Thanks to Jim, a TU trustee on a private sector fund, for this interesting piece.
Executive pay – a few thoughts
I was taking recently to the Head of Corporate Governance at a major asset management firm about executive pay. The conversation was initiated by a question I had asked about their views on Lord Browne’s retirement package at BP and the critical position taken by the LAPFF. I had also asked what their views were generally on the rate of growth in executive pay and whether in their view it was a case of “get used to it”.
The responses seemed to confirm my perception that asset managers, City institutions generally and many spokesmen for “business” live on a different planet to the rest of us and view such issues as social justice, fairness and what “value” and wealth creation are all about from a completely different set of principles and beliefs than the general public.
To be fair to him, he did recognise that there must be limits to executive pay which derive from the existence of a form of “social contract” and that public perceptions about executive pay are bound to play a part in shaping the debate about it. Nevertheless he took the view that BP’s package to Lord Browne on his retirement was appropriate and justified, regardless of BP’s recent share price performance and the recent high profile health & safety disasters that have befallen the company.
The main thrust of asset managers’ corporate governance policies with regard to executive remuneration are based on a focus on the performance conditions that attach to them. There is nothing wrong with this approach per se so the question is why is it that asset managers are failing to apply the brakes effectively to the rate of growth in executive pay?
I think the answer lies in the values and beliefs that define the framework that asset managers work with and apply when determining what performance conditions are appropriate. Furthermore, the values of the true owners of the capital that asset managers manage for them as their agents are not being effectively articulated and so the values that the general public hold to, which shape the “social contract”, do not find adequate expression within the investment process, even if they do manage to find expression within the political arena. As a consequence people who do have concerns about executive pay tend to see the solutions through politics and government intervention. Their own direct role as investors is overlooked.
The following themes are important in the debate about executive pay:
• The “social contract”
• What is “success”?
• Investment time horizons
• Defining best practice
The “social contract”
“Executive pay is rising – get used to it” seems to be the attitude of asset managers and “The City” when it comes to executive pay. There is, however, a countervailing view – the public and workforces deeply resent the developments that are occurring in executive pay which are seen as excessive. It is a high profile social and political issue.
Because it attracts such widespread resentment it is an important aspect of the question of “leadership” and also of the question of the “success” of companies. The long term success of companies (and the emphasis has to be on the words “long term”) depends on internal cohesion within companies and upon a high level of trust being established. Workforces do not trust executives who are seen to be enriching themselves at the expense of workers and society at large. It also undermines wider public trust in “business” and impacts on companies’ “licence to operate”. When large sections of the British workforce face severe restrictions on wage growth and threats to the security of their pensions, the apparent absence of such limitations to executive remuneration and pension packages are a serious problem. The attitude “executive pay is rising – get used to it” displays a complacent disregard for economic, social and political realities.
An important argument often used to explain and justify the rate of growth in executive pay is the influence of a “market for executives” and the role of this market in driving up executive remuneration at a much higher rate than labour markets generally. But is there really a “market” for executives? Arguably it is more of an “old boys club” that is at work. Corporate executives and the higher echelons of the financial community which influences executive remuneration are members of a distinct social class with its own mores (values and belief systems) and institutions. It is a social class with the power to determine its own share of the wealth generated by society overall and the notion of a “market” for executives is a façade which masks this more fundamental reality. Executives commonly sit one another’s remuneration committees – it is hardly a model conducive to mutual restraint!
It is also a contributory factor that Boards of Pension Trustees, who invest capital on behalf of ordinary people, are failing to apply any restraint to executive pay as they do not hold their agents to account. This is because many corporate pension scheme trustee boards include senior company executives who themselves are unlikely to see executive remuneration as a critical issue. Member nominated trustees have not, so far, proven themselves to be able to overcome this obstacle. Their own training and understanding of issues is heavily influenced by the values of mainstream City thinking and the values and beliefs of their own senior managers on the trustee board.
