Groups call for more radical thinking on executive pay

More radical solutions to rising executive pay need to be found than those proposed by the Investment Association’s Executive Remuneration Working Group in its recent interim report, according to the Institute of Business Ethics (IBE) and the High Pay Centre.

Responding to the IA’s consultation on the report the High Pay Centre said the working group needed a more fundamental rethink of executive pay if the model was indeed “not fit for purpose” as indicated in the interim report. Firstly it needed to be clear what remuneration is for and then the “governance and design or structure of remuneration should be supportive of and complementary to the purpose of remuneration.” The High Pay Centre said the objective of remuneration should be to reward and therefore be based on what the executive had achieved just as employees are paid for services already delivered.

The working group also needed to be clearer about whose remuneration they are actually talking about so that companies take a uniform response to the recommendations, the High Pay Centre said. It suggested that the working group used the existing definition of senior executives provided by Section 96B of the Financial Services & Markets Act 2000, which defines a senior executive as a person discharging managerial responsibilities (PDMR).

In its response the IBE said more emphasis needed to be placed on simplifying executive pay. The IBE said it was concerned by the group’s assertion on long term incentive plans (LTIPs) that the timeframe for performance measurement should be increased from three to five years. The group suggested that this was giving the message that LTIPs as a form of remuneration were acceptable but the IBE said that in reality LTIPs present “real operational difficulties because it is so difficult to get meaningful performance conditions”.

The IBE said that the group needed to emphasise the options it proposed for LTIPs other than upfront performance conditions as long as they are aligned with the long-term performance of the company. Company success should not just be about the share price, the IBE said, but also about the management’s delivery of an increasing long term and sustainable cashflow.

The emphasis on annual bonus payments for executive pay, which often seemed arbitrary, should also be reduced the IBE said and instead focus on the payment of dividends on long-term holdings of shares. The IBE said that five years needed to be the absolute minimum number of years that shares should be held by executives even if they leave the company.

The Institute of Directors (IoD) in its response argued that part of the reason for the use of LTIPs and bonus plans was that companies were fearful of the response from the media and shareholders if the right level of base salary for the job was paid. “There is, therefore, an argument for companies to simply pay the correct amount for the work done by executive directors and explaining the decision with clarity and integrity,” the IoD said.

The High Pay Centre argued that the default position for contracted services other than services performed as a director should be paid entirely in cash and shares should only be permissible where there was corresponding salary sacrifice. It also argued that the working group should encourage formal employee representation in the executive pay setting process.

The remuneration committees also needed to be more robust in their questioning of the level of awards being given, the IBE suggested and needed to answer the questions of – can everyone see the value of the awards being given? and can values be justified to incentivise executives to pursue a strategy in the long term interest of the company and the shareholders? Also the broader public needed to be able to understand the connection between company performance and the eventual outcome for executives.

The IoD said that institutional investors need to take some responsibility for taking a long term view in their scrutiny of company performance and in their engagement with companies. The IoD does not feel that the current stewardship principles have yet had the positive impact they should have had in this respect. The High Pay Centre said that there continued to be a disconnect within fund management companies between the proxy voting or environmental social and governance (ESG) function and the investment analysts – a problem identified by the Myners review in 2004.

“The engagement by financial analysts at fund managers is not seen as relevant to the pay vote by institutional investors. This is despite the fact that executive pay can and does form an item that is material to the accounts of several FTSE 100 companies,” the High Pay Centre said. The High Pay Centre said it was worrying that the working group had asserted that there were two distinct perspectives in respect of executive pay – investor and governance, arguing said instead that “the working group should make clear that the benefit of simplicity follows from better line of sight for executives and proper alignment of pay with the financial governance framework, not from the more parochial argument that complexity costs too much to understand.”

 

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