No, don't leave executive pay to the shareholders

Alex Edmans has a blog on executive pay on HBR here. It’s wrong-headed in my view, so here’s a largely sarcasm and swearing-free response to it.

Politicians typically make two suggestions for pay reform. First, to cap, or at least force the disclosure of, the ratio of CEO pay to median employee pay. Second, to put pay packages to an employee vote, or as May suggests, put workers on boards.

In my experience of public policy around executive pay these claims are very wobbly. Actually politicians of various stripes have primarily focused on the disclosure of more information on the nature of executive remuneration and the introduction or extension of shareholder powers. If we look at the last few rounds of reform of executive pay the focus was on these two areas.

In the UK, I think I’m right in saying that the ideas of disclosing pay ratios and putting employees on rem comms, or giving the employees a vote, were part of the BIS narrative reporting consultation. But they weren’t part of the specific consultations on executive pay, which very much focused on disclosure and shareholder powers. It was the same with the original Directors Remuneration Reporting Regulations - nothing in there about pay ratios or employees on boards, or employee votes. And I don’t think I have seen a politician with a brief covering corp gov issues advocate a pay cap.

In reality it is only within the last five years that there has been some interest in both pay ratios and the role of employees in corp gov. But even now, for example in May’s proposals, there is emphasis on shareholders. It is inaccurate to make a claim about what suggestions politicians typically make without acknowledging that shareholder powers and greater disclosure are two most common recurring themes.

It is shareholders who bear the costs of paying the CEO, and so it is unclear whether the government should intervene.

I don’t think either assertion here can pass unchallenged. In terms of “bearing the costs” of CEO pay, as I’ve argued before I don’t think it is legally correct to say that CEO pay ever belonged to shareholders. In practice when an investor buys shares in a company the money they pay over goes to the previous owner of the shares, not the issuer. So there is no contribution of capital to the company that is then used to fund CEO pay.

As to whether the Government should intervene. Even from the perspective of a shareholder primacy advocate (which I am not) you can see this might be necessary. For example, if investors are unable by themselves to force the disclosure of pay ratios at all companies (which seems very likely). It is reasonable for the state to intervene to mandate disclosure of information if some investors think it is useful (as, for example, the Investment Association now does).

While it’s the level of pay that captures politicians’ (and the public’s) attention, it’s the structure of pay which matters more for firm value – for example, whether it vests in the short-term or long-term... The electorate will be more impressed by a politician who proposes a headline-grabbing law to halve a CEO’s salary than a politician who extends the vesting horizon from three years to seven years, even though the latter will have a far greater impact on long-term value creation.

The electorate may not believe that “firm value” has a meaningful impact on them, whereas they may believe that inequality is excessively high. I am personally skeptical that increasing vesting horizons will have a meaningful impact on executive behaviour or value creation. Is it really unreasonable therefore for a politician to focus more attention on a societal issue that angers many, as opposed to a technical reform that may have little, if any, real impact on the electorate?

Moreover, even if shareholders didn’t take into account the effect of poorly-designed contracts on CEO actions, it’s not clear why the government should regulate pay rather than these actions themselves – surely the most direct route to curtailing them.

This is a reasonable point, but doesn’t follow on from the last one. Again we need to be clear about what we are trying to deal with. Our much-mocked vote-grabbing politician may believe that there is more than one issue to be tackled in reform – both inequality and perverse incentives regarding R&D spend, for example. So, yes, they could intervene directly there as well as seeking to put downward pressure on pay levels.

A second motivation to lower pay is to reduce inequality. However, attempts to curtail pay through regulation may backfire. Kevin J. Murphy describes how the entire history of executive compensation regulation is filled with unintended consequences.    

It is certainly true that the history of executive pay policy is filled with assertions of unintended consequences, but I personally believe this often based on a misunderstanding of social action. And this also raises big problems for shareholder primacy advocates.

On the first point, is it really the case that increased CEO pay and perks are an “unintended consequence” of intervention? Do you mean that remuneration committees unwittingly awarded CEOs more pay and perks? Because to me it looks like CEO pay and perks increased because companies intended to increase them. So what we have to isolate here are the actors, their intentions and the outcomes.

Policymakers have typically enacted reform to increase disclosure around executive pay with the expectation that this information would shame companies into restraint and/or encourage shareholder engagement over pay that enforces restraint. The immediate consequence has indeed been the intended one – the disclosure of more information.

However, then we move into the second piece of action – the reaction of companies. Rem comms have reviewed the information available and concluded (presumably) that their CEOs have needed more pay and perks. They have then awarded more pay and perks to CEOs, and that was the intended consequence of their action.

