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OPINION

Weird scenes inside the goldmine

Weird scenes inside the goldmine
April 21, 2017
Weird scenes inside the goldmine

Remuneration committees have been under pressure to tailor pay policies for their company, rather than sticking to a one-size-fits-all let’s-copy-others approach. Consultants have duly obliged, coming up with simplified and innovative recommendations, exactly as required. But now comes the problem: when they consult their largest shareholders, companies are finding that whilst institutional investors are pressing for simplicity, they differ in their approaches. If companies fine-tune the policy to satisfy one fund manager, they risk prompting new objections from others.

This lack of common ground is proving to be a real problem. Chairmen are always happiest if they go into the AGM with a majority of votes sitting in their back pocket, so company secretaries normally canvass major shareholders in advance. This year, fund managers are apparently more reluctant to commit themselves one way or another. The reason is simple: they are wary of the media criticism and, until a pattern emerges, what is deemed acceptable keeps on changing.

Nobody wants the ignominy of seeing their remuneration policy voted down, as happened to Weir (WEIR) last year, even though what the company was then proposing fits with the best practice now being advocated by others. (See “Weir not in this together”, published on 5 August 2016). So companies are responding in different ways:

■ Even if resolutions are carried, substantial dissent can give the company cold feet – that’s what happened to Thomas Cook in February. The remuneration policy had about 80 per cent of the votes and will be implemented, but the new share plan only attracted 67 per cent support. After hearing shareholders object to the new performance conditions and the size of the potential payout, the remuneration committee decided to suspend it.

■ Having published their policy resolutions ahead of the AGM, some companies have realised that they are likely to be defeated. In January, Imperial Brands pulled a resolution that would have increased the potential pay of its chief executive, Alison Cooper, to a maximum of £8.5 million. In March, Chemring also decided to think again. It pulled both its new remuneration policy and its new share plan, even though they complied with guidelines from the Investment Association. A couple of weeks later, Safestore did the same.

■ Remuneration consultants say that some companies are now so wary of the lack of consistency amongst their largest shareholders that they have withdrawn potential resolutions before they are even published. They will tell shareholders that they need more time for the review but in reality, they are waiting for the dust to settle.

Pay tangles

Amid this uncertainty, the Business, Energy and Industrial Strategy Select Committee has published a raft of recommendations on corporate governance. These twelve cross-party MPs accuse companies of short-termism and fail to see “a credible link between remuneration and performance”. They suggest that executive pay should be designed to promote the long-term success of the company. Fair enough, but they offer no definition of success. What is success supposed to look like? They want performance-related pay to be transparent, stretching and rigorously applied. But they don’t like performance conditions linked to share values. They prefer measures like customer service, safety, employment or environmental issues.

There are many worthy recommendations in the report: keep “comply or explain” corporate governance; apply it to private equity as well (but they omit UK subsidiaries of foreign companies); encourage workers on boards; aim for increased diversity. It is on pay that the committee gets into a tangle. It assumes that incentives are meant to incentivise all senior executives, for example, despite much evidence to the contrary. It says that pay needs to be simplified but fails to realise that complexity comes from paying for performance and making pay awards that executives have to wait years to receive. The obvious answer is for lower initial awards, tighter performance conditions and greater enforcement against offenders. Instead the committee has come up with a simplistic solution: encourage long-term decision making by replacing long-term incentive plans (LTIPs) with “deferred stock options”.

The members might not have realised that conventional share options were mostly scrapped several years ago. They suit high-risk growth companies, rather than low-beta ones. Perhaps by options, they mean simply share awards that have to be kept for a number of years. Perhaps they mean nil-cost options (effectively share awards that can be exercised when the recipient chooses, rather than after a fixed period, like three or five years). They do not make this clear.

