Will executive pay decisions change?

If you read nothing else, read this…

• UK chief executives officers’ average packages increased from £1 million to £4.2 million between 1998 and 2010.

• In September, the Department for Business, Innovation and Skills issued two papers on how executive pay should be handled.

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• Organisations have warned against too much disclosure on executive termination costs and bonuses.

• Suggestions of having shareholder and employee representatives on remuneration committees have been challenged.

Executive pay has been under attack, but major changes in how it is decided may be slow in coming, says John Greenwood

Remuneration committees (remcos) did not need the government to remind them of the importance of striking the right balance when it comes to executive reward. With chief executives’ (CEO’s) average packages rising from £1 million to £4.2 million between 1998 and 2010, shareholders, pressure groups, the media and the general public have all been pushing the issue.

The Department for Business, Innovation and Skills (BIS) published two papers onthe subject in September. John Lee, managing partner at FIT Remuneration Consultants, says: “[Business secretary] Vince Cable’s document is a catalyst for remcos to take a wider look at their practices.”

BIS has launched a two-pronged attack on the way executive pay is handled. Its Future of narrative reporting consultation paper proposes ways to improve how remuneration is disclosed by companies. Alongside this, the government has published a discussion paper on executive remuneration, which focuses on the broader link with performance, looking at how reward packages are quantified and whether shareholders or staff representatives should be involved.

The Association of British Insurers (ABI) put yet more pressure on remcos at the end of September by publishing guidance urging them not to engage in crude benchmarking when seeking to justify increases and to strongly resist payment for failure.

Industry’s response mixed

It is too early to say whether the government’s initiatives will affect the next round of remco meetings. The industry’s response has been a mixture of support for measures it believes it is already going some way to carrying out, and a wait-and-see approach on some of the more radical proposals. Mark Quinn, reward partner at Mercer, says: “Employers’ first response to this consultation will be that they have been geared towards paying for success for years and no one wants to pay for failure.”

One of several ideas borrowed from the US is a government proposal to call for a single table showing a single figure for the aggregate remuneration awarded to each director. Directors’ salary, fees, bonuses, share options, long-term incentive plans (L-tips) and pensions must all be disclosed, but can be scattered around different sections of reports, making it difficult for shareholders to compare like with like. The government also wants to bring high earners who are not on the board into reporting requirements.

Another proposal on the table echoes a recommendation of Will Hutton’s review of public sector pay: publishing a figure for the ratio between the CEO’s pay and the median earnings of an employer’s entire workforce.

But Charles Cotton, reward adviser at the Chartered Institute of Personnel and Development (CIPD), says: “I am not sure what the ratio would achieve. If the aim is to highlight income inequality, could that not be better dealt with through tax and benefits policy?”

Transparency is a watchword of the government’s initiative, but Mercer’s Quinn says too much transparency can be dangerous. “Previous guidance has required employers to make termination costs explicit,” he says. “The problem is, when you are agreeing terms with employees at the outset, it is the wrong time to be talking about negatives, so exit clauses can be less onerous. But that means companies often have no choice on what golden handshakes they can give at termination. Payouts can then look like pay for failure, but they are more to do with the way the contract was structured at the outset.”

Remcos have been trying to address this issue, says Quinn. “Notice periods have shortened over the last five years anyway, and tend to be six months and not a year now.”

Bonuses are a top target for BIS, having risen by 356% between 1998 and 2010. Bonuses have to be disclosed, but there is no requirement to publish the criteria they relate to.

Dangers of tying remcos’ hands

Again, experts warn of the dangers of tying remcos’ hands. FIT’s Lee says: “The problem with disclosure up front is that often the information is commercially sensitive. If a company publishes that it has a target of £100 million of new business, that is commercially sensitive. Also, [employers] might incentivise a director to make a set number of members of staff redundant. We should not get into a situation where too literal disclosure leads to dysfunctional behaviour.”

Although bonuses rose steadily over the last decade, they plateaued in 2011. At 180% of salary, maximum potential bonuses were the same in 2011 as in 2010, according to Hewitt New Bridge Street’s 2011 FTSE 100 executive remuneration report, published in September. But in these austere times, remcos are getting more for their money. In 2011, more than 70% of FTSE 100 companies required part of the bonus to be deferred into shares, and over 35% now disclose a clawback facility in their annual bonus plan.

How the numbers are presented is also under scrutiny. Directors’ remuneration reports are required to publish a performance graph showing total shareholder return over the previous five years compared with peer companies. Shareholder groups like seeing chief executive pay plotted against this line, but some say it could be restrictive.
Yet more challenging to the culture of UK PLC are government discussions around shareholder and employee representatives on remuneration committees.

Sean O’Hare, reward partner at PricewaterhouseCoopers, says: “UK shareholders do not want to do this. They want to be able to hold companies to account. By getting involved in the operation of the company, they are no longer at a distance from the management to be able to judge it.”

Some of the ideas promoted by Vince Cable’s consultations will become best practice, but it appears remcos are unlikely to adopt the more radical steps suggested unless they are made to do so by law.

Impact on engagement

• According to the Department for Business, Innovation and Skills’ Future of narrative reporting consultation, the government wants employers to publish:

• A single figure for the total remuneration of each individual director.

• An explanation of how remuneration in the relevant financial year relates to performance, including graphical
representation of company performance.

• Remuneration policy and performance measures for the year ahead, including an illustration of remuneration if performance measures are exceeded, met or not met.

• The relationship between executive pay and pay across the organisation, and expenditure on executive pay as a
proportion of profit.

• Information on service contracts and shareholdings of all directors.

• A summary of how the remuneration committee came to its decision.

Who should be on a remco?

• Having shareholder or employee representatives on remuneration committees (remcos) would require a complete rethink of corporate governance.

• Employee membership is an idea that comes from the co-determinism of Germany, where the relationship to capital is very different.

• Remcos could have professional members, but they would not operate without the understanding of the context
of the board’s activities as a whole.

• Having shareholders on the committee begs the question, which shareholders? If a company invests in hundreds of other companies, how does it decide?

Source: Katharine Turner, vice-president of performance and reward at the CIPD, and executive compensation consultant at Towers Watson

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