It’s time for asset owners to stand up and be counted on executive pay, or face legislation

Announcing a major review last week into investment and corporate long-termism: “A long-term focus for corporate Britain”, UK Business Secretary, Vince Cable, distilled much of his argument on excessive pay into one major point. On average, he said, the remuneration of FTSE 100 chief executives between 1999 and 2008 had risen 15% each year while the FTSE 100 had fallen 3%, at a time when average earnings growth had been 4%. That long-term pay discrepancy shows no sign of post-crisis abatement. A report last week by Incomes Data Services said total average earnings (including long-term incentive schemes, share options and bonuses) by FTSE 100 directors had risen by an average of 55% during the past year, with a median rise of 23%. By contrast, most average institutional investor returns over the last decade have been in the low single digits, albeit fortified by market rises in the last 12 months. It’s obvious we have a serious problem here: executive pay levels are not reflecting long-term business growth or returns to shareholders. Institutional investor fiduciary duty surely means getting value for money over time; a case that looks hard to make when executive pay figures seem to have only one direction of travel. That looks like rent extraction.
Cable’s headline figures, of course, mask the devil of the detail: executive pay jumps pre crisis often reflected share price rises. They unravelled, of course, when crisis hit; demonstrating a tenuous link to risk or the potential to be ratcheted back sufficiently in febrile economic times like these. Clearly, institutional investor metrics and representations to company boards on pay are not geared sufficiently to the long term.In some European countries that executive pay/economic growth ratio will be lower; in the US undoubtedly much higher. It will be interesting to see what impact the first year of a US ‘say on pay’ requirement introduced under Dodd-Frank will have on the 2011 US AGM season. A speech last week by former UK City minister Lord Myners picked up the theme and pointed out the vital ‘self-interest’ angle for many asset owners to be tougher on pay and how it is measured. Myners said pension schemes must tell banks to restrain themselves on next year’s bonus round and put in place long-term pay policies, or face the consequence of more legislation and higher tax. Banker remuneration may be the very ‘public’ face of this pay/governance/crisis debate – and I believe there are equal, if not more important systemic issues – but it is the main political lever for palatable reform that justifies the massive government intervention and expense to rescue the financial system and assuage future crises. Banks have become the bellwether for the way executive remuneration is perceived more broadly. And pay has become symbolic of the kind of economy society should be promoting: long-term growth or short-term gambling. Myners warned that the European Commission looks set to legislate on shareholder governance responsibilities – in effect ‘making’ them ‘responsible owners’ – rather than applying the kind of ‘comply or explain’ principles inherent, for example, in the new UK Stewardship Code. As RI reported last week, Michel Barnier, the European Commission’s Internal Markets Commissioner, has intimated as much: EU’s Barnier rejects voluntary approach to corporate governance
Indeed, the EU’s current consultation on its Green Paper on corporate governance in financial institutions and report on remunerations, goes much further, questioning whether employees and trades unions should have a strengthened role in establishing remuneration policy. It also posits greater disclosure by institutional investors of the remuneration policy of their fund management intermediaries. That suggests the EU believes one reason why institutional investors have not stepped up to curb corporate/banking pay excess is that the status quo suits their own financial remuneration incentives. Pay levels were not the primary cause of the financial crisis, but as the continuing foreclosure mess in the US demonstrates, remuneration set the mood music for excess risk and potential fraud. Banks and other large corporates, however, have largely returned to business as usual. Few have outlined much in the way of genuine, long-term remuneration plans. If anything, we’ve returned to the stock-in-trade threat that localised legislation would distort competition and ultimately force them to desert markets where pay rules are tough. In realpolitik terms, both are valid, long-term concerns. No government alone wants to play that game. The EU as a bloc, however, looks like it might. Nonetheless, the law of unintended consequences in a global financial world suggests that excessive regulation could, over time, drive revenue-generating arms of banking/finance groups that are not geographically sensitive (client servicing, etc) out of Europe, or anywhere else that takes a lead. I’m also not convinced that a legislation drive on pay is even workable when many shareholders, notably short-term stockholders, see high remuneration as a proxy for management focus on returns. To change that would require an altogether more complex discussion on reforms to the principle of shareholder equity and voting rights. So what do our asset owners think of all this? Well, it’s hard to tell. It was disappointing not to hear any signals from institutional investors about the public hearing last week convened by the Committee of European Banking Supervisors (CEBS) on its new bonusguidelines. They recommend that 40% to 60% of a bonus be deferred over three to five years, with a retention element so a bonus is paid in shares or related instruments. They also set out an explicit maximum ratio for bonus size in relation to basic salary. With the exception of some of Sweden’s AP government buffer funds, which apply a “shareholder interest” test to pay deals link I’ve yet to hear many public declarations of long-term remuneration criteria, although there are behind-the-scenes moves. Many of the proxy voting agencies have firm policies. Eumedion, the Dutch governance body, has been coralling its members on pay issues. The UK Association of British Insurers and the National Association of Pension Funds have written to the country’s largest listed companies asking for talks on executive pay and bonuses to promote long-term value. But we have little idea of what those talks have delivered. In short, the world’s pension fund and asset management associations have not taken a clear lead on the issue, despite the threatening noise from politicians. Would EU rules ‘forcing’ institutional investors to be long-term active owners be a bad thing then? Perhaps not, considering the current vacuum. They could, however, be a blunt instrument, and a missed opportunity for institutional asset owners to stand up and push the agenda for long-term corporate behaviour and investment themselves, rather than be passive bystanders. A shift towards public, globally accepted – but not prescriptive – standards on corporate remuneration ratios biased to the long-term and formulated by asset owners and their fund manager agents could circumvent the realpolitik bind that governments face in setting socially acceptable pay levels. Perhaps the UNPRI could step up to the plate here? Such moves would shift the political scales in favour of long-term investors (and drive other necessary market reforms) and might also start to restore some of the sore lack of public faith in a sustainable economic rationale for their pensions and investments. It’s time for asset owners to stand up and be counted on executive pay, or someone will do it for them.