 2015 ( the Code ), multiple directives for remuneration in the financial sector, and the European Commission s revision of Shareholders Rights Directive. These regulations all aim to enhance transparency by demanding better disclosure of executive remuneration, to prevent excess risk-taking and too much focus on short-term returns, to increase shareholders influence over executive pay, and to boost companies long-term success. The Code also recommends promoting the diversity of the know-how, experience and opinions of the directors of the board. There is a lot of evidence that diversity in boards and management teams leads to better company performance. Still, the boards and management teams of Finnish companies continue to be dominated by Finnish males. Even though the proportional number of women and non-finns is on the rise, the pace of change is slow. There have been no significant changes in the Finnish tax and social security legislation in 2016 and 2017 concerning executive remuneration. However, the Supreme Administrative Court has issued certain rulings that impact taxation of equity-based executive remuneration. Also, partially related to these rulings, the Finnish tax authorities have revised their guidance around taxation and associated compliance obligations related to employee stock options and other equity awards. Furthermore, increasing public and institutional investors interest in sustainability issues continue to put pressure on companies to consider sustainability issues in their decision-making and incentive structures. So far, the actual influence of sustainability on salary policies in Finnish companies is very small, and only a few companies have sustainability and ethics committees as part of their boards. However, we predict that especially in consumer goods, utilities, energy and automotive industries, sustainability and ethics committees will become more prevalent in the near future. These developments are in line with EY s view on executive reward: Ideal remuneration arrangements strike the right balance between strategic and tactical business goals, attract and retain the right talent to deliver on such objectives, and discourage excessive risk-taking. On the other hand, remuneration structures should not reward executives for shortcomings, should be fair and valued by executives, and reflect performance both at individual and company level. Executive Remuneration in Finland 2017 7

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CHAPTER 3 Global trends Globally, EY has identified the following key trends in the current executive remuneration environment. Executive remuneration must be fit for purpose and take growing investor influence and say on pay into account. There is a perception that executive remuneration is excessive in relation to the company s financial results. Therefore, many companies now focus on better aligning executive remuneration with the long-term interest of the company and its shareholders. As such, executive remuneration is in general more performancebased, weighing multiple conditions over several years. As setting long-term goals in a less predictable market becomes more difficult, companies are including other performance measurements, such as relative performance compared to peers and applying discretionary adjustments. Consequently, investors require more influence on the executive remuneration in companies in which they have invested. Take Norway, for example: Due to the economic downturn following the fall in oil prices, public opinion has forced the national sovereign wealth fund to take a stand against excessive pay. As a result, the oil fund has withdrawn from some of its existing investments. In several countries, including the US, the UK and Sweden, companies have to put their executive remuneration under vote in annual general meetings. Thus, proxy advisors such as ISS, influence their remuneration. Such trends are strengthened by more countries introducing (further) say on pay legislation. Examples include the recent amendments to the Corporate Governance code in the Netherlands and the new directive on European Shareholders Rights Directive adopted by the European Council on April 2017, which establishes specific requirements to encourage shareholder engagement. The map below demonstrates the current differences between European countries. Executive Remuneration in Finland 2017 9

FIGURE 1: 2016 SAY-ON-PAY LEGISLATION IN EUROPEAN COUNTRIES Say-on-pay Binding vote on policy and/or pay amounts Non-binding (advisory) vote Shareholders neither decide nor advise on executive pay Simplification and transparency In order to better align the executive remuneration with the (long-term) interest of the company and its shareholders, there is a strong push to simplify the executive remuneration packages. Germany, for instance, is repealing the obligation of self-investment and increasing more straightforward performance criteria. The challenge in this respect is to prevent diluting the link between reward and 10 Executive Remuneration in Finland 2017

company performance. A simplified executive remuneration will enable companies to disclose on executive remuneration in a shorter and simpler manner. The result will be a more transparent disclosure a trend we identified in our 2016 report on executive remuneration. However, for several countries, increased legislation has so far not proven an effective means to achieve more simplification and transparency, according to monitoring committees in the Netherlands and other countries. Global benchmarking As a consequence of globalization, the war on executive talent is impacting executive remuneration and vice versa. Recently, after global cuts in bonuses at a large European company, several senior executives in their Asian branches resigned. Knowing this, multinational companies in Asia are introducing local incentive plans that better suit the local market to retain and attract the right talent. Attracting talent may also be the reason why state-owned companies in China, which generally have lower remuneration due to government regulation, are starting to explore equity-based remuneration. In Europe, large companies are increasingly benchmarking their executive remuneration policies with global competitors, rather than comparing them with smaller local competitors. We anticipate that this trend might drip down to medium sized companies. An interesting development to follow in the near future is the effect Brexit might have on executive remuneration in Europe. The potential shift of company headquarters and executive functions to other European Union countries could affect executive remuneration in the UK. Consequently, this could also affect executive remuneration elsewhere in Europe, as executives in the UK generally lead the European benchmark. Alternatively, one could argue that competition on mainland Europe for executive talent would increase, which in turn could drive executive remuneration upwards in an environment with scarce talent. Remuneration design Contrary to the first three topics, where we see trends moving in the same direction, a discrepancy is developing with respect to the design of the remuneration package. In North America, we see no indications of major shifts in executive remuneration, which is currently largely equity-based. China, as mentioned earlier, is just beginning to explore equity-based remuneration. In Europe, however, the pay-mix is still overwhelmingly cash settled, even though equity-based remuneration is common. It will be interesting to see in what direction executive remuneration design will develop following the earlier mentioned trends on fit for purpose, regulation and push for simplification. Based on the prevailing scientific view, simplifying the executive remuneration should make it more effective. Executive Remuneration in Finland 2017 11

