Thursday 29 March 2012

Misdirection in the exec pay debate

BIS is currently consulting on a series of executive pay reforms that would improve shareholder rights in this area. I've noticed already that there are some misunderstandings emerging, an in some cases some parties benefit from such misuderstandings. So I thought I'd tackle a few particular arguments that could be used to derail the BIS proposals.

1. A binding vote would interfere with contracts.

I'm increasingly convinced, the more directors' contracts that I read, that this is simply false. Most contracts seem to say the director can participate in bonus and incentive schemes under the rules of those schemes. Where specific targets/payouts are mentioned, contracts seem to say that the rem comm has discretion to change them. In a sense this should not be a surprise, since otherwise contracts would have to be rewritten all the time to take account of changes to bonuses and LTIPs

2. Shareholders would oppose less often with a binding vote.

This is the "giant snakes will roam the land" argument - or unintended consequences if you prefer. We can't know that this will happen and I do wonder which investors are planning to vote less often if such a binding vote were introduced. As a comparator, we don't think there has been an across-the-board change in voting on director appointments since annual elections were introduced. Yet it was argued that, with the ability to dump a whole board, investors would vote more cautiously when it came in. Shareholders already vote down share schemes on occasion, so, on reflection, I don't buy this one. It's just another Hirschman special.

3. Having two remuneration votes would be too complicated.

Except that we often do already have two (or more) remuneration votes - on the rem report and on any new share schemes. Also Amec already has a vote on both the report and the remuneration policy, so if they have a new scheme proposed on the AGM agenda you get pay three votes. This also happened in the US last year - Say when on pay, say on pay + other manager or shareholder proposals on pay. And in some European markets can't you get several too? (management board fees, supervisory board fees, new incentive plan.)

4. A 75% threshold to pass a pay vote would be too high.

Except you already need that level of support on special resolutions for things like share issue authorities, changing company articles and... ahem... calling meetings on short notice. You can make the argument - looking at a forward-facing vote on policy - that, since you giving authority to the directors to help themselves to the company's assets, a higher level of support should be required.

Wednesday 28 March 2012

Attract, retain and demotivate

As I've blogged much in the past, I think the effectiveness of performance-related pay should be properly reviewed by shareholders and others involved in the executive remuneration debate. In particular I think the question of motivation needs further analysis. In passing, I was pleased to note that in the Hermes discussion doc on exec pay there was a brief nod to this
They should consider how best to motivate the executive directors and top management, using other tools at their disposal as well as those provided by pay. We note that there are many studies, from Maslow onwards, that demonstrate that pay for performance is not always the best motivator, particularly for those in senior positions and we expect boards to ensure that they take account of this.
OK, it's brief & basic, but at least a mainstream asset manager has noted that there is a debate starting here.

In fact, I think when you dig into this stuff it becomes fairly obvious that both current and planned practice in exec pay doesn't sit well with different perspectives on motivation. As I've said before, in essence performance-related pay appears rooted in a behaviourist view of human psychology - the consequences of behaviour affect whether that behaviour will be repeated. So, from a behaviourist viewpoint, bonuses, share awards etc are a positive reinforcer. And by positively reinforcing we expect more of the desired behaviour to occur. Do X and you'll get Y.

But why do behaviourists, or those that think like them, think positive reinforcement is required, and how do they think it can be achieved most effectively? Here's Aubrey Daniels in Performance Management (all about the use of positive reinforcement) on why:
Four basic reasons explain why people don't do what we want them to do on the job: 1) they don't know what to do; 2) they don't know how to do it; 3) obstacles in the environment discourage or prevent them from doing it; or 4) they don't want to do it.
How much of this applies to board directors? Whilst I might agree that, actually, board directors don't know what to do or how to to do it (because in very large organisations it's sometimes really hard to see which combination of factors works) I think that they think they know what to do and how to do it. It is to be hoped that, having got to the board, they do want to do the job. So it's not immediately obvious to me that positive reinforcement is needed.

But even if we concede that it is, what's the best way to do it? Aubrey Daniels is interesting here, as he stresses the need for 'consequences' to follow the thing we want to see happen:
Behaviour is affected by the consequences which follow it. Consequences either strengthen or weaken behaviour. Because a consequence affects the behaviour that precedes it, it is critical that the consequences be timed to follow the behaviour we want to be affected.
There's not much point praising, or rewarding, someone months after the behaviour you want to reinforce has occured. It needs to take place soon after to have the desired reinforcing effect.