If the necessary will existed it would be possible to address the issues of executive remuneration by focussing primarily on the performance conditions. The question, then, is what values (beliefs) inform the definition of the performance conditions. Here we inevitably move into discussion of what “success” is and what “qualities” investors should value in executives (and directors). Should the performance conditions be informed by the values of the true owners of capital (ordinary people and pension scheme members for the large part) or by those who are actually the agents for these owners?
Is success defined by short term performance against such measures as earnings per share, total shareholder return or are other long term measures (including EPS and TSR over the long term) more important? If long term “success” is what matters then what are the real drivers of such long term success and value creation?
Studies into the drivers of “high performance companies” have identified human capital factors as of huge importance amongst the group of success drivers critical to long term success (e.g. the 2005 study and report by the Work Foundation). “Trust” is the essential glue holding successful companies together and, as discussed above, the question of executive remuneration plays an important role in either engendering or destroying trust inside companies.
Understanding these critical drivers of success is also relevant in defining what qualities investors should be seeking in executives and also in shaping what the “duties” of executives and directors should be. The proposed “duty to promote the success of the company” in the new Companies Act may well weaken the interests of shareholders with short term time horizons who are interested mainly in share price performance and movements over the short term (shareholders who behave more like speculators than owners). On the other hand it may well strengthen the interests of long term owners, who in any event are also the employees, customers and communities who ultimately own the capital being invested. Asset managers who argue that the “duty to promote the success of the company” will weaken shareholder interests might well be indicating that they hold to the beliefs of short term, speculative investors. .
“Success”, “Leadership” and the qualities investors look for in executives.
If success is defined by short term EPS/TSR measures then what investors want from executives and how they judge them is different than if success is defined by looking to the long term. Many chief executives have been critical of investors who pressure them to deliver short term financial results without giving proper consideration to the long term health and success of the company. The damage wreaked on UK plc by a financial system driven by short termism is described in the hard hitting book by Don Young and Pat Scott– “Having Their Cake”. The interests of long term investors are better served by executives having the leadership qualities that will deliver long term success for the company, through building trust and cohesion within the organisation, and the performance conditions attaching to remuneration packages need to be built from this perspective. This may or may not halt the “unstoppable” growth in executive remuneration, but, more importantly, it will allow developments in executive remuneration to be managed within a context of promoting social cohesion and trust. (This could have a beneficial social influence beyond the boundaries of companies themselves and help shape a new and more healthy social commonwealth generally – arguably at present too many people who play leadership roles in society – and this includes business leaders - engender a culture of selfish individualism which is undermining the fabric of our society.)
Turning to how best practice is defined and who should define it. Whilst a pragmatic and flexible approach to applying a framework of principles is right, it is important to recognise that the process of defining what is best practice is in fact a political process in which a variety of “actors” play a shaping role. No one organisation or interest group can claim to have sole rights of determination and in this context it is inappropriate to label other groups with alternative values and views on what best practice should be as “unrepresentative”. Best practice is a matter of public interest and whilst corporate governance “experts” have an important role to play they are not and cannot be the only “representative bodies”. It is entirely appropriate and legitimate, for example, for the TUC as a voice of the trade union movement to be able to contribute to the process of defining and evolving best practice in corporate governance. Boards of companies, investment managers, pension trustees and even individual pension scheme members, and many other groups or individuals, all have a right to play a role. Indeed, pension trustees probably have a duty to play a role, which too few of them actually recognise – if they do not then the interests and beliefs of ordinary pension scheme members are not properly articulated and the field of action is left open for the agents of the owners to shape the agenda instead. It is the quality of their contribution and whose interests it serves which matters, not whether membership of some “representative body” can be demonstrated. For an investment manager to accuse other actors in the arena of corporate governance as being “unrepresentative” implies that they view themselves as in some way a “representative body”. They are certainly entitled to express views on corporate governance matters but if they wish to claim a “representative” status then it can only be as the agents of the owners of capital.