High Pay Commission report tackles excessive high compensation

Since the beginning of the global crisis, the topic of Executive Pay has been a major point of focus for many observers, journalists, economists, governance and  remuneration specialists, as well as the “man on the street”. Recent developments in the US have included the implementation of stricter rules regarding Say on Pay (shareholders voting on matters related to executive compensation) and the (in)famous Occupy Wall Street movement, which was formed by some activits who want to protest against the growing inequalities between the richest 1% and the rest of the population.

In the UK, a recent report from the High Pay Commission called “Cheques with Balances : why tackling high pay is in the national interest” has generated a lot of reactions.

The report investigates the increasing earnings differences in the UK private sector and analyses why it is bad for the economy. It argues the “business, economic and social case for fair pay” and formulates some recommendations. Here they are with a few comments from my side :

Transparency

1 – Pay basic salaries to company executives. The Commission recommends paying only basic pay, and maximum “one additional performance-related element only where it is absolutely necessary”. That performance-based pay components should only be long-term, long-term being “defined as longer than the current norm of three years”. I see the point of such a recommendation, especially in simplifying pay and making executives accountable for their actions in the long term. However even execs are human, and some element of extrinsic, short-term motivation is good for them like it is for the rest of the company. And, establishing relevant KPIs for the long-term is difficult because of the many factors influencing outcomes, especially when targeting more than 3 years ahead, and especially in emerging markets. So the leverage is very high, with a high risk of extreme positive or negative payout from the variable component.

2 – Publish the top 10 executive pay packages outside the boardroom. In some of the US multinationals I used to work for, I had to report the top 10 highest regional incomes in the previous year to Corporate, because it was a requirement for US publicly listed companies and they needed the compilation in order to extract the top 10 for the whole company. Very often, a significant number of the top 10 highest earners were sales people. They had earned their high income through amazing sales achievements in the course of the year, and were calculated through a precise (and often quite complex) sales incentive plan. Does communicating that really bring value to the organisation and to the shareholders and investors ? Maybe, but I believe that knowing the income of the Executive Leadership Team also brings some value and understanding, as they are the ones driving the organisation even if their income is sometimes not in the top 10 of the company.

3 – Standardise remuneration reports. That one would be really useful to shareholders and remuneration professionals, but many companies resist it, for a number of reasons ranging from the downright desire to make it difficult to understand executive pay, to the belief that the pay mix and pay components are so specific in the organisation that it would not make sense to “force” it to fit a standardised definition or report.

4 – Require fund managers and investors to disclose how they vote on remuneration

Accountability

5 – Include employee representation on remuneration committees. This is already in place in governance rules in countries such as Germany and Nordic countries, but their approach is often based on a two-tier board model. The Commission is aware that “This reform could fundamentally alter the structure of boards, and the way pay is determined”.

6 – All publicly listed companies should publish a distribution statement. The Commission adds : “The distribution statement could include: total staff costs – company reinvestment – shareholder dividends – executive team total package – tax paid. This would be enlightening for shareholders and the public in all businesses”. I agree and believe this would create better engagement and understanding from shareholders about issues affecting pay and the distribution of profit between the various stakeholders.

7 – Shareholders should cast forward-looking advisory votes on remuneration reports. “This would include future salary increases, minimum bonus awards, on-target bonuses and maximum bonus awards, as well as current hidden benefits such as pension provisions. The shareholders would be voting on the total potential remuneration, and the potential pay outs of a performance element, if one is included, based on a range of outcomes. This would allow shareholders to have a genuine say in the remuneration package of executives rather than an advisory vote on a package that has already been implemented” (through voting on a remuneration report that represents pay for the past 12 months).

8 – Improve investment in the talent pipeline. The idea is that continuing to recruit externally for executive positions has an inflationary impact on executive pay compared to “hiring” or promoting internally-grown talent.

9  – Advertise non-executive positions publicly. In effect, there are few people that constitute the pool from which Non-Executive Directors are recruited/appointed.  The Commission recommends broadening that pool by looking at diversity and increasing the number of females on boards for example as this would help reduce the “closed-shop mentality” that could support inflationary trends in executive pay. This kind of recommendation holds very true in countries like the UAE, where there are regulations with respect to the number of Nationals being represented on boards. Given the limited pool of candidates in view of the overall relatively small local (and business-experienced) population, expanding to more females and making openings public, would probably help reinforce diversity and therefore reduce the risk of “convenience” decisions on pay to please peers.

10 – Reduce conflicts of interest of remuneration consultants by limiting their ability to cross-sell. Current regulations are largely self-imposed, and therefore not necessarily binding, so remuneration consultants are sometimes tempted to sell their services in view of implementing the recommendations they advise the remuneration committee upon.

Fairness

11 – All publicly listed companies should produce fair pay reports. This means, as per the Commission, producing a ratio of highest pay to median pay over a 3-year period. I like the idea of this comparison, especially if there is a trending report with it. However any organisation that undertook significant restructuring, merger or acquisition, divestiture from a part of the company, or any company that has international representation, will understand how difficult this apparently simple metric is to produce if we want it to be meaningful and therefore useful. Numbers are easy to distort or misinterpret….

12 – Establish a permanent body to monitor high pay. I’m unsure about this one. It could be a good idea in order to ensure consistency and application of recommendations and laws. Yet at the same time, creating one more monitoring body just adds a layer of complexity, and especially may involve potentially misguided public pressure because of lack of understanding of the issues from the general public. (The Commission recommends that this body represent not only shareholders but also the general public through an annual assessment of public opinion).

What are your thoughts ? Do you agree or disagree with some of these recommendations ? Express your views through the comments  section !

 

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