I apologise to people with a background in psychology, for whom this will be behaviourism 101, but it's an important point. In recent efforts to 'reform' executive pay, much emphasis has been put on the need for reward to take account of long-term performance, and, increasingly, to be paid out only over the long term too. This is all very laudable on one level, since we trying to avoid a) incentivising short-termist decision-making and b) paying out rewards on the basis of performance that turns out to have been illusory. But - if you take behaviourism seriously - you have to doubt that reward of this nature will have an effective positive reinforcement effect. In fact exactly this point was made (arguably for different reasons!) by PwC last year.

Maybe you think this is still ok, after all the payouts from incentive schemes are rewards for hard work, it's a fair reward more than anything. That's a valid point, even if I don't necessarily agree. But then let's accept that the idea that long-term incentive schemes (as in those that pay out over the long term) aren't particularly 'motivating'. Maybe they 'retain', but not motivate.

Remember too that this is looking at things from a behaviourist perspective (which I believe is implicit, though unacknowledged by most corp gov people, in remuneration design as it stands). There are, as I've bored on at length about, a whole host of other reasons why we might not think it's a good idea. I think what we need to tease out here are the assumptions people are making about the interactions between incentives, behaviour, motivation and performance. These overlap but are not the same thing, which is why there is sloppy thinking in this area. Incentives might get more of a certain behaviour, but not extra motivation or better performance. (No matter how much you pay me I'm never going to be a great dancer, or want to do it!) This is why performance pay may only be really effective at uninteresting, straightforward and measuraible tasks.

If we can make explicit what we think about performance-related pay, we may find that we don't feel it does the job (or well enough to be such a huge part of directors' reward) and therefore will want to scale it back. That in turn can feed the desire on the part of almost everyone in the executive pay debate for simplification.

Thursday 22 March 2012

I said, didn't I say?

...that we're tilting towards a more regulatory approach to governance in the UK, and that people should think about that rather than banging on about Europe. I'm a bit sceptical that the current generation of people in charge at many asset managers are likely to be able to do any better than the FSA at improving the boards of banks. So dunno if they're in the string position to moan about the direction of travel (voting records of asset managers at UK banks 2006 - 2009 very unimpressive, for example). But hey.

UK bank watchdog's board meddling could backfire

Thu Mar 22, 2012 2:18pm GMT

* Shareholders should retain final say over board roles

* Regulators could end up with blame if things go wrong

* Banks already taking action to improve governance

By Sinead Cruise and Anjuli Davies

LONDON, March 22 (Reuters) - Chastened by their failure to foresee the financial crisis, it's little wonder that UK regulators might think a plasterer, among others, unfit to supervise a bank.

Britain's Financial Services Authority has halted the 1.5 billion pound sale of 630 Lloyds Bank branches to the Co-Operative Group, a move one FSA insider said was due to worries the eclectic board of the food-to-funerals giant lacked the nous to manage one of the UK's biggest retail banking networks.

A nurse, a horticulturalist and a Methodist minister keep the plasterer company at the Co-Op, along with a farmer, an ex-teacher and a retired publisher, all elected by members, with various responsibilities on subsidiary or regional Co-Op boards.

After the high-profile failures at some of Europe's biggest banks during the 2007 financial crisis and beyond, regulators looking to beef up oversight of bank boards are unlikely to appreciate the value of that breadth of experience.

But industry experts warn regulators could live to regret heavy-handed interference in the make-up of UK bank boards, as one-off interventions risk evolving into a burden of day-to-day supervision they could struggle to handle.

Wednesday 21 March 2012

Problems of ownership

Just catching up on some of the stuff in the Ownership Commission report. Below is what they say about stuff in my territory. My initial reaction is "meh". A couple of old ideas that I don't think will work, plus seems out of whack with actual pension fund practice. Quite like the idea of enfranchising individual punters, and we suggested this in response to a PADA (rememeber that?) consultation I think. But generally "meh".

The solutions to these problems may be relatively simple –

• Fiduciary duty – trust law already describes a duty for pension fund trustees to look after the financial interests of the pension fund’s beneficiaries. However, this is almost universally interpreted in a short-term way, leading to actions such as stock-lending and supporting the situation of excessive transactions through ‘supplier control’ described above. The UK Government could issue guidance on the interpretation of fiduciary duty making clear that this should be considered from a longer-term perspective, leading to less value lost through excessive transactions and more gained through good stewardship.

