The Investment Association (IA) is concerned that executive pay structures have become too rigid, and that while pay comparisons make for easy headlines, the underlying dynamics are much more complex. It hopes to simplify its “Principles of Remuneration” later this year, but how much of a difference are these likely to make?
The IA expects companies to tailor pay based on what's appropriate for each situation. Some companies, for example, might wish to drop the performance conditions on share awards, and so award only restrictive shares. Some may wish to award both, although that would make pay look more complicated – and shareholders often say they want simpler pay structures. At the same time, though, they’ve demanded stronger safeguards – such as mandatory holding periods, the ability to claw back pay and requirements for executives to keep shareholdings after they resign. Since the financial crisis of 2008, companies have had to publish more about how their executives are paid, and to hold binding shareholder votes on remuneration policies. These have all added layers of complications.
Another relatively recent issue is “distributive justice”. Investors expect executive pay to be driven by company performance, but criticise when pay-outs are perceived as excessive, or if they become disproportionate to the pay of other employees. Aware of the reputational risk that comes with adverse publicity, non-executive directors play safe. They hold back from exercising discretion, particularly when higher rewards might be called for, and fall back on tried and tested pay structures to constrain how much executives can receive.
The problem, the IA suggests, is executive pay is supposed to incentivise success (as in the US) but the UK emphasis seems to have become more about “disincentivising” failure. This blunts the impact of pay structures, particularly in large companies where they can be both "prescriptive" and "convoluted". These heavy-handed structures erode their perceived value, which makes them less meaningful for executives. Everyone agrees that executive pay should avoid rewarding short-term gains at the expense of sustainable success, but the growing concern is the lack of the UK's competitiveness.
Last year, this prompted Julia Hoggett (who heads the London Stock Exchange) to call for a wider conversation about how executive pay hampers the ability of companies to recruit high-calibre candidates and make retention more of a challenge. She argued pay inhibits the ability to create “globally consequential companies” in the UK and has caused several companies (such as CRH (CRH), Tui (TUI), Ferguson (FERG) and Flutter (FLTR)) to move, or consider moving, their primary listing overseas (where pay is often higher). Executives have also migrated to private equity. But. at the heart of this is a fundamental question: is the government prepared to back national champions?
Her sentiments were echoed by Rupert Soames, chair of Smith & Nephew (SN.) which has had four chief executives in five years, who drew a distinction between UK-reliant companies and “Brilos” (British in listing only: companies listed in London that generate most of their revenues abroad). At its AGM on 1 May, he’ll ask shareholders to approve a remuneration policy to enable the group to pay its US people more. The London Stock Exchange Group (LSEG) is also proposing to double the potential pay of its chief executive, David Schwimmer (ironically, Hoggett’s ultimate boss), to about £11mn, in line with global peers.
The argument that larger packages foster a more entrepreneurial spirit is perhaps tenuous. What’s more certain is that since most executive pay comes from share awards, when the time-shift between the award and vesting is accounted for, high pay and share price performance ought to move broadly in step. Some attribute uncompetitive UK pay to Brexit: the estimated 4 per cent reduction in GDP (according to the Office for Budget Responsibility) and the devaluation of sterling. They blame the subsequent government antics for damaging Britain’s reputation of stability, which has stifled investment, growth and competitiveness. This loss of confidence, they say, is why the UK market has underperformed in recent years. The knock-on effect of this dampening of listed share prices has constrained UK executive pay, particularly in dollar terms.
The IA emphasises a different political concern: the power of proxy voting agencies. The Principles of Remuneration that the IA sends to the FTSE 350 remuneration committee chairs are intended as guidelines to foster best practice, not as hard and fast rules. But it says they’re often treated as such by the agencies and by those fund managers who vote according to the agencies’ advice. This inhibits remuneration committees from being more flexible.
The focus of the IA’s review will be on remuneration structures. But it warns that without a fundamental shift in proxy agencies' influence, the dynamics are unlikely to change in the near future.
