Wednesday, 27 July 2016

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:

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:

  1. 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 shareholdersunderstanding. 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:

  1. 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.

No comments: