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A question of control

No Free Lunch

A question of control

According to the Prime Minister, and almost everyone else it seems, high pay is too high. “For many working people, it’s not always clear that business is playing by the same rules as they are,” she says in the recent Green Paper on Corporate Governance Reform. “The behaviour of a limited few has damaged the reputation of the many… Something has to change.” Since companies have failed to curb excessive pay, the Government threatens to do it for them. But how? That’s what the consultation is all about.

Over the years, Governments have taken several stabs at how companies are run. One concern was the agency problem - that executives were lining their own pockets at the expense of stakeholders. The solution was to pay them in shares to encourage executives to behave like shareholders. When share prices rise - and most have over the past few years - executive pay goes up too. That morphed into another concern: high pay has outstripped employees’ pay, largely because employees are not paid in shares.

The Green Paper puts a figure on this. It says that between 1998 and 2015, the ratio of the pay of executives to that of full-time employees has gone up from 47:1 to 128:1. These ratios are flaky but until definitions are tightened it’s the best that we’ve got. The paper asks whether every company ought to publish this ratio annually, but worries about what that would tell us. Apparently, Goldman Sachs would have a smaller ratio than John Lewis. And if the media attacks those with high ratios, will companies outsource more low paid jobs?

 

Unintended consequences

An earlier review linked executive pay to company performance. Better performance generated higher pay, so of course in successful times, executive pay outstripped shareholder returns. More suspicions. Could performance conditions be too easy to achieve? So in 2013, the Government empowered shareholders to overturn pay policies if they seem too lenient. Only one company has lost its policy vote so far, and as discussed in “Weir not in this together” in August 2016, shareholders arguably made a short-sighted decision.

How practical would it be to extend these powers to past pay agreements? More scope for havoc. So, to get round this, the Green Paper wonders about introducing a shareholder, or even stakeholder, committee to take over some of the current responsibilities of directors. It fails to see the irony of this. On its own admission, the behaviour of a few is the problem, so why heap even more bureaucracy on all? A tax on excessive amounts may be a simpler solution – if anyone can work out how much is too much. In the US, corporate tax can only be reclaimed on the first million dollars of pay unless it is demonstrably linked to performance. An alternative is for higher personal taxes. But these could result in higher gross pay and executives spending more time working overseas.

A previous review required companies to say how much their executive directors earned. Surely, naming and shaming would result in pay moderation. But the opposite happened. Now that they could see what others were paid, executives who were paid less had the evidence to push for more. Strangely, those paid more did not push for less. Overall, top pay went up - from about £1m in 1998 to £4.3m in 2015, according to the Paper. But then comes a frank admission. That the median increase for FTSE 100 chief executives over the past two years has been about 2 per cent. This is similar to those for employees, which suggests that the pay gap has not grown recently after all. Perhaps, they need to get behind these superficial numbers to see what is really going on before pushing through new legislation.

 

Attacks on apathy

Underlying this is the concern is that although shareholders are supposed to hold companies to account, in practice, they don’t. And because they don’t, companies can too easily become self-perpetuating entities, with nobody, apart from senior executives, apparently in control.

According to the Paper, on average only 72 per cent of FTSE 100 shareholders bother voting. Overseas investors now own 54 per cent of the UK stock market and, the Paper says, they don’t seem too interested on the level of pay or how it relates to the wider UK society. This might come as a relief to those who resent foreign interference in domestic affairs but it hardly helps the cause of corporate governance.

Since fund managers can’t afford the time to look at pay in detail, they rely on proxy advisers to direct them. The Paper sees a danger that these advisers are becoming too influential – and don’t always get things right. It suggests that fund managers should disclose how they voted and whether they relied on proxies.

Being able to vote and not bothering is one thing. Being denied a vote is another. You might own shares but hold them in individual savings accounts (Isas) or in funds. You can’t vote at company meetings because your shares are in nominee accounts on the registers. The Paper proposes what this magazine has long advocated: that the brokers and fund managers who manage these accounts should vote according to your wishes, not theirs.

 

Pushing the envelope

One reason top pay has such a high profile among the companies we can invest in is because they have to make it public. But what about the pay in private companies and limited liability partnerships? This includes private equity, where equity-driven top pay can dwarf that elsewhere. The Paper asks whether they too should be made subject to the same corporate governance and reporting standards as publicly listed companies.

Mumsnet subscribers once asked about buying shares in Aldi and Lidl. They can’t. Both are privately owned German companies. What corporate governance applies to them? You can’t buy shares in ASDA either. You can buy shares in its parent company, Walmart. But Walmart is US-based and so subject to US, not UK, corporate governance. If you shop at Tesco, you’ll be a customer of Tesco Stores Limited. You can’t buy shares in Tesco Stores either, but you can buy shares in the parent company, Tesco plc. For the sake of fair competition, should the UK operations of all of these be subject to the same governance rules?

We’re back to definitions. If your concern is pay inequality within the UK, the appropriate company is Tesco Stores Limited and its peers, not Tesco plc. If your concern is the absolute level of top pay, the appropriate company is Tesco plc, but then what about its international peers? The UK depends on global markets, but UK corporate governance rules only apply to those listed in the UK. To curb pay globally will require international co-operation just at the time that the country is heading in the opposite direction.

 

So many elephants, so little room

Other examples quoted in the Paper of large, privately held businesses include “significant family ones” like Warburtons Limited and large mutuals like the Co-Operative Group Limited and presumably building societies. Surprisingly, those not mentioned are the very ones charged with ensuring that good corporate governance is followed: institutional investors, including fund managers, and proxy advisers. It would be a paradox if they were to be left out.

There are other omissions too. Some senior executives are required to own a minimum number of company shares so that they run the same risks as any other shareholder. This is often a multiple of their salary and normally, can be built up from maturing share plans. Since it’s a condition of their employment, dividends from these shares, together with any changes in their value, are really an element of pay - so it’s strange that they are not included in the single figure of total remuneration that companies now have to publish. And doubly strange if pay is then compared between companies with different requirements. There’s no mention of this in the Paper.

Nor of pensions. Employees resent salary-linked pensions being paid to senior executives when such schemes have been taken away from them and their colleagues. Meanwhile, tax increases have made company-funded pensions for the higher pay somewhat anachronistic. The Paper could have suggested that senior executives provide for their pensions from their own resources.

But the biggest omission is more about what troubles the Government about corporate governance. The clue is in those words about the perceptions of “working people” and “something has to change”. This should worry investors. The risk is that damaging changes will be driven by snap judgments based on superficial information. One populist perception is not only that pay is unfair but that the wealthy avoid tax, so why not test that?

If the average FTSE 100 chief executive earns £4.3m and is only taxed in the UK, his or her take-home pay would be £2.3m - still high, but more like half the headline number. The Treasury would take £2.6m. (This is after income tax at 45 per cent, national insurance at 2 per cent from the employee and 13.8 per cent from the employer.) If we accept the 128:1 ratio quoted in the Paper, the equivalent average FTSE 100 employee earns £33,500 gross and keeps £26,000 net. After tax, that ratio of executive to employee pay reduces by a third to 88:1 – again, still high, but much smaller than the gross figure.

It seems odd that this is not mentioned, especially since the ratio is lower due to the raising of everyone’s tax thresholds – and Governments deserve credit for that. So how about companies being required to publish the tax paid and take-home pay of their executives. And that any comparison with employee earnings should be made after tax.

After all, when there are elephants in the room, you might as well make them perform.

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