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CHAPTER 4 Board and management team diversity The Finnish Corporate Governance Code 2015 pays more attention to board diversity, especially to gender diversity, but also to the diversity of the know-how, experience and opinions of the directors. Looking at Finnish boards, we see that even though current developments indicate more ethnic- and gender diversity, the change is slow. Gender diversity Earlier research indicates that having more female leaders in business can significantly increase profitability. According to the report Is Gender Diversity Profitable? Evidence from a Global Study by the Peterson Institute for International Economics and EY (2016), an organization with 30% female leaders could add up to six percentage points to its net margin. This in-depth study analyzes results from approximately 21,980 global publicly traded companies in 91 countries from a variety of industries and sectors. In Finnish companies in 2016, almost 90% of boards and 80% of top executive teams have female members. Even so, the median numbers of women sitting on the boards of Finnish companies remain between 20% in small cap companies and 33% in large cap companies. Moreover, the median numbers of women in top executive teams are even lower; only 6 out of 127 companies had a female CEO in 2016. Figures 2 and 3 show the percentage of female board members and female management members by company size. The three key findings are: large and mid cap companies tend to have relatively more female board members than female management team members; small cap companies differ significantly from larger companies in terms of gender diversity; and the variation of gender diversity between companies of different sizes is higher in boards than in management teams. We will elaborate on these three key findings below. FIGURE 2: PERCENTAGE OF FEMALE BOARD MEMBERS BY COMPANY SIZE Percentage of companies 80% 70% 60% 50% 40% 30% 20% 10% 0% 0% 0%-20% 20%-40% 40%-60% 60%-80% 80%-100% Percentage of female board members Small Mid Large Median 20% 23% 33% Average 18% 25% 33% Small cap companies Mid cap companies Large cap companies Executive Remuneration in Finland 2017 13

FIGURE 3: PERCENTAGE OF FEMALE MANAGEMENT TEAM MEMBERS BY COMPANY SIZE Percentage of companies 50% 40% 30% 20% 10% 0% 0% 0%-20% 20%-40% 40%-60% 60%-80% 80%-100% Percentage of female board members Small Mid Large Median 17% 17% 20% Average 24% 21% 21% Small cap companies Mid cap companies Large cap companies Large and mid cap companies tend to have a higher percentage of female board members than female management team members. Furthermore, even though almost all large and mid cap companies have female board members, they do not necessarily have any female management team members. For example, only 3% of the mid cap companies do not have female board members, but 24% do not have female management team members. How can we explain this? First, the gender diversity of the board may get more publicity than the gender diversity of the management teams, as companies tend to disclose gender diversity of boards more often. Second, the Finnish Corporate Governance code states that both genders shall be represented in the board of directors, and companies have to provide reasoning if they do not follow this recommendation. However, there are no such requirements for the management team. In terms of gender diversity, small cap companies differ from larger companies in many ways. Contrary to larger companies, small cap companies have a higher percentage of female management team members, but a lower percentage of female board members. Furthermore, the variation within small cap companies is significantly larger than within other companies. For example, some small cap companies have a female majority in the management team, but about one third of small cap companies do not have female management team members. Initially, one might explain the differences by the smaller size of the board and the management teams of small cap companies. However, the median numbers are quite similar between small- and mid cap companies, as you can see in table 1 below. Therefore, the size of the board and management team can only partially explain the differences. TABLE 1: MEDIAN NUMBERS OF MANAGEMENT TEAM AND BOARD MEMBERS BY COMPANY SIZE Company size Median number of management team members Median number of board members Large 9 8 Mid 6 6 Small 5 5 14 Executive Remuneration in Finland 2017

Between companies of different sizes, there are larger variations of gender diversity in boards than in management teams. The median and average of female management team members is similar in companies of different size, but the medium and average of female board members strongly deviate, as shown in figures 2 and 3. Again, there are many potential explanations for this. Here too, more publicity of board diversity may encourage larger and more international companies to ensure they have at least some female board members. The fact that most of the large- and mid cap companies tend to have respectively 20%- 40% or 10%-30% female board members, while a similar range cannot be found in management team members, could point in that direction. In small cap companies, the variation is significant both in boards and in management teams. To some extent, an explanation could be that certain small cap companies need specific skills from male- or female-dominated areas of expertise, which could encourage them to include more men or women with the required skills. Nationality diversity The boards and management teams of Finnish companies are clearly dominated by Finnish nationals. In 2016, approximately half the boards and management teams had one or more non-finnish member. The median percentage of non-finnish members differs significantly based on the size of the company. For instance, the median percentage was 33% in large companies and 0% in small cap companies. Moreover, only 16 companies had a non-finnish CEO in 2016. Figures 4 and 5 represent the percentage of non-finnish board members and non- Finnish management team members by company size. The three key findings are: 1. Similarly to gender diversity, large- and mid cap companies have a larger median percentage of non-finnish board members than non-finnish management team members; 2. Variation in nationality diversity is larger than the variation in gender diversity, both within and between the three categories of companies by size; and 3. Small cap companies are clearly dominated by Finnish nationals. FIGURE 4: PERCENTAGE OF NON-FINNISH BOARD MEMBERS BY COMPANY SIZE Percentage of companies 100% 80% 60% 40% 20% 0% 0% 0%-20% 20%-40% 40%-60% 60%-80% 80%-100% Percentage of non-finnish board members Small Mid Large Median 0% 18% 33% Average 8% 20% 36% Small cap companies Mid cap companies Large cap companies Executive Remuneration in Finland 2017 15

