I recently attended a seminar for independent directors on Executive Remuneration organised by Ernst & Young with Sir Roger Carr, President of the Confederation of British Industry (CBI) as principal speaker. I referred to this issue briefly in my blog Life in the Boardroom (tag Boards 20.2.2010) and since then the temperature of the potato has warmed up considerably. The environment has become acutely hostile with public anger, media pot boiling and shareholder springs. Government’s reaction, while sticking to the line that it is a matter for shareholders, has been to initiate consultation exercises. The Department for Business, Industry and Skills is consulting on possible binding shareholder votes on future remuneration policy and enhanced disclosure on exit payments. It is also considering enforced disclosure of a single figure for total remuneration and a new framework for remuneration reports.
In addition there is a Treasury Committee inquiry into corporate governance in financial services while the Financial Reporting Council is conducting reviews on changes to the Corporate Governance Code, including claw-back arrangements for incentive awards and limiting the practice of executive directors sitting on remuneration committees of other companies.
Some of this is no doubt desirable and possibly overdue. After all over thirty years there has been a widening gap in pay between those at the top and those at the bottom of companies. This is partly due to the globalisation of senior roles with a greater demand for international experience. Top jobs are benchmarked globally while jobs lower down are benchmarked locally. A study by Mark Williams, fellow in the Employment Relations and Organisational Behaviour Group at the London School of Economics, demonstrates that more than two-thirds of the growth in wage equality among British men between 1975 and 2008 can be attributed to just 20 professions out of 366 occupations analysed.[i]Chief executives of large organisations have benefitted the most with a fourfold pay rise.
And while there has been some increased shareholder activism, also desirable, the fact is that 80% of FTSE 100 companies get 90%+ approval of their remuneration reports. Only 12 companies have got less than 75% approval in the past year. When I consider such statistics I often remind myself that, while I have never earned the sky high salaries of today’s FTSE 100 CEO, I have many times put myself up for re-election by shareholders as a director of four different public companies, on a much more frequent basis than any politician, and have never had less than 97% approval of those voting. Furthermore, while executive remuneration is subject to approval by shareholders, politicians decide their own pay and rations.
In the recent past the majority of FTSE 350 senior executives have received base salary increases while a small number of companies continued to freeze or reduce salaries. The majority also received an annual bonus payment but there is continued use of mandatory referral. The majority also received a long term incentive payment, usually based on total shareholder return in combination with absolute growth in earnings per share.
In such an environment the key issues for UK companies are to maintain the continuous review of remuneration policies and practices to ensure compliance with ever evolving regulatory frameworks; more frequent interaction with shareholders and key investor groups; ever increasing responsibilities for non-executive directors, particularly those who draw the short straw and serve on Remuneration Committees; acute focus on appropriate risk management in reward structures; and, especially, clear demonstration of the link between performance and reward.
The BIS consultation is testing the idea of a binding vote versus the current advisory vote. This might be annual if the remuneration structure is changed, or every three years if there is no change. Various scenarios are being developed to report a single figure for total remuneration. I fear that this will just make it easier for lazy journalists to report that Sir Xavier Yfronts has ‘taken home’ £5 million when in fact he might have taken home a tenth of that as most of it is deferred and the rest is taxed at 50% plus. BIS is also looking at a statement that shareholder views have been taken into account. There is evidence that companies, especially the pariah banks, are getting the message. HSBC has introduced a career option based on a ten year plan which has gone down well with major shareholders like Hermes and Standard Life.
So what does Sir Roger Carr think of all this?
He traces the root of the problem back to the Gordon Gekko syndrome, based on the Michael Douglas character, a ruthless corporate raider in the Oliver Stone 1987 movie Wall Street. An outbreak of Mergers & Acquisitions fuelled by the desire of corporate bankers, lawyers, accountants and publicists to earn fees drove up executive remuneration not least because advisors usually earned bigger bucks than the advised who carried all the responsibility. Stock options contributed to the problem as they only reward success with no penalty for failure. Over the past fifteen years markets have stagnated leading executives to pile on extra layers of remuneration. Then there is the question of benchmarking. Everyone wants to be compared with the upper quartile, even the upper decile, which ratchets up earnings in an ever inflationary spiral.
The music stopped when the banking crisis hit in 2007-8 but in the eight years from 2002-10 average earnings of top executives had increased by 16% per annum or 236% cumulatively, a staggering rise and well above the comparatively modest rates of inflation of that period.
Sir Roger blames all this on weak chairmen with insufficient control over their executives. He cites a degree of mutual back slapping with high pay awarded for mediocre performance. He also observes payment for failure with inflated exit deals for those who get fired. He states quite clearly that the CBI doesn’t like this and asks us as independent directors to stand up and be counted.
Sir Roger came in for vigorous questioning, which I joined in, but he stood his ground.
I am in sympathy with all this and see that a serious problem has developed in our public companies. But I also think that we are only looking at a narrow definition of that problem. Public companies are subject to especially robust requirements for reporting. Privately held companies have much less onerous requirements placed over them. It is easy for the hypocritical media to report on the fat cats of the public companies while failing to disclose the even higher earnings of their own editors. [ii]They rarely investigate the possibly much higher earnings of those in private equity held businesses or in the law firms and others that advise the public companies on their transactions.
So if the point is to try to develop a fairer society in which we really all are in it together it is doubtful that these actions will have the desired effect. Instead they are more likely to drive companies, and /or their directors to go private or off shore. Ever more regulation does not seem to be the answer, either. The problem with regulation is that it constrains the good guys while rarely discouraging the bad guys. Just as the criminal law does not stop crime, it just defines it and then prescribes the penalty for those who get caught, so much of regulation does the same.
The highest paid executives may not even be on the board of directors and subject to all this disclosure. Highly paid traders in bonds or swaps may milk millions in bonuses. They will be declared to Her Majesty’s Revenue and Customs but not to shareholders. And when the music starts again there will be all sorts of schemes invented to get round a new set of rules and regulations. Back in the 1970s the Government of the day tried to banish the waves of inflation by controlling incomes and prices. Increases in wages and salaries were tightly controlled by Roy Hattersley’s men. At that time the only executives who had company cars were those who genuinely needed them to do their jobs, such as salesmen. That was one of the reasons why I became a salesman. But the companies started to find reasons why their key executives also needed a company car as a way of rewarding them instead of a prohibited salary increase. In a few short years Britain became the country in the world with the highest ratio of company cars versus privately owned. Only complex and onerous tax reform changed that some decades later.
[i] Mark Williams Occupations and British Wage Inequality, 1970s–2000s Eur Sociol Rev first published online July 18, 2012 doi:10.1093/esr/jcs063
[ii]I am grateful to Private Eye for their frequent exposure of this point.
Copyright David C Pearson 2012 All rights reserved