Equality of income - did Channel 4's Dispatches have the answer?

Last night’s Dispatches on Channel 4 focussed on the state of executive pay in the UK.   

The programme featured the former Greggs chief executive Sir Michael Darrington “as he launches a campaign to halt corporate greed. With the country deep in recession he asks: are we really all in it together?”

The programme identified a range of problems and a set of solutions.  The main problems I felt that it highlighted were: (i) “inequality in society” (as a more equal society is assumed to be a happier one), (ii) wanting to avoid rewards for failure, and (iii) the fact that the lowest paid in organisations sometimes do not receive enough (e.g. less than a ‘living wage’).

Alongside these three issues that the programme raised, Sir Michael’s manifesto focuses in on the need to reduce inequality in net pay across society.

To achieve this he suggests (i) changing the structure of pay as well as its disclosure, (ii) making remuneration committees have a more diverse composition, (iii) making AGM votes on pay legally binding, and (iv) making tax avoidance harder.

I like the sound of much of Sir Michael’s manifesto - and I get the impression that his direction is not all that far from the recommendations made in the Policy Exchange report that I co-authored.

However, I believe that the recommendations he outlines in his manifesto would be more effective at limiting “rewards for failure” rather than his stated goal of reducing “the growing gap in net pay, between the highest paid and the majority in society”.

Let’s start with this problem with “inequality in society”.  When I talk to people in order to understand their opinions on executive pay, I often find that it is this aspect that is the main concern.  For example, if you have no known ownership of, or employment relationship with, a particular company, but are still concerned with how much the CEO just got paid … then I suspect that the inequality issue is your source of concern.

Now let’s think of ways you might affect the pay of the highest paid in order to solve/improve the inequality situation.  Here I am specifically talking about inequality of income and not about issues of low pay at other parts of an organisation (e.g. relative to a living wage benchmark).

Firstly, all the recommendations made in the programme only focus on pay at those companies in the FTSE 100.  Sure, through legislation you could dramatically change how these 100 CEOs get paid…but it is very hard to have a significant impact on all those very well paid people at non-listed companies.   What about all the hedge fund managers, asset managers, managers at private equity houses, partners at law firms and consultancies, TV personalities, etc. ?  I am not sure on the numbers, but I suspect that the pay of the 100 CEOs at the FTSE 100 companies is a pretty small portion of all high pay in the UK.  Just consider the pay of the top 100 footballers in the UK for a quick comparison.  So if inequality is the issue to tackle, then even implementing the manifesto fully will sadly fall short of the objective - we will still have significant inequality.

Secondly there are two tools for impacting the net income of the highest earners: either by lowering their pay, or by increasing taxes.  The main slant of the manifesto is about limiting the pay itself, however, we do have the last point about “making tax avoidance much harder, so that the rates actually paid by wealthier people are higher than those paid by the less well off.”  My experience is that income tax avoidance is not something that really goes on at UK-listed companies.  If you want to look at professions where tax avoidance techniques such as employee benefit trusts are used, then football is a good place to start, with recently publicised examples here and here.

So I suspect that closing these loopholes doesn’t really change the net pay of the highest earners - sure, it will catch a few people, but will it really get to the heart of the issue?

In my opinion, if you want to change inequality of income, then the simple way is to tax the higher income earners more (as well as preventing aggressive avoidance techniques).  Getting stuck in the detail of executive pay at listed companies just can’t go far enough in tackling that issue.

Excessive pay?

A rather nice cartoon from the Guardian here

(http://www.guardian.co.uk/business/cartoon/2012/sep/21/kipper-williams-executive-pay)

Can executives award themselves bonuses?

It is commonly reported in the newspapers that executives awards themselves large pay packets.  This sounds like a really bad way to determine the pay of the fat cats - of course, if they can determine what they are paid, then they will award themselves huge bonuses!

Deborah Hargreaves, (Director of the High Pay Centre), like many others, thinks that this a bad way to do things: “it is quite obscene for bosses to continue to award themselves big pay-outs when company performance is mediocre…”

However, this is not how pay is determined for the senior executives. At least not at large listed companies in the UK - i.e. the ones that get in the news for the size of the bonuses.  This fact is sometimes forgotten, but doing so can help to spice up the journalism a little.

So how does it work?

Well, there are four main ‘bodies’ that play a role in the design of senior executive pay at a UK plc

• Remuneration Committee
• Advisers and Remuneration Consultants
• Shareholders
• Executives

 The main one here is the Remuneration Committee - sometimes referred to as the RemCo - and today’s post will look at the role played of this group of directors.