FIGURE 5: PERCENTAGE OF NON-FINNISH MANAGEMENT MEMBERS BY COMPANY SIZE Percentage of companies 70% 60% 50% 40% 30% 20% 10% 0% 0% 0%-20% 20%-40% 40%-60% 60%-80% 80%-100% Percentage of non-finnish board members Small Mid Large Median 0% 11% 23% Average 15% 21% 33% Small cap companies Mid cap companies Large cap companies In large and mid cap companies, the median percentage of non-finnish members are higher in boards than in management teams, but all medians are quite low. Even though large companies have gender diversity in general, they do not always have nationality diversity in the board and management teams. Contrary to the gender diversity numbers, the average of non-finnish members are higher in management teams. This indicates that the variation of non-finnish members is larger in management teams than in boards. Operating in foreign countries may potentially increase the need for non-finnish management team members as the need for local knowledge increases. There are more variations in nationality diversity compared to gender diversity, both within and between the company size categories. In other words, it is much more common to have at least one female board or management team member than one or more non-finnish board or management team member. On the other hand, a majority of non-finnish board or management team members is more common than a female majority. Assuming that multinational companies need local knowledge of the countries they operate in, hence benefitting from having several nationalities in the board and management teams, could at least partly explain this. Finnish nationals clearly dominate small cap companies in Finland. More than 80% of small cap companies have no non-finnish board members and 60% have no non- Finnish management team members. We could partly explain such large numbers by the local operations, but even though some small cap companies would prefer to have, and perhaps benefit from having, a non-finnish board or management team member, it may be challenging and costly to attract non-finnish executives to small companies. 16 Executive Remuneration in Finland 2017

CHAPTER 5 Board remuneration and committees Board Remuneration levels of the chairman of the board and board members tend to vary significantly by company size, as seen in figure 6. However, regardless of the company size, the chairman of the board tends to receive roughly double the annual fee to that of the board members. While the median chairman s fee in large cap companies increased slightly in 2016 compared to 2015, the board member fees remained approximately the same. The median chairman and board member fee of small and mid cap companies decreased slightly in 2016. FIGURE 6: MEDIAN CHAIRMAN AND BOARD MEMBER FEE BY COMPANY SIZE Euro 120 000 100 000 80 000 60 000 40 000 20 000 0 Small Mid Large Company size Chairman's fee 2015 Chairman's fee 2016 Board member fee Committees The prevalence of audit and remuneration committees varies largely by company size, as seen in table 2. Large cap companies tend to have both audit and remuneration committees, but mid- and small cap companies are more likely to combine these two or operate without any committees. In addition, some companies have a nomination committee. This can either be a separate committee or be combined with the audit or remuneration committee. Other committees are grouped around themes such as sustainability and ethics, corporate governance and research and development (R&D), as well as temporary working committees like demerger committees. We predict that sustainability and ethics committees, in particular, will become more prevalent in the future due to the focus on corporate sustainability and ethical behavior. TABLE 2: PORTION OF AUDIT AND REMUNERATION COMMITTEE BY COMPANY SIZE Audit committee exits Remuneration committee exits Large cap 100% 100% Mid cap 77% 57% Small cap 37% 37% Executive Remuneration in Finland 2017 17

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CHAPTER 6 CEO and management team remuneration This section provides insight into the remuneration level for CEOs and other management team members in 2015-2016. In general, no significant changes have occurred in remuneration of CEOs and other management team members during the research period. Base salaries have seen a modest increase in most companies. Short-term incentive (STIs) and longterm incentive (LTIs) payouts have proved more volatile, but on aggregate level, the makeup of remuneration remains stable. Variable pay remains a hot topic, particularly the ratio between fixed and variable pay. Indeed, it is very important to ensure an optimal pay-mix that gives executives sufficient incentives for improving (long-term) business performance, while preventing taking excessive risks. To create an optimal pay-mix, we need to understand the purpose of each remuneration element, what we want to achieve by it, and how we can measure it. It is widely accepted that the quality of performance measures depends on how much control the executive has over the targets, as well as the extent to which the measures align with the interests of company owners. Consequently, when available performance measures are weak, variable remuneration should ideally carry less emphasis, and vice versa. Therefore, optimal pay-mix for an executive in a specific company cannot be determined by benchmarking alone. By taking the quality of available performance measures into account, remuneration committees can optimize a pay-mix based on a benchmarked starting point. Finally, behavioral aspects are also important to find the right balance in a paymix. Altogether, remuneration committees must consider various, often complex factors in their decision-making, reflecting the level of the challenge they face. CEO and management team total compensation In general, compensation of the CEO and other management team members is categorized into the following elements: base salary, benefits, short-term incentives (STIs), long-term incentives (LTIs) and pensions. We will analyze these elements in more detail later in this report. As figure 7 illustrates, levels of CEO total compensation strongly depend on the size of the company. While large companies have seen an increase in median CEO total compensation levels in 2016 compared to the previous year, mid- and small companies have experienced a slight decline. Executive Remuneration in Finland 2017 19