I don’t see unintended consequences – I see unrealized expectations. The first of which is the failure of rem comms to exercise restraint.

This is the process: Actor A is trying to achieve Outcome 1 through Policy X, but Actor B does not want Outcome 1, and prefers Outcome 2. Actor A successfully implements Policy X, but Actor B undertakes Response Y that achieves Outcome 2. In this case is Outcome 2 an “unintended consequence” of Policy X, or is it an “intended consequence” of Response Y? When we are dealing with two sets of agents who have different desired outcomes these issues are not as clear cut as some would have us believe. 

Similarly, the other “unrealized expectation” of executive pay reform is that shareholders would respond to disclosure by exerting some pressure for restraint. But they have rarely done so. This raises all sorts of questions – not least do they really have the right incentives to act, and might shareholders approve of pay that society considers unacceptable? I will come back to this, but in my opinion those who promote both the “unintended consequences” theory of pay and shareholder primacy need to account for the failure of their favoured stakeholders to act.

A CEO might reduce his company’s pay ratio by firing low-paid workers, converting them to part-time status, or increasing their cash salary but reducing their non-financial compensation (such as on-the-job training and superior working conditions).

Really? We can all think of possible negative outcomes of policies we don’t favour, but they have to pass the bullshit test, and this one doesn’t for me. If CEO was seriously willing to fire low-paid workers or radically restructure their remuneration just to manipulate a pay ratio figure then I hope the other board members would fire them. Risking alienating the workforce over something so trivial would clearly not be in the company’s interest and I don’t believe that CEOs are that dumb.

A cap could also lead boards to focus on the “optics” of pay (e.g. a low ratio) and ignore more important dimensions, such as performance targets being long-term rather than short-term.

Again I perhaps have a more optimistic view of board directors’ mental capabilities. I will go out on a limb here and say I think they could manage to consider both how a pay ratio looks AND make sure targets for incentive schemes are long-term.

And we need to unpack all the assumptions in this claim. Are long-term targets "more important"? Perhaps if you think that inequality doesn't matter, and that boards can't learn anything useful from looking at their own internal pay structures. And you also have to believe that making targets more long-term would have a meaningful impact on executive behaviour that would have positive impacts that go beyond those from looking at pay across the business. This in turn relies on implicit beliefs about how people will respond to incentives and targets (particularly those several years ahead) that might be highly questionable if spelled out. (they very rarely are in exec pay policy discussions though.)

The reality is that what is being asserted here does not take account of the fact that there are different interests and objectives in executive pay policy. 

So if capping the pay ratio wouldn’t work

Not convinced this has been proven by the above, but go on…

what about putting workers on boards, or submitting CEO pay packages to an employee vote? There are reasons to be skeptical here as well. An employment contract is an extremely complex issue and cannot be whittled down to a simple number such as a pay ratio, which the vote might focus on. It covers topics such as the optimal vesting schedule, the appropriate mix of stock vs. options vs. salary vs. pensions vs. bonuses, whether industry performance be filtered out and, if so, how (indexed options? indexed stock? options on indexed stock? Stock with indexed performance vesting thresholds?) Confused? Well, so might employees be, should CEO pay contracts be put up for a vote.

First, we’ve conflated two things here – employees on boards (and presumably rem comms) and an employee vote on exec pay. If we are talking about the first case, I don’t see why employees (plural!) on a rem comm need be inherently less capable of forming a view than any other committee member. If they don’t understand they can ask (as more rem comm members should) and other board members or the rem consultant can explain. If they still don't understand in my opinion they shouldn't agree to what is being proposed.

If we are talking about a vote, I don’t see why a union or some other representative body if no union is recognized couldn’t analyse the proposals and make a recommendation to employees on how to vote. Yes these arrangements are complex, but that is a result of lots of attempts to redesign performance pay, with the knock-on that many execs don’t understand the system either. In fact, this is a good argument for scrapping most of the existing structures and going back to fixed pay as the main element, but that’s for another day.

As an aside, it seems to me that underlying this section is the implication that employees are just too thick to understand exec pay.

Companies already have natural incentives to treat employees as valued partners to the business – one of my own studies showed that firms with high employee satisfaction beat their peers by 2-3%/year. 

Hang on a minute, you just said that chief execs would be willing to fire low-paid employees or fiddle their pay just to skew their internal pay ratio. Which is it – are employees valued partners, or viewed as a line of data to manipulated? I find it hard to think the answer is both. And might not employees feel themselves valued if they were allowed some involvement in the direction of the business through board membership?

