The false sense of security around executive pay
Investors risk being lulled into a false sense of security over executive pay.
This year’s voting season saw fewer shareholder rebellions over remuneration packages for the largest companies but that does not mean an end to the controversy.
The UK AGM season this year has seen a fall in the number of FTSE 100 remuneration packages that received significant opposition from shareholders.
There was a 35% decrease in the number of remuneration resolutions opposed by over 20% of the vote compared to 2016, according to Investment Association figures.
The Investment Association also noted that shareholders had voted against more pay packages for CEOs of medium-sized companies.
It saw these signs of shareholder activism as sending a “strong signal” to boardrooms that investors were concerned with spiralling pay awards out of line with company performance.
The increased activism seems to have had some impact even before the latest round of voting, according to the High Pay Commission and the CIPD. They have calculated that executive pay fell 17% last year, with the average salary for a FTSE 100 Chief Executive at £4.5m.
On the face of it, it would seem that shareholder democracy is working, and that companies are being held to account and are responding.
Moreover, the boards of sub-FTSE 100 companies are now very much on the radar and having to think about how they pay their leaders. Yet it is far too soon to relax. Increasingly, institutional investors are voting against pay packages which award bonuses on the basis of insufficiently stretching performance criteria.
It is worth asking why shareholders generally support performance-related packages. They may consider that bonus scales act as incentives to better performance from the CEO.
Yet if this is the case, we should expect reams of reports from institutional investors analysing the efficacy of performance-related pay.
In any event, CEOs often express their enthusiasm for the job and insist that pay levels are incidental.
Alternatively, investors may believe it is just to reward (presumably) exceptional performance after the event, even though they have little or no evidence to suggest that higher pay led to that better performance.
Shareholders need to be mindful of unintended consequences. Andrew Smithers has argued, for example, that pay schemes encourage CEOs to focus on measures to boost earnings per share in the short term through share buybacks.
This is in contrast to risking investments in long-term projects which may not deliver returns during their tenure. The result, it is argued, is that overall levels of investment in the economy are depressed.
Lower levels of investment mean, ultimately, lower productivity in the economy, which means lower average wages. This is why we still need to take a hard look at executive pay.
The High Pay Commission and CIPD note that on an annual salary of £28,000, 'it would take the average UK full-time worker 160 years' to earn the average salary of a FTSE 100 CEO. The TUC noted last year that between 2010 and 2015, the median total pay of a FTSE 100 director, before pensions, rose 47% while average wages rose 7%.
It can therefore be no surprise that many advanced economy countries are experiencing tumultuous times politically. The basis of our capitalist market economy is being questioned because it is not sufficiently equitable.
Companies and investors need to get this point and work to ensure that we have a market economy that delivers for everyone, not just those at the top.
High salaries themselves are not necessarily a problem. Running a FTSE 100 company is a great responsibility, many livelihoods depend on the decisions a CEO makes and a genuinely good CEO will come at a price.
These points are not widely appreciated. Yet the question is whether, overall, pay rewards are at the right level in the context of society. A good place to start is to check how companies are treating their lower paid employees and contractors. In Epworth, and the Central Finance Board of the Methodist Church, we find ourselves voting against almost two-thirds of remuneration packages at company AGMs but we also lobby companies to pay the living wage.
There is probably more we could do. Investment managers as a whole should engage even more intensively with an issue which continues to be controversial.
(writing as Chief Investment Officer of Epworth Investment Management Limited, regulated by the FCA, a wholly owned subsidiary of the Central Finance Board of the Methodist Church)
This article was first published by Citywire on 13 October 2017.