FIGURE 7:MEDIAN CEO TOTAL COMPENSATION BY COMPANY SIZE IN 2015-2016 ( ) 2 500 000 2 000 000 1 500 000 Euro 1 000 000 500 000 0 Small Mid Large 2015 2016 As shown in figure 8, the relative sizes of CEO compensation elements are notably different depending on the company size. The figure illustrates the median fraction of each compensation element by company size in 2016. Because many companies disclose the base salary including benefits, such as company car or telephone, we have combined the base salary and benefits in figure 8. In small and mid cap companies, the salary and benefits constitute a major part of CEOs total remuneration. In large companies, however, the remuneration elements are more evenly distributed, as short- and long-term incentives together constitute approximately half of the CEOs total compensation. In large companies, the distribution between salary and incentives in 2016 has remained roughly the same compared to 2015. Between different types of incentives, we have noticed an increase in relative proportion of STI and a decrease in relative proportion of LTI in large companies from 2015 to 2016. In small companies, however, incentives have decreased significantly from 2015 to 2016. For mid cap companies, we have not noticed significant changes with respect to the distribution between salary and incentives. 20 Executive Remuneration in Finland 2017

FIGURE 8: DISTRIBUTION OF MEDIAN CEO COMPENSATION ELEMENTS BY COMPANY SIZE IN 2016 15% Small 13% 30% 18% Mid Large 46% 85% 69% 24% Base salary and benefits STI LTI Changes on the relative proportions of different pay elements from 2015 +14% -3% -11% -1% +2% -1% +1% +6% -7% Tables 3 and 4 below show the median and average compensation paid to the CEO and the average management team members respectively, by remuneration element and company size. The CEOs median compensation, both salary and incentives, is significantly higher compared to the average management team members, regardless of the size of the company. Furthermore, the median compensation level for a CEO in a small company was lower than that of an average management team member s in a large company. For both groups, the median amount of LTI paid in 2016 has decreased compared to the previous year, regardless of company size. We see the most significant change in small companies, where both the CEO and average management team member median LTI compensation was zero. Importantly, very few small cap companies have paid out LTIs in 2015 and 2016. TABLE 3: CEO MEDIAN AND AVERAGE COMPENSATION BY ELEMENT AND COMPANY SIZE Company size Small Mid Large Remuneration element Base salary and benefits 2015 Median 2015 Average 2016 Median 2016 Average 258,000 258,085 253,910 247,795 STI 63,000 94,857 43,677 58,609 LTI 41,000 76,261 0 95,991 Base salary and benefits 432,758 426,094 381,486 474,707 STI 99,059 111,358 100,265 142,242 LTI 85,574 168,846 74,442 157,535 Base salary and benefits 678,180 762,343 692,736 779,521 STI 261,340 380,836 359,393 393,194 LTI 552,786 971,192 445,711 1,089,039 Executive Remuneration in Finland 2017 21

TABLE 4: AVERAGE MANAGEMENT TEAM MEMBER MEDIAN AND AVERAGE COMPENSATION BY ELEMENT AND COMPANY SIZE Company size Small Mid Large Remuneration element Base salary and benefits 2015 Median 2015 Average 2016 Median 2016 Average 138,149 147,119 131,390 129,063 STI 12,407 31,748 5,314 14,507 LTI 11,450 17,037 0 9,303 Base salary and benefits 202,500 211,142 195,283 202,157 STI 29,617 62,561 37,071 43,587 LTI 34,148 54,146 26,419 51,152 Base salary and benefits 306,091 324,566 291,864 314,565 STI 64,613 113,523 83,002 108,039 LTI 153,855 243,203 128,296 264,114 Tables 3 and 4 suggest that the average payment tends to be higher compared to median payment in each remuneration element. This indicates that some firms are paying very high compensations, which in turn raises the average value. Short-term incentives (STIs) Short-term incentive levels relate to performance over the previous one-year period. As company performance varies from year to year, we typically see that STI payouts vary as well, indicating a pay for performance relationship. Short-term performance is typically measured by the level of profit that a company generates in a year. However, focusing on maximizing annual profit can be very harmful for sustainable profitability. For instance, executives who are solely incentivized to maximize annual profit might reject sound investments or cut R&D costs to increase the bottom line, potentially harming long-term business performance. In an effort to mitigate this risk, most companies provide executives with longterm incentives as well. In addition, in the absence of one perfect short-term performance measure, many companies have chosen to combine different shortterm performance measures. As shown in figure 9, most companies had an STI plan in place for the CEO in 2016. 22 Executive Remuneration in Finland 2017

FIGURE 9: COMPANIES WITH A CEO STI PLAN IN 2016 11% 89 % Yes No Figures 10 and 11 show the CEO and average management team members median STI payments as a percentage of the base salary and benefits. The percentage of median STI payment for CEOs is notably higher than for average management team members, especially in small and large companies. In mid cap companies, this difference is somewhat smaller. Moreover, the gap between maximum STI and actual payouts seem to be larger for average management team members in small and large companies compared to CEOs. In mid cap companies, this difference is less significant. Compared to the previous year, it looks like the STI payment as percentage of the base salary and benefits has increased both for the CEO and for average management team members in mid- and large cap companies. However, in small cap companies the percentage of STI payment of the base salary and benefits is lower in 2016 compared to 2015. FIGURE 10: MEDIAN CEO STI PAYMENT AS PERCENTAGE OF BASE SALARY AND BENEFITS BY COMPANY SIZE 80% 60% Percentage 40% 20% 0% Small Mid Large 2015 2016 Maximum STI Executive Remuneration in Finland 2017 23

