New executive pay rules introduced in October 2013 gave shareholders a binding vote on directors’ pay whereby more than 50% of shareholders had to vote in favour of a policy for it to pass. At the time, then Business Secretary, Vince Cable, said the shift should make “a clearer link between pay and performance”.
The evidence from this year’s AGM season suggests that hasn’t happened.
Railpen’s Gilshan says there seems to be an increasingly consistent view among shareholders that “pay structures often represent a misalignment of interests rather than a way to deliver alignment of interests between shareholders and management”.
And, even if pay were aligned, Bridgeland says: “There is nothing to stop it being too high.”
The current practices for setting pay for UK executives do little to get around this problem. Most pay packages for UK plc executives have been benchmarked against peers, calculated using formulae based on performance and overseen by the remuneration committee (remco) in the presence of advisers. The use of peer-group benchmarking alone results in an ever-increasing spiral of top pay given ambitious CEOs strive to be above median as their measure of success.
As Bridgeland says: “It just locks us into paying better from year to year.”
And, as boards don’t want to lose such a key figure, they are proving reluctant to challenge the numbers their pay policies spit out, regardless of their justifiability.
If executives have agreed success measures and the remco agrees these are aligned with improved shareholder value it is “genuinely difficult” – as Bridgeland puts it – to say they are not justified. However, there is a function in place that can ensure pay (whether aligned or not) is appropriate in terms of its sheer quantum, something that should in theory be able to stop pay packages from being too high.
COMMON SENSE CHECK
Remcos have the ability to apply a common sense check to the numbers their pay policies produce, yet, clearly, few are putting this tool into practice. Companies need to apply the pay policy investors have voted for, but they also need to apply discretion around the edges to look at those outcomes.
RLAM’s Hamilton Claxton says: “Boards need to make sure the appropriate discretion is being applied to determine pay, but they are often not applying a sense-check to make the best decision for the company in the long term. They need to make a human decision, rather than just relying on mathematical scorecards, and justify that decision to shareholders.”
RLAM recently voted against what it described as an “unreasonable and insensitive” 20% increase to BP CEO, Bob Dudley’s remuneration despite BP reporting its worst ever annual loss”.
BP felt the wrath of angry investors in April with an unprecedented protest against Dudley’s package, but it is far from alone. This year has also seen investors revolt against packages at Shire and Weir Group, among others.
Gilshan says: “Some of the pay packages we see in the market do worry us. If companies don’t use common sense to control pay outcomes, shareholders have to question what else is going on at the organisation and the dynamic between the chief executive and the board.”
REMUNERATION COMMITTEES IN THE FIRING LINE
The apparent failure of remuneration committees to apply judgement to pay packages has sparked a marked change in strategy among some large institutional investors. In 2012, institutional investors’ engagement initiatives more often than not overlooked the make-up of remuneration committees. Today, remco members have become the direct subject of target.