• Longer term mandates – as described above, investment mandates currently promote short–termism to the detriment of good stewardship. This includes the commonplace quarterly assessment of investment managers’ performance. Pension funds and other long-term end assets owners should be encouraged to take more control over the terms for the management of their beneficiaries money. An example of such encouragement, is the International Corporate Governance Network’s Model Mandate Initiative.

• Education of trustees – given the current part-time and lay nature of trusteeship, there is a good case for greater professionalisation and education of trustees. In the context of stewardship, this could include a ‘trustee toolkit’, which would be of particular interest to member nominated trustees and could be promoted through their networks or, where relevant, the underlying trades unions.

• Enfranchisement of beneficiaries (citizen-owners) - Pension funds and other long term savings
vehicles should use web based technology to canvass the opinions of their beneficiaries directly and provide them with information on the stewardship of the assets in which they invest. Such views and information could be provided through a collective engagement platform (see below).

• Aggregation of pension fund ownership –pension funds are very well aligned as long-term investors, with many investments in common and without the conflicts that exist amongst their investment managers. They are therefore able to share stewardship resources and pool their common investments in order to implement good ownership on behalf of their beneficiaries. The Commission supports the establishment of a formal collective of international pension funds to jointly own and fund an engagement platform, possibly as dedicated not for profit mutuals. Such an aggregation of resources and ownership rights would provide a stable, consistent and knowledgeable share-owner voice to the benefit of listed companies and the wider economy.

Saturday 17 March 2012

James Murdoch's position looking shakier

Last night it was revealed that James Murdoch isn't going to stand for re-election at Sotheby's. He has been the target of pressure from investors who want his removal, led by the US unions. Of all the positions I thought he could lose I thought the Sotheby's one was the safest. But coming after his stepping down from GSK, this was the next obvious target.

There is, of course, much focus on his continuing chairmanship of BSkyB. As I've blogged previously, the threats to him are various - DCMS committee report, Ofcom 'fit and proper' test, possible police interview - and any one of them potentially could kill his chairmanship off. It's in this context that we should consider both his letter to the DCMS committee, and the noise around Nick Ferguson stepping down as chair of BSkyB.

First the letter. Essentially it's an articulate defence of his position that aims to invite the conclusion that he wasn't told enough to know, and what he was told wasn't conclusive. He goes as far as trying to tell the committee members what *that* email actually meant. It looks like an attempt to steer the committee to give him a minor ticking off (which a cowed BSkyB board might conclude can be toughed out) rather than accusing him of incompetence or, much worse. of misleading Parliament. I think we can probably conclude that the Tories on the committee will prevent the worst outcome, but a charge of incompetence from Parliament would probably do for him.

On the SVG rejig, I'm personally not convinced it's necessarily about, or solely about, freeing up Nick Ferguson to be BSkyB chair. There are evidently other things at play at SVG. In addition, I do wonder if Ferguson is a safe bet now as chair in the event Murdoch has to step down. Remember that he has backed Murdoch even as the picture of what he knew and when has become more... ahem... complicated. I personally think he made a bad judgment call. Also I think BSkyB could have taken the sting out of this last year - what about Murdoch temporarily relinquishing the chair but continuing as a NED until things worked out? I don't think that's a realistic option now.

In addition, by taking the position that they wouldn't even review the chair's position unless anything 'material' occurred, the board has essentially put the decision in other people's hands. So, when *that* email appeared before xmas, the company would have got a lot of media calls about whether it was considered material or not. Similarly the news that Ofcom had set up a project. For these reasons, I don't think yo can conclude that Nick Ferguson has played a blinder, and I think some shareholders will want an entirely new chair.

To conclude, I think that unless James Murdoch clears all three hurdles faultlessly he is going to have to go. And if the board doesn't ask him to go, shareholders will increase the pressure. In short I don't think he'll make it to the next AGM. But then I thought he would have gone last Summer, so what do I know?

Sunday 11 March 2012

Bob wants a sandwich

Bob Diamond. We'd have to event if he didn't exist wouldn't we? Somehow he has come to epitomize everything we don't like about the banking sector, and his pay packet provides the kind of enjoyable outrage usually only to be found by reading the Daily Mail.

The figures out over the last couple of days shouldn't surprise anyone who has been paying attention too much. The head of a big public company will earn a lot of money, and if that company is in the financial sector you can expect it to be bigger still.