FIGURE 11: MEDIAN AVERAGE MANAGEMENT TEAM MEMBER STI PAYMENT AS PERCENTAGE OF BASE SALARY AND BENEFITS BY COMPANY SIZE 60% 50% 40% Percentage 30% 20% 10% 0% Small Mid Large 2015 2016 Maximum STI Figure 12 presents the performance metrics that are typically used in STI plans. Most prevalent measures in 2016 are related to profitability, growth and individual performance. However, many other metrics have also been used. FIGURE 12: FREQUENCY OF METRICS USED IN STI PLANS IN 2016 Other Individual performance Cash flow ROCE / ROI / Other returns TSR EPS Growth (revenue, sales etc.) Earnings (EBIT, profit etc.) 0 10 20 30 40 50 60 24 Executive Remuneration in Finland 2017

Long-term incentives (LTIs) Companies offer long-term incentives to executives to motivate them to focus on the longer term, aligning the interests of executives and companies (long-term) shareholders. Plan length varies from one to six years, but three-year plans are the most common in Finnish companies. Most companies offer LTI grants every year to continuously ensure long-term incentives. This prevents longer-term focus from faltering, should performance targets of previous grants become or seem unattainable. A viable alternative for strengthening the executives focus on the longer term is the use of shareholding requirements. This will require executives to hold a certain amount of shares in the company, often expressed in value as a percentage of fixed salary typically 50% or 100% of annual base salary. As seen in figure 13, only one fifth of the companies disclosed that they did not have an LTI plan in place in 2016. FIGURE 13: COMPANIES WITH CEO LTI PLAN IN 2016 19% 81% Yes No FIGURE 14: MEDIAN CEO LTI PAYMENT AS PERCENTAGE OF BASE SALARY AND BENEFITS BY COMPANY SIZE 100% 80% Percentage 60% 40% 20% 0% Small Mid Large 2015 2016 Executive Remuneration in Finland 2017 25

FIGURE 15: MEDIAN AVERAGE MANAGEMENT TEAM MEMBER LTI PAYMENT AS PERCENTAGE OF BASE SALARY AND BENEFITS BY COMPANY SIZE 60% 50% 40% Percentage 30% 20% 10% 0% Small Mid Large 2015 2016 As shown in figures 14 and 15, the percentage of LTI payment of base salary and benefits is clearly higher in large companies compared to mid- and small cap companies. This applies both to the CEO and average management team member. The percentage of LTI payment of base salary and benefits has decreased more or less in all categories of company size from 2015 to 2016. Please note that several companies disclosed that they have not paid LTI compensation in 2016. If a company has an LTI program, but made no payments, figures 14 and 15 consider these as zeroes. Performance shares Shares that vest after a performance period upon fulfillment of performance conditions. Stock options The right to purchase a specified number of ordinary shares at a fixed price during a stated period. Matching shares Free company shares where the number to be granted depends on employee s self-investment and which vest subject to continued employment and often upon fulfillment of performance conditions over a vesting period. Restricted shares Shares which vest after a restriction period, generally upon continuing the employment. Figure 16 illustrates the most common types of LTI programs used in Finland in 2016. We have divided the programs into four categories, namely stock options, performance shares, matching shares and restricted shares. In large and mid cap companies, performance share plans clearly dominate over other plan types. On the other hand, stock options are the most common plan type among small cap companies. 26 Executive Remuneration in Finland 2017

FIGURE 16: FREQUENCY OF PLAN TYPES BY COMPANY SIZE IN 2016 100% 80% Percentage 60% 40% 20% 0% Small Mid Large Stock options Performance shares Matching shares Restricted shares Figure 17 below shows the distribution of performance metrics used in LTI plans in 2016. The most prevalent metrics are related to profitability, total shareholder return (TSR) and earnings per share (EPS). In addition, growth and return metrics are common. In most developed countries, TSR has been the most prevalent performance metric in LTI plans for a long time. The expectation for Finland is that TSR, especially relative TSR, will become an even more prevalent metric when Finland implements the Shareholders Rights Directive and say on pay policy. The number of metrics used per plan varies between 1 and 5. On average, around 1.8 metrics were used per LTI plan in 2016. FIGURE 17: FREQUENCY OF METRICS USED IN LTI PLANS IN 2016 Other Individual performance Cash flow ROCE / ROI / Other returns Relative TSR TSR EPS Growth (revenue, sales etc.) Earnings (EBIT, profit etc.) 0 5 10 15 20 25 30 35 Executive Remuneration in Finland 2017 27

Pension plans Defined contribution plan emerges as the preferred pension plan type, and the age of retirement in these pension plans has risen. In 2017, Finland implemented a pension reform. The reform will gradually raise the earliest eligibility age for the statutory old-age pension from 63 to 65 years. After that, it will be linked to life expectancy. Companies are facing the choice of how to compensate for the higher retirement age, or whether to compensate for it at all. The retirement age of statutory pension is currently 63. With supplementary pension, a company may have offered employees the old-age pension track at the age of 60. When the retirement age for statutory pension rises, a company can increase the retirement age for the supplementary pension respectively. Keeping the existing retirement age policy will increase insurance premiums in defined benefit plans. In these cases, defined contribution plans are more flexible. For example, in order to keep the same payment program and the retirement age, the level of pension can be adjusted to a lower level. Naturally, available options also depend on the existing agreements between the company and its executives. Figure 18 demonstrates the preferred pension plan types in Finnish companies. Clearly, the defined contribution plan (DC) dominates over the defined benefit plan (DB). However, a major part of the companies did not report what type of pension plan they operate with for executives. FIGURE 18: DISTRIBUTION OF PENSION PLAN TYPES IN 2016 15% 85% DC DB 28 Executive Remuneration in Finland 2017