The committee is typically composed of three to five non-executive members of the board.  Furthermore, as recommended by the Higgs Report, “all members of the remuneration committee should meet the test of independence”.  This makes it much harder for former chief executives, and non-executives who have been on the board for more than nine years to sit on the board.  Those who have been on the board for over nine years, may well be the subject of shareholder concern.  For example, ISS have commented about Alison Carnwath’s tenure on the Man Group remuneration committee saying that it "does not consider her to be independent; she remains a member of the remuneration committee, which should be wholly independent".

The committee chairman is the main individual involved in the drafting of the remuneration framework for future years and in the dealing of any issues that might arise over executive pay.

The rest of the committee members support the chairman, but typically have a much smaller time commitment.  Typically their main involvement is in the two or three weeks leading up to a Remuneration Committee meeting when the proposals are discussed and revised.

RemCo meetings will happen roughly six times each year, although if new plans are being drawn up there may well be more meetings (both formal and informal) that take place.

The RemCo papers will be often drafted in advance by one or more of the HR team, the CEO/other Executive Directors and the remuneration consultants - the choice of author depends on the topic in question.  For example, the HR may produce a recommendation but the consultants would be asked to comment on them as well, especially if there is a potential conflict of interest, or an outside and sometimes more experienced perspective is wanted.

The Remuneration Committee members typically do not prepare the papers themselves.  However, the RemCo chairman may indirectly write a paper by working more closely than usual with the consultants in preparation for a meeting.

Some companies publically set out the terms of reference for the committee (Electrocomponents is one such example)

So in conclusion, the fat cats do not simply award themselves large pay packets.  It is the Remuneration Committee which is tasked with approving the executive pay arrangements… and, since 2002 shareholders get to vote as well.  Yes, the vote has not historically been legally binding - but it has still kept the process a bit more shareholder friendly.  Of course, executive pay can still be ‘obscene’, but we need to dig a bit deeper to find out why.  Sorry Deborah.

Exec Pay in the UK

How UK pay works

As an early step it is probably a good idea to explain how pay works in the UK.  When I say ‘pay’ I am referring to how the most senior executives get paid at the top of large companies.  These companies are those that are listed on the FTSE350, and so incorporated in the UK.

It is worth remembering that it gets a bit more complex when you have people of various nationalities (i.e. non UK) and also when individuals run business units that operate outside of the UK.

Pay structure

Senior executive pay is typically comprised of

• a base salary
• an annual bonus
• a long-term incentive scheme (or schemes)
• pension arrangements

Executives may receive some benefits as well, but these are generally small in comparison with the other elements of reward.

These elements can be divided into two categories, (i) that which is fixed, and (ii) that which is variable, i.e. performance-related.

The salary, pension and any other benefits are not performance related.

The annual bonus and long-term incentives are performance related and payment is subject to meeting certain performance criteria.

At any one company, these incentives are almost all based on performance against pre-determined targets with only a small fraction based on the remuneration committee’s discretion.

We can delve into more detail on each of these elements soon…

Daily Telegraph pick up on our report

We have been getting some good press coverage for the report... this article is in the Daily Telegraph.

Executive Compensation: Reward for success not failure

So for the last couple of months I have been working with Policy Exchange (a leading think tank in the UK) ... and we have been discussing how executive pay might be improved.  The paper I have co-authored was published this week


The main consideration has been around how to reduce the potential for 'rewards for failure' 


Our main recommendation is that companies embrace the existing shift towards having greater deferral of incentives


Once you have this structure set up it then becomes possible to introduce a set of  “clawback” measures to try to end the potential for significant rewards for failure.  Such clawback mechanisms would be an effective way of ensuring shareholders are able to reduce the outgoing pay of a poor performing director who had decided to resign.

To do this, remuneration committees should set downside conditions to incentive arrangements which, if breached, would then trigger the clawbacks. Clear limits in terms of, for example, poor total shareholder return performance or collapsing profits, would enable shareholders to see whether the company and its managements had failed in some way.  Clawback could still be avoided if the shareholders decided, through a vote at the AGM, that it was not appropriate.

The report has been published to coincide with the government’s consultation into executive pay and shareholder rights.


For further details, our report page can be found here
And a pdf of the report can be downloaded for free here

Welcome!

Welcome to this new blog where I aim to discuss various topics related to executive pay and corporate governance...