Indeed, Gary Gorton and Frank Schmid found that worker representation on German boards is associated with lower profitability and firm value.

I won’t go into a full review of the literature, since this is a big topic. Only the other day I saw a Bloomberg article that said firms with employee representation outperformed, for example. But in any case, again we don’t just argue this in relation to firm value and profitability, it is a much bigger argument.

Is the message to do nothing? Far from it. It’s to leave the decisions to major shareholders, who have the expertise and incentives to get these decisions right.

Once again, I think what’s being asserted here is hugely contestable. Do shareholders have the “expertise” to get it right? In an ideal world, executive pay would be about recruiting and motivating the best people. For shareholders to have “expertise” here I think would require them to be a mixture of recruitment agents and behavioral psychologists, and clearly they are neither. Instead they apply very general rules of thumb – pay the going rate, tie pay performance – that both easily to manipulate (former) and of questionable effectiveness (latter).

The question of whether shareholders have the incentives to act is equally troublesome. There are obvious conflicts of interest – asset managers may manage money for the pension fund of the target company, or be part of a bigger financial services group with a client link. There are biases – asset managers are well-paid, certainly relative to most beneficiaries, and thus not as likely to share concerns about high pay (because they don’t consider it high).

Then there’s the collective action problem: why bother engaging over pay if the benefits of doing so, which are likely to be small, accrue to all investors (including other asset managers who are overweight in the stock relative to you)?  

Even if our asset manager does have an incentive to intervene, because they have a big overweight position in a particular company, we can't assume the outcomes would be better, certainly not in terms of addressing high pay. If the asset manager believes in the “war for talent”, aren’t they going to want to pay as much as possible to secure that talent? For example, here's what one institutional investor said when M&S awarded Marc Bolland a large upfront payout:

"If the company is going to hire the best people, if they are going to take them out of the company they have been working for, then they have to buy them out. That is the way the world works."

And what if another investor overweight in a competitor, thinks that same? Won't they push for "pay what it takes" too? And isn't the likely result an exec pay arms race why may result in increasing both the cost of executives across the board and the pay gap within firms?

Therefore we should be absolutely clear that there a) there are sound reasons for shareholders to not act effectively and b) even if shareholders do act there is no guarantee that the pressure will be downwards.

Unlike regulation, which is one-size-fits-all, shareholders can decide what the optimal pay package is for that particular firm.

But in reality does it result in pay packages that meet the needs of the firm, or does it just replicate the type of pay that asset managers are used to? David Sainsbury made a good point in the largely disappointing Progressive Capitalism that the directors of PLCs now have financial markets style pay. Most pay structures seem to look pretty similar in essence: smallish base pay, short-term cash bonus, various share schemes. Is that really right for all companies? Isn’t that “one-size-fits-all”?

And, again, there is no guarantee that the impact will be preventing executive pay going further up overall. Here’s what BlackRock said a few years back –

One of the difficulties we face as investors is that we (rightly) assess a company’s arguments for pay changes or increases in light of that company’s circumstances. Generally, companies do present strong arguments for the changes they wish to make. But our assessment tends not to take into account the impact it will have on the trend overall.  

This is what I think happens in practice. What looks right firm by firm can bid up the price across the board.

Moreover, when pay is inefficient, it is often a symptom of a more underlying corporate governance problem, brought on by conflicted boards and dispersed shareholders. Addressing pay via regulation will solve only these symptoms; encouraging independent boards and large shareholders will solve the underlying problem. That will improve not only pay, but other governance issues.

So, a minute ago we were being told that we need to leave pay to the shareholders because they have the expertise and incentives to act. But now it turns out that that both boards and shareholders face challenges that result in poor pay practices. And the solution to this is to “encourage” different boards and different shareholders to be put in place. If we have to change the nature of the two principal actors (as shareholder primacy advocates see corp gov anyway) in order to get better outcomes that seems like an indirect way of tackling the problem.

The bottom line is that, to the extent pay is a problem, it should be shareholders, not politicians or employees, who fix it.

Based on my experience of public policy relating to executive pay, I would say we have tried to rely on shareholders to fix it, and the results aren’t great. The reality is that shareholder oversight is a weak tool and has not restrained executive pay. If it has had any impact, it has been to make executive pay (regardless of sector) look more like pay at the top of financial services companies.  

Relying on shareholders to fix executive pay requires us both to accept that the views and interests of shareholders (in reality asset managers) are the only ones that count, and to make some heroic assumptions about how they will react in practice. In my opinion it's a very partial take on executive pay as an issue, and in practice leads to monomania in terms of policy ideas, always returning to the same old same old: better disclosure, better targets, better shareholder powers. If we yet again choose this path, we will get more of the same: exec pay will simply look like what asset managers think is reasonable (both in structure and scale). But that is a very long way away from where the public is at. 

