UK government indicates binding pay vote on the way: but will it work?

PM Cameron says there is a market failure on pay, so let the ‘market’ decide!

UK Prime Minister (PM), David Cameron, gave his clearest indications yet at the weekend as to how the government will act over the troublesome debate over excessive executive pay, which has the country’s newspapers huffing and citizens puffing; in an interview on television the PM said executive rewards for failure made “people’s blood boil”. To paraphrase Cameron, a review on executive remuneration by the UK Department for Business, Innovation and Skills (BIS) to be published next month looks like it will have three major prongs: clarity on pay packages (to solve the problem of often incomprehensible incentive structures), a binding shareholder vote on executive pay (to replace the current advisory vote) and reform of remuneration committees, possibly to include some form of employee representation (to deal with allegations that they are currently not challenging enough on pay). RI welcomes the policy intervention, believing that government action to police pay itself would be unwieldy and prey to all sorts of unintended, uncompetitive consequences. The UK debate is a microcosm of similar engagement on executive pay happening globally, and instructive to that end. Unfortunately, the far less clear point in Cameron’s pay outline is how the government believes it is going to make the current failing shareholder oversight of pay work in practice. And failing it is.
November 2011’s report by the UK High PayCommission, whose six commissioners included Brian Bailey, director of pensions for the £8bn West Midlands Metropolitan Authorities Pension Fund and Robert Talbut, Chief Investment Officer, for Royal London Asset Management, found that executive salary growth in the ten years to the end of 2010 bore no relation to market capitalisation, earnings per share or pre-tax profit. Over the ten-year period, the report found that within companies listed on the FTSE 350 index, the average long-term incentive plan for directors had risen by 253.5%, bonuses by 187% and total earnings by 108%. During the same period, average company pre-tax profit was 50.3%, earnings per share 73% and average share price down by -5.4%. However, in almost the same period of time that ‘advisory’ votes on remuneration reports have been in place, shareholders have collectively defeated less than 20, and even then with very little indication of ensuing change. The reasons are manifold; and the government’s proposals will certainly deal with some of these. But they may also throw up as many problems as they aim to solve. As the UK’s Confederation of Business Industry (CBI), warned today, shareholder votes on pay are retrospective (on the prior year’s package) and could, at best, be complicated to implement or, at worst, face legal challenge: “Government concern on this issue is understandable, but prevention of the problem has to be the answer.
Binding shareholder votes would simply be shutting the stable door after the horse has bolted, as shareholders would only be voting after the problem has happened.” Another more practical issue is that pay votes rarely attract the ire of more than 50% of investors: many investors like to encourage executive high pay to boost short-term company reward, or else the company itself or its partners will hold large blocs of the firm’s equity. A cynical take on the chain of pay is that well paid asset owners and asset manager staff themselves see little incentive in cutting back on corporate executive pay, which might inevitably lead to questioning of their own pay structures. Some investors say companies’ remuneration committees need to be much more vocal at pushing for up-front contractual tightening to avoid litigation. They claim that the current advisory shareholder vote is also firm enough to warn companies about future action and that a binding vote might actually incite fewer not more shareholders to vote. The more pressing political question, however, will be whether this approach will satisfy a public that wants to see clear action on pay. To this end, initiatives such as the UK Stewardship Code, which obliges managers to publish voting records, as well as tighter pay recommendations from trade bodies such as the National Association of Pension Funds andthe Association of British Insurers, will also weigh in. And today’s announcement that fund managers including Blackrock and Aviva will start acting collectively to lobby companies on pay and governance is also welcome. Asset owners and asset managers need to be far more proactive about presenting clear, long-term pay calculations to companies via a remuneration board representative, voting more, and being under constant, tough public pressure to do so.
It’s hard though to see where that maintained ‘pressure’ will come from in the UK government’s current thinking. It’s tempting to think that a binding shareholder vote is the answer, but once the spotlight is off executive pay will it actually work? Ultimately, I think that only a mechanism whereby pension investors can vigorously lobby their retirement fund on pay (if they see fit), or in the case of retail funds, clearly see whether their manager is looking after their financial interests via a clearly defined policy on executive pay, will enable the end client to decide. Related public information and media coverage will do the rest. The UK Prime Minister talked about a “market failure” in pay at the weekend, so let’s really let the market decide what executive pay levels should be! Pension fund beneficiaries deserve nothing less after the rip-off of the last decade.