CHAPTER 7 Regulatory perspective The Finnish Limited Liability Companies Act (FCA) lays the framework for companies organization, governing bodies, their roles, responsibilities and relation to each other. However, the FCA includes only a few specific rules concerning directors and managing directors remuneration. When it comes to credit institutions and insurance companies, the Finnish Insurance Companies Act (Section 6:17) and especially the Act on Finnish Credit Institutions (Section 8) contain more detailed rules on remuneration. The Finnish Corporate Governance Code 2015 provides by far the most important and pertinent guidelines concerning the remuneration of directors, managing directors and other executives in companies listed on the Helsinki Nasdaq. The Code includes i) three recommendations ( 22-24) on remuneration ii) a recommendation on remuneration committee ( 17) and iii) a separate section on remuneration reporting. The Finnish Corporate Governance Code 2015 The Code is a collection of recommendations on good corporate governance for listed companies. The Code is to be applied in accordance with the comply or explain principle. Thus, the starting point is that the company shall comply with all recommendations of the Corporate Governance Code. The company may only depart from the specific recommendations provided it has good reasons for doing so. The company must disclose any such departures from the Code, including the reasons, on its website and in its annual Corporate Governance Statement. Companies cannot depart from the obligation to issue a remuneration statement as specified in the Code s reporting section. The current Code has been in force as of 1 January 2016. For more information regarding the Code and its recommendations and rationale for the recommendations, please visit: http://cgfinland.fi/files/2015/10/hallinnointikoodi-2015eng.pdf The Code recommends the following concerning remuneration: Recommendation 22: Decision-making relating to remuneration The general meeting shall decide on the remuneration payable for board and committee work as well as on the basis for its determination. The board of directors shall decide on the remuneration of the managing director as well as on the other compensations payable to him or her. The company shall specify the decisionmaking procedure for the remuneration of the other executives. According to the rationale in the recommendation, it is generally the body responsible for the appointment of a person, which decides on the remuneration of said person. However, the general meeting of the shareholders should always decide, or authorize the board of directors to decide, on the issue of shares or option rights as part of the remuneration package. Executive Remuneration in Finland 2017 29

If the company has a remuneration committee, the committee may be assigned the preparatory work for defining the remuneration of a managing director. The remuneration committee can also prepare the decision-making process for the remuneration of other executives. Final adoption of the Shareholders Rights Directive The Council adopted the new Shareholders Rights Directive on 4 April 2017. After the new directive has been published in the EU s Official Journal, the EU member states must incorporate the new provisions into domestic law within two years. From a remuneration point of view, the most interesting articles are 9a (Right to vote on the remuneration policy) and 9b (Information to be provided in the remuneration report and right to vote on the remuneration report). According to article 9a, the shareholders have the right to vote on the remuneration policy for directors at the general meeting. The remuneration policy shall, among other things, contribute to the company s business strategy and long-term interests and explain how it does so (further information is available in article 9a). The remuneration policy shall be made public on the website of the company without delay after the vote by the shareholders at the general meeting. The companies shall submit the remuneration policy to a vote by the general meeting at every material change and in any case at least every four years. In addition, according to article 9b, the shareholders have the right to vote on the remuneration report. The remuneration report shall include a comprehensive overview of the remuneration, including all benefits in whatever form, awarded or due during the most recent financial year to individual directors in accordance with the remuneration policy referred to in article 9a. The vote on the remuneration policy will be binding. Thus, companies shall pay remuneration to their directors only in accordance with a remuneration policy that has been approved by the general meeting. However, EU member states may ask for the vote at the general meeting on the remuneration to be advisory. Member states may also allow companies, in exceptional circumstances, to temporarily derogate from the remuneration policy. The vote on the remuneration report (article 9b) will be advisory. However, for small and medium-sized companies EU member states may ask, as an alternative to a vote, for the remuneration report to be submitted for discussion in the annual general meeting as a separate item of the agenda. After the general meeting, the remuneration report shall be published on the company s website. Recommendation 23: Remuneration and shareholdings of the board of directors A company can pay remuneration for board and committee work, either fully or in part in the form of company shares. Remuneration of a non-executive director (of the board) shall be arranged separately from the share-based remuneration scheme applicable to the company s managing director, other executives, or personnel. According to the rationale in the recommendation, using share-based remuneration schemes to remunerate non-executive directors is not, as a rule, justified from the perspective of the shareholders interests. If the board of directors participates in the same share-based remuneration scheme as the other executives or personnel, it could hinder the supervisory duty of the board of directors, potentially leading to conflicts of interest. 30 Executive Remuneration in Finland 2017

Recommendation 24: Structure of remuneration The objective of remuneration is to promote the long-term financial success and competitiveness of a company and ensure a favorable development of shareholder value. Remuneration must be based on predetermined and measurable performance and result criteria. According to the rationale in the recommendation, with regard to variable components, the company must specify the evaluation period for the fulfilment of the set performance and result criteria (earning period). In addition, the company may require that the remuneration for the earning period is disposable only after a certain predetermined period once the earning period (restriction period) has closed. Remuneration reporting: companies cannot depart from the obligation to issue a remuneration statement. A company shall issue a remuneration statement, which is a consistent description of the remuneration of the directors and executives containing the following information: Up-to-date description of the decision-making procedures for remuneration of the directors, managing director, and other executives Up-to-date description of the most important principles for remuneration of the directors, managing director, and other executives A remuneration report providing information on the remuneration paid during the previous financial period The company shall publish its remuneration statement (or incorporate it into the corporate governance statement) in the corporate governance / investors section of the company s website. The company can use links to provide the statement, as long as the links lead directly to the relevant information. Remuneration committee (recommendation 17): The board of directors may establish a remuneration committee to prepare matters concerning the remuneration and appointment of the managing director and the other executives as well as the remuneration principles observed by the company. The majority of the members of the remuneration committee shall be independent of the company. The company shall not appoint its managing director or other executives to the remuneration committee. Executive Remuneration in Finland 2017 31