Policy “solutions”, if there can ever be any that are more than temporary fixes, have to take account of the reality that there are different interests, and they may pull in different directions. You may not be able to make executive pay seem more reasonable to the public AND structure it in a way that asset managers like. To say “leave it to shareholders” is an assertion of the primacy of asset managers' views and interests. It is not unreasonable for politicians to conclude, after various attempts to make shareholder oversight work, and facing the reality of both high executive pay and an angry public, that other options are worthing looking at. This isn't making the issue political, it is acknowledging the nature of the problem that politicians have to deal with. 

The only positive I can see from agreeing to a “leave it to the shareholders” approach is that (while it will waste a few years) it will fail to tackle the problem, which makes more radical action further down the line more likely. It is the “anti-capitalist” option, provided that you are measuring performance over the long term… 

Pay ratios: the argument moves Left

After all the pre-billing, the Investment Association's report on executive pay (issued yesterday) looks a little bit behind the curve. It has already been overtaken by events, with the new Conservative Prime Minister already advocating disclosure of pay ratios, more (!) binding shareholder votes and workers on boards (and perhaps rem comms too).

But today I just want to focus on the ratio point. The IA doesn't advocate that companies disclose pay ratios in its headline recommendations. However it does talk about public disclosure in the report itself. Excerpts below:

RECOMMENDATION 9:
The board should explain why the chosen maximum remuneration level as required under the remuneration policy is appropriate for the company using both external and internal (such as a ratio between the pay of the CEO and median employee) relativities. 
The internal reference point should preferably be the ratio between the remuneration of the
CEO and median employee pay, which should then be publically disclosed. 

This will look pretty weedy to a lot of people. However we should bear in mind that the asset management lobby tends to move at the speed of its slowest members. They are not a group that advocates for radical change, ever. Add to that the fact that the working group includes people who are firmly on the conservative end of the spectrum (Edmund Truell is a Tory donor, for example). Therefore, in my opinion, we should consider these recommendations to be roughly at the Right edge of the ever-popular Overton window.

And thinking about this, we should acknowledge that on the issue of executive pay the window has shifted to the Left pretty quickly. For example, here's what the IMA (the forerunner to the IA) said in November 2011, the last time the Government consulted on pay ratios -

We consider that disclosing the ratio between the pay of the company’s Chief Executive and the median earnings of the organisation’s workforce would be a meaningless figure as the work force’s earnings would depend on the industry the company concerned operates in and the work force’s location – for example, there would be a difference between a company where the bulk of its work force is in India as opposed to Sweden. As such these disclosures would be unlikely to be comparable and useful to shareholders. 

To go from saying pay ratios would be meaningless and not useful to shareholders to saying companies should use them to make pay decisions and disclose them publicly is significant. Whether it represents a change of heart or simply a recognition of the way the wind is blowing is irrelevant. The current IA position is a pretty good proxy for the conservative mainstream business/investor view, and it's pro disclosure of pay ratios.

Looking back to the same consultation, the other two major investor bodies - the ABI and NAPF - took ambivalent to negative positions.

The ABI said:

0. We believe that caution should be exercised when considering disclosure of the relationship between directors’ and employees’ remuneration. Remuneration disclosure is for the benefit of the shareholders, to help them understand how their agents are being incentivised and to ensure that there is no excessive rent extraction. It is not clear to us how a simple ratio or description of the relationship would help shareholders’ understanding. The nature and business of companies vary immensely. Some have thousands of staff receiving very low to very high pay. Others have relatively few staff all of whom receive high levels of remuneration. We note that the disclosure of this ratio would be further complicated where companies outsource their activities abroad. Given this lack of comparability between companies it is difficult to see what investors would gain. However, we note that if it is consistently applied, the progress of the ratio within an individual company may add value over time. 

The NAPF said:

0. Whilst some stakeholders may find this information useful, it is difficult to find a measure that is truly accurate and therefore relevant.
   We note with interest that this practice is becoming used more widely – in the United States and among UK public sector organisations for example. 

So back in 2011, none of the triumvirate of investor lobby groups actively backed disclosing pay ratios, nor did most asset managers.