They are worried that executive pay is too high. Against this is another concern: sound management of companies is vital, not just for investors, but as the gold mine of the wider economy - and quality management comes at a price. If pay is too high, how high or low should it be? Few are prepared to answer that question. One reason for the apparent distortion of executive pay is that its main currency is not sterling, but shares. Why pay in shares? Because investors insist that executives must run similar financial risks to them.

This is inconvenient. If executives are expected to risk their pay by holding shares in the company they work for, in bull-runs their pay is bound to outstrip those who are paid just in cash. By the same token, this pay gap will narrow in bear markets. Well-designed performance conditions moderate excessive volatility; scrap them entirely and you rely solely on absolute share prices for pay. Pay then depends more on luck than performance.

Mark Cutifani, the chief executive of Anglo American (AAL), knows this only too well. When commodity prices were crashing in 2015, the shares he received from his maturing LTIP slumped to £0.8m. His new LTIP that year had a potential value of £4.4m. Since then, world commodity prices have rebounded; Anglo’s share price has almost tripled and so has the potential value of this LTIP. At this point, the remuneration committee stepped in. Too much, it said. It has used its discretion to amend the performance conditions and place a ceiling on his eventual payout. His pay is still too high, critics say, but at least this was a step in the right direction.

There are signs that others are getting the message too. Bob Dudley’s pay at BP (BP.) in 2016 was down 40 per cent (or 27 per cent if his pension is excluded). The pay that Sir Martin Sorrell received last year from WPP (WPP) is expected to fall by about 30 per cent. At RB (RB.), the remuneration committee has at last over-ridden the performance conditions of Rakesh Kapoor’s LTIP to reduce it by half. He also lost his 2016 bonus. Overall, his pay fell by over 40 per cent.

There’s a big catch here though. We tend to focus on pay movements, but they cloud the absolute level of pay. Sir Martin’s pay will still be in telephone number territory at about £50m. Mr Kapoor’s pay fell by almost £11m to £14.6m. It’s a reflection of how high this has been that, despite the cut, the pay he received in 2016 was still double that received by Paul Polman, chief executive of Unilever (ULVR), a company that is twice as large as RB. So, for those paid the most, there is still some way to go.

Gap minders

Some believe that the gap between chief executives’ pay and that of the average employee will give a clue as to how high executive pay should be. The committee claims that the average FTSE100 chief executive is paid 150 times that of the average employee, but this is misleading. This ratio omits several of the benefits, bonuses and share plans available to employees, and so is dramatically overstated. The gap would also be much narrower if pay-after-tax was used.

The time-lag of executive pay is also often overlooked. Executive pay is reported normally three years after shares have been awarded and the rises and falls in share prices during that time exert such a strong pull not just on executive pay, but on the pay ratio as well, that they account for most of the fluctuations in the pay gap.

Then there are other questions, such as whether the ratio should apply just to the UK or apply across borders. The committee wants every company to publish this ratio in the mistaken belief that it is easily obtained. It is based on past pay awards; changes to current executive pay will take years to work through to the figures. The intention is for shareholders to press for lower ratios but what they would actually make of them is another matter.

Trying too hard

Some past corporate governance reviews have helped foster best practice; others have had unintended consequences. Executive pay grabs the attention because a past review required it to be made public in a way that higher pay in other walks of life is not. The Prime Minister has admitted that the real concern lies with “a small minority of business figures [who] appear to game the system and work to a different set of rules”. But that does not apply to all, so one solution would be greater enforcement of the existing rules.

Shareholders have always tried to ensure that executive pay aligns with company performance. The difference this year is that executives, directors and their advisers are seeking better ways of achieving this. This can conflict with large investors who are targeting policies that they fear could lead to excessive pay further down the line. If a company innovates on pay, it’s a fair bet that enough shareholders will object to make it untenable. By default, the existing policy – the very one that everyone wishes to improve – then continues. The joke amongst remuneration consultants is that to keep your existing policy, you just need to come up with a radical new one.

The current impasse may be ironic, but it is also an unintended consequence of the push for better corporate governance.