The Performance and Reward Centre (PARC) Discussion on Executive Remuneration

PARC Discussion Meeting & Dinner - 23rd June 2016, London

The night of 23 June, as the heavens opened over London with thunder, lightning, and downpours and as the EU Referendum voters headed back home from the polling stations, I joined a panel of three experienced remuneration advisors, chosen to field questions on the subject “The Changing Performance and Remuneration Landscape.” This group included Stephen Cahill, Partner at Deloitte LLP; Chris Johnson, Senior Partner at Mercer; and myself. We were grilled by The Right Honourable Sir Vincent “Vince” Cable, former Secretary of State for Business, Innovation, and Skills (BIS) in the 2010 UK Coalition Government and architect of the Enterprise Bill, 2013—the core legislation on remuneration governance in force in the UK. The meeting was Chaired by Angela Knight CBE, the former CEO of the British Bankers’ Association, former CEO of UK Energy, prior Remuneration Committee Chair at Brewin Dolphin, and a Remuneration Committee member at Tullett Prebon.

Vince introduced the subject for discussion by providing some perspective on his time at BIS. The context was that, in 2010, it was a time of economic crisis. There were huge pay disparities between those with executive pay packages and the general working population. Broadly, the world fell into two camps: those (such as the Trades Union Congress [TUC]) who felt the gap between executive pay and ordinary pay was too wide and getting wider, and others who took a laissez faire attitude, taking the view that disparities in wealth are resolved through taxation. Broadly, he was of the latter view but had a “Road to Damascus” moment on meeting a CEO who said “he would do it [his job] for nothing, but was paid in the manner he was because it showed his value [to the company] relative to peers.” He identified six problems to sort out:

1. The market in executive pay works badly;
2. Incentives were contributing to instability in the banking sector;
3. The “Fallacy of Composition” where each element of pay (salary, bonus, long-term incentives) was chased to the upper quartile, ratcheting pay upwards;
4. Poor governance—the natural constraints you expected didn’t work (Vince cited the example of the Chairman of Barclays over-ruling Alison Carnwath’s decision not to award a bonus);
5. Other factors that should have been considered, were not considered: hacking at TalkTalk, low pay at Sports Direct, stakeholder unhappiness about pricing at energy companies; and
6. The gap between CEO and median worker pay was too wide (“95%+ of the fruits of US economic recovery in the period since 2008 have been enjoyed by the top 1% of the population”).

We now have the Enterprise and Regulatory Reform Bill, with its binding and non-binding voting by shareholders.

Now retired, Vince asked himself “What, if I had my time again, what would I also have done?”

The answer:

1. Build a requirement to consult the workforce;
2. Find ways to objectively measure the gap between CEO pay and that of workers; and
3. Have a requirement that investors report whether they voted on pay.

Sir Vince laid down the challenge: if disclosure is bad (benchmarking increases pay inflation and regulation is bad—red tape!), what would the panel and the audience do differently to create self-regulation?

• Stephen felt that none of Sir Vince’s regulatory add-ons would work in practice.
• The situation on executive pay is improving: only one company failed its say-on-pay vote in 2013 and there were only two failed votes in 2015.
• There is limited shareholder rebellion and it is short-lived: in 2013 80% of companies could achieve 90% support for their remuneration, in 2015 the figure had fallen to 70% (of companies) had 90%+ support, yet still 95% support was the median.
• The embarrassment over high pay has gone: even 92% of WPP shareholders are in favour of Sir Martin Sorrell’s package.
• Proxy voting agencies swing votes: of the bottom seven vote outcomes last year, ISS had “picked on” seven of them, and ISS can expect 25% of shareholders to support a ‘No’ ruling.
• Despite knowing in advance the small number of companies who ISS will not be supporting, ISS is not willing to give early indication of problems so they can be sorted out in advance.
• Fund managers—those judging executive pay programmes—are themselves paid massive sums.
• Chris felt that the HR community could be more effective and more strategic.
• Sir Vince was concerned that listed companies may transition to private status if pressure on executives’ pay goes further.
• Simon: unintended consequences arise often, for example the push for total shareholder return (TSR) metrics in long-term incentives (LTIs) made them unpopular, and therefore risked their extinction (a bad thing).
• Simon focused on value of talent, not cost of talent. Using the UK CEO Value Index (Total Value Added to all shareholders divided by Total Realised Pay over same period):
  • Over half (52%) of all FTSE 100 companies listed in the UK deliver between £240 and £740 to all of their shareholders for every £1 paid to the CEO—a range of just £500;
    
  • 71% deliver with the range £210 to £1,210—a £1,000 range;
  • Big versus small companies: median CEO of FTSE 350 has index of £1210, median CEO of FTSE 151-350 has index of £132;
  • New CEO or keep CEO—median index of companies with same CEO: £183 and with a change in CEO: £278; and
  • Impact having a female remuneration committee chair—average difference at median is +£87, at upper quartile is +£183.

• Remco chairs perhaps need to be more informed (and bolder) and engage with the executive and HR teams, external advisors, and shareholders to develop pay programmes that take into account all stakeholder views—investors, executives, employees, regulators, and the communities they serve.
• There needs to be more variety in pay structures across the market: restricted stock, performance shares, bonus plus deferral plans, stock options, cash-based programmes—all serve different purposes and may be suitable in different circumstances across all businesses at different points in time.
• Too much time is spent determining “best market practices” which really only equals most prevalent practices.
• Use of discretion is a good thing, so long as the trust is there. Stephen gave examples where boards let themselves down when it came to building trust.
• Chris Johnson: boards, presumably through the Remco, need to have regard to the sustainability of their talent pipelines, not just at the very top.

Rem.n's position from the evening’s panel discussion is:

• Focus on what you are paying management to achieve (for shareholders) not just on how much to pay:
  • Performance metrics should represent how you create value in the business;
  • “One-size” does not fit all companies, the company context (and circumstances) is critical; and
  • Pay policy, pay practices, and pay design should help align all of the elements of the business (executives and staff should all play by the same rules).

• To bring about improvement in executive pay governance, everyone involved needs to do more:
  • Remuneration committee chairs to be more informed, bold, and engaging;
  • Executives and HR teams to support recommendations with evidence of value creation;
  • Regulators to focus on better governance, not prescriptive “solutions”;
  • Investors to use advisors but stand by the decision of the board (focus on the calibre and performance of the board);
  • Remco advisors to provide a full range of fit-for-purpose alternatives, not just best practice analysis; and
  • Proxy advisors to engage with Remcos aiming to raise and address concerns, not build a “tick-box” template.

A good discussion with a very informed audience, representing a wide range of large- to mid-sized mostly UK business organisations and academic institutions.