Tuesday, 22 November 2011

Exec pay, and how some still fail to get the point

Today saw the publication of the High Pay Commission's final report which is, as should be obvious, well worth a read. I won't do a re-tread of the arguments & proposals it contains because you can find much better versions of that elsewhere. Instead my quick take on a few of what I think are the Commission's key points are, and their wider significance.

Radical simplification of executive pay is, just about, a win-win since no-one except remuneration consultants really benefits from complexity. Investors are sick of reading rem reports that go one for a dozen or so pages, and anecdotal feedback from directors suggests that they don't really know what they're getting when things get to a certain level of complexity.

But, as David Prosser (whose comment piece on the report is probably the most interesting I've read) points out in the Indie, complexity is a result of what investors supposedly want - carefully-designed performance linkage:
it is worth noting that the pay structures in place at many companies today reflect previous attempts to hold executives to account (rather than, in most cases, to obfuscate, as the High Pay Commission rather uncharitably suggests). Executive pay is now set with reference to hugely complicated performance yardsticks because remuneration committees have sought to show they are sensitive to complaints about rewards for failure. So sensitive, in fact, that it is almost impossible to understand the pay formulas they put in place.
This is a point that deserves to get made in responses to the BIS consultation that closes this week.

Of course this also feeds into the question of whether the performance linkage that investors have sought to put in place is actually desirable after all. For one, does it simply replicate the performance pressure that asset managers (who cast most of the votes on rem reports) are themselves under? Do we really want our largest public companies run with one eye on short-term share price fluctuations that, in reality, may be nothing but noise?

Secondly, are we sure that performance linkage delivers... err... performance? It's notable that the Commission digs into this a bit and comes up with a fair bit of evidence, academic and anecdotal, that complicated incentive schemes don't really motivate directors. Again, this seems to be an argument that is gaining ground and, in my opinion, with good reason.

The other headline proposal that has got most attention is rem comm reform, and in particular the idea that employees should have representation. Within a couple of years this idea has gone from being advocated by just a handful of organisations (with the TUC the most obvious) to being seriously discussed. There are a number of reasons for this. One is that the idea that rem comms are too clubby, and that directors set each others' pay and therefore have no incentive to be tough, is easily graspable, so (unlike much corp gov policy) reform here has a tiny sliver of populist resonance. Second, as I've argued a bit, there's some psychological evidence that shaking up group membership to make it more diverse (opinions wise) can make decision-making less extreme (see Cass Sunsteain for details). Third it's a reform that seeks to address exec pay earlier in the process - at the decision-making stage - rather than most recent reform which has focused on disclosure+shareholder empowerment so that decisions already taken can be challenged.

This last point is important, because it's a tacit admission that shareholder oversight, as currently constituted, isn't really cracking the exec pay problem. It could be because they still don't have the right tools and/or right info, but I suspect most informed comment on this topic would now concede that it's actually a deeper problem relating to share ownership. We either don't have the right shareholders to make it work, or they aren't motivated to do so. Here the Commission admits that the subject is beyond its remit, but it is striking that they highlight a potential problem in relying on shareholder oversight alone. Many of us would argue that a stronger focus on the stewardship aspects of share-ownership is required, but a look at the voting records of asset managers on rem reports (see TUC survey for details...) shows that we face a huge challenge.

In all of this I think the Commission has pushed the debate on executive pay onto new terrain (or shifted the Overton window if you prefer!). It's recommendations will probably become the new normal pretty quickly, which was I'm sure the aim. There will be a fight over the employee reps point, but some kind of rem comm reform looks increasingly likely.

So far so simple, which leads me to the failure of some people to get the point. The FT's editorial on the Commission this morning was particularly weak. It reads:
A better strategy [than employee reps] would be to strengthen the role of shareholders. At the moment, they have only an advisory vote, relating to decisions already made.
This implies two things - a binding vote and/or a forward-looking vote. A binding vote would in essence be an instruction to the company, and a forward-looking one could, presumably, affect the distribution of resources. I'd certainly be interested to see these ideas fleshed out. But given that in nine years of advisory votes on remuneration reports, shareholders collectively have defeated under 20, where is the evidence that simply improving shareholder powers is "a better strategy"? Given that many asset managers rarely use the weak power they have already, what leads the FT to conclude that the solution is to tool them up further? The Telegraph makes a similar point in its editorial, but I expect them to put forward solutions they expect to fail to a problem they, in truth, are not sure actually exists (markets should get pay right, right?). The FT really ought to know better.

Which leads me onto my final point, and back to David Prosser's article. I think the Commission has done a good job as it has essentially aimed a couple of years into the future, plotting forward a bit from where we are. So, unless you are the sort of person who thinks that employee reps on rem comms is a Cuban approach to policy, none of the proposals are particularly radical, IMO. But if people really want to fight the last war, and propose another throw of the dice for disclosure+shareholder empowerment, let's see where that takes us. I suspect that it will mean a few years down the track we will far more illiberal ideas for dealing with pay come into play:
In the end, capping pay, or pay ratios, might be impossible politically, but it would be a much more direct way to tackle the problems identified by the High Pay Commission.

1 comment:

james said...

The ITV news report on this story had some bod basically suggesting any public policy consideration of this issue could result in communism. Which is amusing, given that the last thing that Communist states did or do = allowing employee representation in corporate governance. And of course, since corporations exist because of the legality provided by the state, so the degree to which rewriting company law interferes with private property rights is questionable...

Watching Chuka Umunna and Elizabeth Truss debate this on Newsnight was interesting - though a bit of remote control democracy meant it got switched off. From what I heard, there was some consensus on increasing shareholder power - but obvious but very quiet opposition from Truss on employee representation. She was very vocal on competition - and I was wishing the host would repeat Cable's "capitalism kills competition" line, or perhaps a Red Tory reference, to provoke her.

There is something in the Telegraph approach, though - not in that markets produce infallible outcomes, but that it can't be much of a problem for shareholders that exec pay has skyrocketed. Otherwise we'd have government ministers announcing more disclosure/empowerment measures alongside consultations on eroding employment protections. We would have ministers chomping at the bit for pay ratios, just as they are for curbing strike ballots.

I suppose there's a comparison to be made between the democratic markets of "one person, one vote" and the plutocratic markets of "one pound, one vote".