32 Executive Remuneration in Finland 2017

CHAPTER 8 Sustainability Investor pressure to link executive compensation to long-term sustainability In the last years, we have seen investors across the world rebelling against generous bonus packages and urging companies to link executive pay and sustainability. This momentum has only increased this season of companies annual general meetings. Shareholder resolutions related to executive pay are flying in and some companies have already caved under the pressure. For example, Swiss bank Credit Suisse recently cut planned executive bonuses by 40% in response to shareholder criticism of its plans to make a big bonus payout in spite of heavy losses. In the UK, Wells Fargo cut executive bonuses and three-year equity awards by 50% following a miss-selling scandal that caused shareholders to demand that the company links executive compensation to ethical conduct. Some investors are also taking a more proactive position to the issue. The Norwegian oil fund, the world s largest sovereign wealth fund and one of the forerunners in the responsible investing movement, recently voiced a strong opinion on executive pay. The oil fund published a position statement on CEO remuneration, which emphasizes simplicity, transparency and tying remuneration more strongly to longterm value creation. It makes sense that as a long-term shareholder, they want the CEOs of the companies they own to focus on long-term value creation rather than short-term wins. Black Rock, one of the world s largest asset managers, took a similar position when they published their engagement priorities for 2017-2018. Black Rock also expects companies to articulate their strategic frameworks for long-term value creation and will focus on how boards establish performance metrics and incentive plans that are linked to such long-term strategies. A growing amount of research, for example from Harvard Business School, supports this trend in the investment community. This suggests that sustainable businesses could generate more profit to their stakeholders than other businesses. Is the concern over excessive executive pay justified? EY s 2017 EMEIA Fraud Survey found that 77% of board directors and senior managers could justify unethical behavior to help a business survive. These respondents are also more prepared to act unethically to improve their remuneration, with two in five willing to do so. This finding proves that the demand for more transparency on how bonus payments are determined is very much justified. Executive Remuneration in Finland 2017 33

34 Executive Remuneration in Finland 2017

CHAPTER 9 Taxation Changes in Finnish taxation There have been no significant changes in the Finnish tax or social security legislation in 2016 or 2017 concerning executive remuneration. However, the Supreme Administrative Court has issued certain rulings that impact taxation of equity-based executive remuneration. Also, partially related to these rulings, the Finnish tax authorities have revised their guidance around taxation and associated compliance obligations related to employee stock options and other equity awards. Transfer taxation of employee stock options In one key ruling, the Supreme Administrative Court overturned the Finnish tax authorities practice regarding the obligation to pay transfer tax (1.6%) on options granted to employees on the basis of employee stock option plans. According to the ruling, granting options to an employee based on an incentive plan is considered an issuance of new security and not a transfer of securities subject to the transfer tax. This would apply regardless of whether newly issued or existing shares are used to settle the options. The ruling significantly reduced uncertainty over the applicability of the transfer tax legislation to equity incentives and reduced the amount of administrative work required from employing companies. The Supreme Administrative Court also stated in its ruling that when a company issues shares to itself that it later grants to employees to settle equity incentive awards, it will not be considered a transfer of securities subject to transfer tax. This will create some additional flexibility in settling equity awards without incurring unnecessary costs in terms of transfer tax payments. Carried interest structures The Supreme Administrative Court also ruled in March 2017 on the tax treatment of so-called carried interest in a private equity structure. This is a typical feature in private equity investment structures in Finland and elsewhere, and has been a contentious area of taxation for a number of years. In this case, the employees of the private equity company who participated in a specific investment team were shareholders in a Finnish limited liability company. The limited company in turn acted as the general partner in a Finnish limited partnership, together with a number of limited partners. They agreed to distribute the profit of the partnership partially as carried interest to the general partner after the limited partners share of a certain hurdle interest. The key legal question addressed in the ruling was whether the carried interest is to be taxed as (salary) income of the Finnish investment team members, or as income of the limited liability company (i.e. the general partner in the limited partnership). In this particular case, the Supreme Administrative Court ruled that the income was taxed as income of the general partner (i.e. the limited liability company). However, details of different Executive Remuneration in Finland 2017 35