Since then, the ABI investment division merged into the IA, so its position is now the IA's - pro disclosure of ratios. The NAPF has become the PLSA, and just the other week the PLSA issued a report encouraging investors to push companies to disclose more info on their workforce -

As such, we would encourage our members to ask for universal reporting from investee companies against the following metrics: ....
Pay ratios – The ratio between the CEO and the pay threshold at each quartile of the organisation, as well as the gap between the CEO and the next- best paid executive. Ratios are a useful proxy for measuring the culture of the company and whether certain constituencies within the workforce are benefiting disproportionately to colleagues and other stakeholders. The gap between the CEO and their next-best paid colleague provides a telling insight into a company’s succession-planning and whether a single personality is perceived to dominate the company’s fortunes. Again, this is particularly relevant to pension fund investors whose time horizons often extend beyond the tenure of a single CEO. 

So, presumably at some point the Government will consult on its proposed executive pay reforms, and within this it will ask for views on disclosure of pay ratios. Given that both the IA and the PLSA have now issued reports advocating disclosure of ratios in some form it seems reasonable to assume they would back this proposal, at least in principle (they may shy away from it being mandatory). That alone would represent a big shift in mainstream investor opinion in the UK. And I wonder whether many organisations would want to pitch to the Right of them.

We are winning this one.

Sports Direct: investors now have to act or lose legitimacy

About a year ago, the group I'm involved in - Trade Union Share Owners (TUSO) - wrote out to major Sports Direct shareholders calling on them to challenge the company. Specifically we recommended that other shareholders join TUSO in signalling concerns about both corporate governance and workplace practices by voting against the chairman.

The background to this was that numerous cases of poor treatment of workers had been exposed by Unite whilst at the same time investors were concerned by various long-standing corporate governance issues. These issues were brought together vividly when Keith Hellawell gave evidence to the Scottish Affairs committee and admitted he had been in the dark about the collapse of Sports Direct subsidiary USC.

TUSO held a briefing for investors on precarious work last summer, at which Sports Direct had been featured as an example. Many large shareholders who were/are major Sports Direct investors attended. It is fair to say, then, that investors have been told the inside story about this company directly.

At the September AGM abut a third of the non-Ashley vote went against Keith Hellawell. In a normal company that would be getting close to fatal, but this is Sports Direct we're talking about. But perhaps what was more surprising was that two thirds of independent shareholders apparently thought Hellawell was doing a good job.

What's more, one of the company's major investors told the Telegraph (anonymously) that unions were basically thick and didn't get capitalism, that Sports Direct wasn't doing anything wrong, that corporate governance reforms were a waste of time, and that the board were under-paid. No, I'm not joking -

“Unions and capitalism are not a natural fit but it is important to remember that Sport Direct has not broken any laws... If you look at those companies who have impeccable corporate governance and have ticked all the boxes, they are also those who are the most cumbersome... Mike Ashley is a ferociously effective entrepreneur who, as a major shareholder, is aligned with the success of the company. You can chastise Sports Direct for all of its quirks but if you compare the board’s remuneration and its share performance to other listed companies, then Sports Direct’s team is under-remunerated.”

This was in September 2015, when Sports Direct was a FTSE100 company and its shares were worth about £8.

Not even a year later and the picture is very different. Sports Direct shares closed on Friday at £2.57 a pop, about a third of where they were at when Mr "unions are too thick to understand capitalism" was mouthing off in the Telegraph. The company is now in the FTSE250. Mike Ashley admitted in front of the BIS committee that the company had broken the law by paying less than the minimum wage in some cases, and an HMRC investigation is ongoing. Chief exec Dave Forsey is subject to an investigation into the collapse of USC. Sports Direct has been repeatedly in the news because of the continuing exposure of inhumane treatment of workers at its Shirebrook site. Unite's excellent campaigning has drawn the veil from the reality of precarious work in Britain in the 21st century, and it looks ugly.

This week the BIS committee reported on Sports Direct and knocked lumps out of it:

"Whistleblowers, parts of the media and a trade union shone a light on work practices at Sports Direct and what they revealed was extremely disturbing. The evidence we heard points to a business whose working practices are closer to that of a Victorian workhouse than that of a modern, reputable High Street retailer. For this to occur in the UK in 2016 is a serious indictment of the management at Sports Direct and Mike Ashley, as the face of Sports Direct, must be held accountable for these failings."    

The BIS committee report says Sports Direct needs to have an independent review of its corporate governance alongside making significant changes to its workplace practices.

