Public anger over high levels of executive pay has provoked new government proposals in Britain for binding shareholder votes on remuneration committee reports. This will mark a revolution in corporate governance as shareholders would vote both on the past year’s awards and on the coming year’s plans for salary increases, bonuses and long-term share awards. Boards will find it difficult to deal with such intervention in complex pay structures. A ‘no’ vote is a blunt instrument which will not provide a clear steer on where to go next.
As a former chairman and member of several remuneration committees, I support the move to a binding ‘say on pay’ vote, despite its difficulties. The market for chief executives has a number of inherent flaws which can be ameliorated by regulation. There is a strong element of ‘winner take all’ behaviour in this market, just as for top athletes or musicians. They compete globally on their respective playing fields and these are jobs that require real experience, and a proven track record. The supply of such people is limited. If a board has good ones, it will want to keep them and keep them motivated. Their compensation is often tiny when compared to the overall profits of the firm, and the value at risk by losing them appears correspondingly high. Risk aversion and uncertainty about the value of alternatives are classic characteristics of winner-take-all markets where the top performers capture a disproportionately large share of the gains. The motivational considerations also explain why there is so much inertia in the bonus element of pay even during a year of poor results. That is often when the demands on the CEO to turn things around are the highest and the costs of destabilisation the greatest, should the CEO leave.
The other side of this coin is that there is nothing more damaging to a company than a poor CEO, one who is just not up to the task or who creates a negative internal culture. But in such a case, the board’s response will not be to dock the bonus, but to find someone new. Unless there is an in-house successor, this often ratchets up the remuneration because it will be necessary to lure the preferred candidate away from their current employer. If that is in the United States, where executive rewards are on very high (and set up to lock executives in to the company), then the price will be even higher.
These market characteristics have the effect of escalating executive compensation. To offset this, it is helpful to enhance the countervailing power of shareholders. This has already happened to some extent with the advisory vote on remuneration reports, as shown by the recent cases of large negative votes by shareholders in Barclays, Aviva and Xstrata. Boards do pay attention in such cases, even when an overall majority backing is achieved. But the level of prior engagement and consultation with institutional shareholders would certainly go up if the vote were binding rather than advisory.
There are risks to this approach. Shareholders may simply vent their anger at other aspects of corporate strategy through the vehicle of the remuneration vote, leaving the way forward unclear. But it is also possible that giving shareholders more power will cause them to accept the responsibility that comes with such engagement. Do they really want to see a bonus linked mostly to share price performance, for example, when that is often more dependent on overall market conditions than on the chief executive’s strategy? Is it right to build so much leverage into the performance-related element of pay when the creation of sustainable performance cannot be reduced to a few financial metrics as a pay trigger? And do pay structures for senior executives have to be so complex in order to give the right balance between short- and long-term objectives?
These are not easy questions, but they are the ones remuneration committees grapple with. If more shareholder engagement can lead to better understanding and simpler pay structures then the extra burdens on both boards and investors imposed by binding votes will be well justified.
This commentary appeared in The A-list blog on FT.com on 11th May 2012