private equity structures can be very complicated and differ significantly. It is therefore very likely that another case might have a different outcome. For the sake of comparison, Sweden s Administrative Court of Appeal has very recently issued several decisions on the taxation of carried interest in private equity structures. In most of these structures, the Administrative Court ruled that carried interest is at least partly taxable as employment income of the employees. The main features of the structures reviewed by the Administrative Court were similar to those decided upon by the Finnish Supreme Administrative Court. The Swedish Supreme Administrative Court took a substance over form approach in its analysis, looking specifically at the commercial arrangements in the context of the Swedish rules regarding so-called closely held companies. The outcomes of the Finnish and Swedish rulings are thus very different, which illustrates the impact of both differences in the detailed structures subject to review as well as the applicable legislations in each country. Reporting requirements regarding equity awards The Finnish tax authorities have updated their guidance on taxation of employee stock options and other equity awards twice, in December 2016 and April 2017. In the guidance, the tax authorities have inter alia introduced stricter reporting requirements for employee equity awards in cross-border situations. For instance, the revised guidance places more requirements on the employer to confirm whether the employee stock option benefit or other equity awards can be exempted from taxation in Finland if it has accrued during work abroad. One of the requirements for such exemptions is that the award has been reported to the tax authorities of the country where the employee worked during the vesting/accrual period of the award. The guidance emphasizes that the employer is obligated to confirm whether this requirement is met, or otherwise report the award as fully taxable in Finland. Further, according to the revised guidance, the employer needs to report the taxexempt portion of an employee stock option benefit or other equity awards to the tax authorities. We expect this to lead to tax authorities focusing significantly more on such situations. Both the employer and employee should be prepared to provide documentation related to the reporting and taxation of such equity awards abroad. The tax authorities have also further departed from the interpretation of the Centre of Pensions and other social security institutions on when synthetic equity awards or cash-components of equity awards provided to cover tax liabilities on such awards can be exempted from employee and employer social security contributions. Based on the guidance, an increased number of awards will be exempted from e.g. pension, unemployment and accident insurance contributions. However, they will be subject to employee and employer s health insurance contributions, despite the identical wordings of the exemption clauses in all of these legislations. 36 Executive Remuneration in Finland 2017

Taxation of start-up companies employee share schemes According to the current Finnish Government s official Government Programme, the rules for taxation of salary and capital gains should be amended. Such an amendment would mean that a non-listed company could grant stock options or shares to key employees with a lower valuation than that used by private equity investors investing in the company, without counting as taxable income for the employee. In addition to the obvious aim of giving key employees a possibility to participate in the company s value creation with less up-front capital investment, one could speculate that one of the main purposes would be to decrease the employees risks related to valuation of such shares for tax purposes. The somewhat unpredictable valuation of non-listed shares by the Finnish tax authorities is especially problematic for start-up companies with minimal assets and historical profits, but potentially high valuations when obtaining financing. Currently, employees who acquire shares in such companies carry a risk that the tax authorities will retrospectively take a position that the shares were in fact worth more than what the employee paid for them. For instance, this could be due to investments made or proposed by external investors around the same time. The difference would then be considered taxable salary income for the employee. This problem of volatile valuations is less relevant for more established non-listed companies. For them, the key feature of such a possibility would be to facilitate creating material shareholdings for key employees without unreasonable personal investments or upfront tax implications. Thus, the key employees interests would be better aligned with those of the (other) shareholders. Unfortunately, the government has yet to action on this statement of the Government Programme, and apparently, no legislative actions are currently under preparation in this regard. However, some of the countries that are competing against Finland in attracting start-up entrepreneurs and companies have addressed similar issues. Netherlands The Netherlands recently introduced a favorable tax regime. This regime would be applicable to certain types of share option schemes provided by innovative startup companies. The Netherlands have stated that they introduced the favorable tax regime because innovative start-up companies often lack sufficient liquidity to give employees salary increases or bonuses. In such scenarios, awarding share options might be an alternative. As of 2018, a benefit gained from a share option scheme awarded by an innovative start-up will be 25% exempt. The 25% exemption applies to a maximum gain of EUR 50,000. The conditions include: At the time of awarding the share options the employer held an R&D statement for starters; The period between awarding the share option entitlement and its exercise is at least twelve months and no more than five calendar years; and An EU ceiling on state aid referred to as de minimis rule is not exceeded. Executive Remuneration in Finland 2017 37

Sweden Similarly, in December 2016, the Swedish Government stated that Sweden is looking to reduce taxes on stock option payments for employees in small start-ups in a bid to boost investment and jobs. The new rules, which are planned to come into force in 2018, would allow stock options to be taxed as capital gains when cashed in, rather than as salary income. The tax incentive would be available for companies with up to 50 employees, sales of up to SEK 80million and be available for up to ten years. The outcome depends on whether the European Commission approves the changes. The proposed Swedish rules have been criticized for their strict limitations on the number of employees. However, it is clear that if the rules are implemented they will act as a further attractive tax feature in the increasingly competitive market for the best talent and most robust start-ups. This will compound the differences between Sweden and Finland in the field of taxation of equity incentives, with Sweden s rules already currently allowing for capital income taxation of gains from warrants purchased by employees for fair market value. It would thus be highly important for the Finnish government to seriously consider the current tax environment in this area, and implement the idea stated in the Government Programme in order to stay competitive. 38 Executive Remuneration in Finland 2017

CHAPTER 10 Our team Mikko Nikunen Partner People Advisory Services +358 44 547 6498 mikko.nikunen@fi.ey.com Sakari Helminen Partner Law Services +358 40 545 4683 sakari.helminen@fi.ey.com Hannu Tyyskä Senior Manager People Advisory Services +358 50 544 6623 hannu.tyyska@fi.ey.com Jani Alenius Senior Manager Climate Change & Sustainability Services +358 50 598 2750 jani.alenius@fi.ey.com Tuomas Anttila Senior Manager People Advisory Services +358 40 867 1332 tuomas.anttila@fi.ey.com Laura Kalén Senior Consultant People Advisory Services +358 40 550 4573 laura.kalen@fi.ey.com Executive Remuneration in Finland 2017 39