Corporate governance is there to ensure that in running companies, boards balance the interests of the many different stakeholders, including the employees and workers. In a well-run company, widespread evidence of poor working practices would be detected at an early stage, reported to the board and properly addressed. This did not happen. We recommend that Mr Ashley should complement his working practices review with an independent review of his corporate governance arrangements. We believe that such a review would improve the running, and hence performance of his company, as well improving the reputation of Sports Direct amongst stakeholders and investors. (Paragraph 74)

There is no way any major shareholder in Sports Direct can have missed any of this, not even those that think unions don't understand the maverick entrepreneurial genius of turning £8 shares into £2.57 ones that Mike Ashley brings to the party.

Sports Direct's AGM takes place on 7th September, about 6 weeks away. Shareholders have various way that they can hold the board accountable, and make sure that the company fundamentally overhauls how it treats its staff, and its corporate governance. This company is the poster boy of poor practice, and it has cost asset managers' clients a lot of money to leave these problems unaddressed. Therefore it is vital that investors act, and are seen to do so.

Shareholders have been granted ever greater powers in the UK in order to enable them to facilitate effective oversight of companies. They have been repeatedly encouraged by governments of various stripes to actively engage with companies, particularly when performance is weak and there are practical steps investors could take to seek to address this. There is no better target than Sports Direct.

So investors really need to act quickly, to do so with real intent, and to do it in a way where there is a very clear signal to both the board and to Sports Direct workers that enough is enough and that real change is needed.

Otherwise we may have to count this as your sixth strike.    

The slow-moving car crash

Executive pay is like a slow-moving version of MPs’ expenses car crash, but without the degree of self-awareness shown by politicians (who do face a meaningful threat of removal from office). Each year the same headlines, each year the same justifications, each year a bit more legitimacy lost. This may continue for years to come, in the way that a car with flat tyres can keep driving on its rims. But you have to choose to not listen to not to hear the screeching. And it really takes a highly-educated mind to conclude that politicians are somehow turning executive pay into a political issue, rather than reacting to problem that won’t go away.

As the newly-installed leader of a Conservative majority government, Theresa May’s intervention on executive pay shows that a third flavour of political administration (previously Labour, then the Tory-Lib Dem coalition) is going to have a crack at the problem. Politicians are not uniquely attracted to executive pay as an issue, they are responding to the prevailing view that the business elite is out of touch, with executives enriching themselves and paying little attention to the needs of others in society.    

Despite this, some people apparently think the obvious response is to indulge in another round of what we have tried before. Leave it to the shareholders, they say, it’s their money, and they have an incentive to act if need be. I won’t beat about the bush: I think this stance is both idiotic and emblematic of a deeper problem in corporate governance and responsible investment.

Let’s look at how we got here. We have left it to the shareholders. And lots of otherwise clever people in the business of managing capital have long contended that we are wrong to get annoyed by executive pay, and that it’s a small cost in exchange for the large benefit of executive talent. They have offered instead the technical fix of performance-related pay. “What matters is structure, not scale,” they have told us each time anger has threatened to boil over.

We have been through several rounds of technical fixes, each of which has decided that the political problem of high executive pay is best solved by giving asset managers more information, and more power to shape it as they see fit. The result has been repeated attempts to redesign performance-related pay, with no real downwards pressure on scale.

Provided with the tools to challenge companies in the shape of increased shareholder voting powers, asset managers have used them to give the large majority of executives and their pay packages overwhelming support. Judged by this metric, the only one that really counts, the picture is clear: the public thinks there is a big problem with executive pay, asset managers largely don’t. There is an enormous gap between beneficiaries and those that manage their capital.

Even the small steps that some shareholders have taken to address executive pay seem utterly feeble to most people. One personal experience illustrates the problem. I did a radio interview during the so-called shareholder spring of 2012 where I explained we were advising shareholders oppose a particular executive pay policy, on the basis that it was excessive. An old mate of mine heard the interview and texted me to say “people actually pay you to tell them that?” Fair point.

Yet to articulate what ordinary members of the public think about executive pay is to invite criticism that this isn’t the “smart” response, and that the issue is becoming “political” (as if the distribution of rewards hasn’t always been a fundamentally political issue). Rather than directly address the repeatedly expressed view that executives are simply paid too much, most investors and their advisers seem far more comfortable re-interpreting this anger as a need for more “performance linkage”.

For example, one of the recent “big ideas” in responsible investment is to tie executive pay to ESG metrics. Aside from the questionable effectiveness of this approach, given evidence that monetary rewards can crowd out other motivations, to a less “informed” person it could look a bit like executives needing to be paid more to behave well. Similarly we are regularly told that if we want asset managers to devote more attention to ESG issues we have to pay for it. To which I might reply: “People actually have to pay you to use their own money in their interests?”

The blind adherence to the 1990s vintage Anglo-American corporate governance model is striking. When Theresa May puts forward a vague commitment to employee representation on company boards - something in place across numerous European countries - the immediate response of one asset manager was to write to the FT to say shareholders will resent it. At any stage are the views of beneficiaries, some of whom presumably could end up as employee representatives on boards, ever considered? I doubt the idea that beneficiaries might have views, which might even have validity, is given a second thought.

A regularly heard refrain is the need to “keep politics out of it”, whether it’s executive pay, investment decision-making, engagement priorities or pension fund governance. The clear preference is for technocrats to determine what gets done, and how. Keep out the views of the ordinary punter, and the politicians, the professional intermediaries know best. Rarely is there recognition that everyone (even professional intermediaries) has biases and conflicts, shaped by their own position in society, by their class, their culture and wealth. What may look value-free and apolitical to intermediaries looks laden with assumptions from the outside. Yet it's the views of the intermediaries that carry the day. Incredibly, often they won't even tell you what they are saying to companies (or employers, as most beneficiaries experience them) on your behalf.

The result is that our investing institutions have drifted dangerously far from their beneficiaries, and that many within the system are compounding the problem by assuming public concerns are ill informed and unjustified. Somewhere along the line, the power that comes from the capital that working people have generated over decades has been usurped and used as others see fit.

We have a situation now where well-paid intermediaries, whose only power comes from other people’s money, jet around the world to deliver sermons to an echo chamber of their peers who reinforce their own values. Largely disconnected from those they notionally serve, intermediaries impose their values, their beliefs and their priorities using someone else’s capital. It is the liberalism of the wealthy, and socially and geographically mobile. Look in the mirror: it is the politics of the elite.

Responsible investment does not escape this. ESG events are dominated by sustainability, typically showcasing the numerous investor initiatives addressing climate change. Yet you would struggle to find a single topic at most of them that a beneficiary would consider to be really focused on their interests, either as a saver or in their working life. If you are a lower or middle income worker in a developed country, you are most likely to feature in asset management analysis as a cost, particularly if you have a defined benefit pension. You don't really matter as far as most shareholder engagement is concerned, even though it's your money they are using.

There is an old slogan: if you’re not part of the solution you are part of the problem. So let’s spell it out: if you are voting in favour of companies where executive reward is rising more than that for the workforce as a whole, you are part of the problem. If you fail to support (or even oppose) efforts to improve the pay and conditions of the working people whose money you manage, you are part of the problem. If you oppose attempts to find other ways to tackle the pay gap through other governance models, you are part of the problem. If you want to limit or remove beneficiary involvement in the management and utilisation of their own capital, you are part of the problem.

I have little doubt that the current model, reinforced by unreflective behaviour by investing institutions, can trundle along on its rims for a while yet. Similarly I expect calls for a change in direction to be met in part by claims of special pleading by vested interests. But so what? If you stand back and look at the mess that is executive pay, and cannot see both the legitimacy of public anger and the utter failure of shareholders to make meaningful change, then perhaps further dialogue is pointless.

All I would say is look at current events. You can repeatedly tell people they are stupid, ill informed and harming their own interests to choose a certain path. You can show them the evidence that big corporates and 'serious' figures from industry share your view. You can tell them how lucky they are with the status quo, and that they risk chucking it all away. But if they think you are in it for yourself, that you think they’re thick, that you never listen to them when they try and raise their voice, but most of all that if what you are telling them doesn’t match their own experience, then one day they will kick you in the bollocks.    

Worker directors: some initial responses

So, just a day in and already we can see some are already unhappy with the prospect of workers being represented on the boards of companies. There is a letter from an asset manager in the FT here specifically on worker directors, and a response from the ICSA here which looks more broadly at corp gov but also talks about it.

A lot of people in UK corporate governance have (inevitably) a very UK-focused view of this subject, and may be unaware of other systems, so here are a few quick points that I think are worth making to inform the debate that is likely forthcoming.

First, worker representation on boards is not the same as German co-determination. There are various models out there - it is in place in many more countries in Europe than just Germany - and the UK might not necessarily follow the German approach.

Second, the introduction of worker directors doesn't necessarily mean that shareholders don't get a say on board composition, it depends on the system. You may well already be exercising such a say. If you are an investor that holds FirstGroup shares, for example, have a look at how you voted on the election of Mick Barker.

Thirdly, there is no inherent reason why worker directors cannot perform their role in line with directors' duties just as well as anyone else. The same argument was made in the past in pension fund governance that member trustees would be too conflicted. In practice they are clearly able to do the job and what is surprising is the rarity of conflict.

Fourth, there is no divine right of shareholders alone to exercise control of companies. Shareholders do not own companies despite the widespread belief that they do. I say this as someone who previously accepted the assertion that shareholding = ownership. It's not true in law, and the watery shape of "ownership" that does exist - shareholder control rights - is undermined by the poor use of those rights in practice. As I blogged before, it's not like shareholders haven't been given the tools, but they have chosen to not use them very often. Perhaps if those rights had been used more effectively, or with some sense of public responsibility, then politicians wouldn't be looking at bringing other voices into corporate governance.

Enter, stage right: Workers on boards

“I want to see changes in the way that big business is governed. The people who run big businesses are supposed to be accountable to outsiders, to non-executive directors, who are supposed to ask the difficult questions, think about the long term and defend the interests of shareholders. In practice, they are drawn from the same narrow social and professional circles as the executive team and – as we have seen time and time again – the scrutiny they provide is just not good enough. So if I’m prime minister, we’re going to change that system – and we’re going to have not just consumers represented on company boards, but workers as well.”

So there we go, the incoming Conservative Prime Minister has committed to having workers represented on company boards. As always, these high level statements leave a lot of unanswered questions. By "represented" do we mean the workers themselves are on the board or someone else speaks for them? By "on company boards" do we mean as directors, equivalent to non-executives, or something different? How are these people appointed? Do these policies imply changes in company law?

Nonetheless, this does represent a public commitment to a shift in corporate governance in the UK that it will be hard for the incoming PM to row back from. We need to see the precise details before saying this is unequivocally A Good Thing. But it has certainly set the cat amongst the pigeons, and is definitely a notch to the Left of some of the baby steps Labour "moderates" have advocated. Even the IoD has backed the idea.

May's other proposals are pretty much same old same old - a binding vote for shareholders on exec policy every year rather than every three (which was the original idea before some in the asset management industry lobbied for a triennial vote) and on specific aspects of pay (again part of the last exec pay consultation by BIS undertaken under the Coalition). I also read she proposed pay ratio disclosure - once more an idea consulted on under the Coalition but dropped (and opposed by the asset management lobby if I remember right).

I am going to enjoy the rare privilege of saying I Told You So. I think the direction of policy around corporate governance in general and executive pay in particular has been pretty obvious for the last few years. We had kind of reached the end of the road for the 1990s vintage version of greater disclosure and increased shareholder powers. I mean this in two senses. First, there wasn't a lot more to be done - hence the main thing May has proposed in terms of shareholder powers is increasing the frequency of binding vote, and the disclosure of pay ratios would build on already enhanced disclosure. But second, despite the provision of more powers and more information, and repeated prods from governments and regulators, asset managers have shown themselves to be a pretty weak force for pay restraint.

As I've argued before, giving shareholders prime responsibility for executive pay simply makes it likely that pay will be shaped in a way that asset managers think is reasonable, if they are motivated to engage at all. Asset managers have largely said structure (performance linkage etc) is important, not scale. This may or not be reasonable (I think not, given that the power they have derives from other people's money) but it certainly isn't in line with where the public is at.

This was always going to end badly. Otherwise smart people repeatedly said there's no sense in getting upsetting about the huge and growing rewards for a handful at the top because a) the amounts were small compared to overall company expenditure b) it was performance linked and c) shareholders gained from the "talent". This approach always misunderstood where other people were at, and that they might have different ideas. For a while it looked smart to make shareholders have responsibility for executive pay, and to promote policy to facilitate this, but the danger has always been that if shareholders didn't act this could pull the rug from under shareholder primacy itself. 

I know this is just lefty nonsense coming from me, so it's worth reading someone from the world of finance make a lot of the same points here: 

The UK’s big shareholders and the big boardrooms they are supposed to keep an eye on for us have had endless chances to have a go at fixing the pay problem themselves. They haven’t done it. Now the problem so bad that it looks as if a Tory government is going to have a go at fixing it for them. That’s a political shift that marks a major financial industry failure. And rather a shameful one at that.

Of course, May could still backtrack, maybe by consulting on these ideas and then ditching them when there is pushback. But even a consultation could be politically damaging is it sees some of those with a vested interest arguing against a fairly significant shake-up. I'm not sure the CBI will be putting a joint response in with the Investment Association again saying there isn't really a problem with exec pay, for example. And by opening up this argument, May is only going to take flak for caving into the donors if there is significant backsliding.

I blogged a while back about the need for Labour to set out something thorough in the area of corporate governance and company law reform. It's clear that this now needs to be done rapidly, and radically. The 1990s is over. It's time the Left started setting out a vision of corporate governance in the 21st Century.