But let's listen to the voices of moderation. Yes it's a lot of money, but these are rare cases, most people in banking don't earn a lot. Also, human capital is highly prized in the banking sector - one individual can make a massive difference, so you have to pay the going rate for the talent. And actually, when you look at the benefit delivered by Bob Diamond's stewardship of Barclays, it's a relatively small cost to pay, isn't it?

These are all valid points, so let's push it a bit wider. If Bob Diamond wants Barclays to give him a pony (the animal, not £25), surely this is a no-brainer. Cost-wise the impact is much smaller than a bonus or share-based incentive. They should just agree, and shareholders should back the decision. Similarly, if he asked for a day out at Alton Towers with six friends, the bank might even want to consider hiring the whole venue for the day (because I bet Bob hates having to queue for anything).

But what if Bob asked the CIO at one of his leading investors, a UK institution, to make him a sandwich, right now? Nothing fancy, but he wants a salad garnish and some crisps laid our fan-style. Surely if it's a choice between this and Bob leaving Barclays, even the UK, it must happen? OK, it's a power trip, and an embarrassing request to fulfill, but think about all the value he will generate. And really what's the big difference between that and him asking you to pay his tax bill for him?

The thing is you can make a fuss about this if you want, but whilst that might make you feel better now, in the long term you'll lose out because Bob will leave, taking that tax revenue with him. We need to show that the UK is open for business, rather than sending out the signal that aspiration will be punished.

So just belt up and make Bob's sandwich will you?

Friday 9 March 2012

BSkyB and ownership

The news that Ofcom now has a project running specifically looking at 'fit and proper' as applied to BSkyB is not surprising in one sense given the scale of wrongdoing at its controlling shareholder. It does, however, further up the pressure on the board, and the chair in particular. The sentiment in the investment community towards Murdoch Jnr seems to be split between an active desire on the part of some to get rid and for others, latterly, reluctant acknowledgment that he may have to fall on his sword. Forthright defenders are much harder to find now. But why, really, has it taken this long?

Since the hacking scandal erupted last July, I have often been surprised by how little some investors seem to know about what is going on or understand the likely ramifications of unfolding events. I think the idea that a 'fit and proper' test might be problem for BSkyB has only recently started to trouble some investors, when it should have been obvious for months that this was in the post. And of course Ofcom isn't the only problem. There is still the DCMS committee report to come, Murdoch is also potentially exposed under the Regulation of Investigatory Powers Act, and, of course, Sue Akers might want a word with him at some point. The threats to James Murdoch, and by extension to those companies where he sits as a board director, are varied and potentially very significant. So shouldn't shareholders have realised this, and a lot earlier?

In this context the quote below from this Reuters piece is particularly revealing:

A UK shareholder at a large fund manager, speaking on condition of anonymity, agreed that Murdoch was vulnerable.

"It's probably likely that James Murdoch will have to end up leaving, which will be a bloody great shame," the shareholder said.

"What may happen is there will be enough mud thrown around by Ofcom, but not enough to force News Corp to sell its stake down, but Murdoch could say almost as a trade-off 'I'm out'."

I think this is probably indicative of an old school mainstream asset manager mindset. But more broadly if this is an accurate reflection of their understanding of the situation and views on it I am not surprised we struggle to make ownership work effectively. What is implied is that James Murdoch is a valuable to BSkyB and that he could leave or be forced out because of 'mud' being chucked around (which suggests groundless accusations that damage nonetheless). The conclusion drawn is that this would be a loss for the company. I think this is mistaken on numerous points.

For one, it is obvious to those willing to acknowledge it that what we see at News International is a full-on corporate scandal. There was wide-spread illegal activity of various kinds, which some senior NI executives were aware of and yet repeatedly denied knowledge of, including to Parliament. The company also destroyed evidence, and in earnest when it became clear that its public denials were not holding out. The cover-up at NI continued under James Murdoch's watch, and some of those involved are likely to go to jail. This is not 'mud', this is what is emerging from the police investigations, DCMS committee's inquiry and Leveson. Ofcom doesn't need to throw mud, this stuff is already out there, and damaging information about the former NI regime turns up in the papers most weeks. So our mystery manager is mistaken on that point.

But more worrying to me is the idea that even if you don't believe that James Murdoch was directly involved in the cover-up that he should be able to just carry on as normal. (NB - If you look at RIPA - very relevant to hacking, obviously - directors don't actually need to have known about illegal actions to be held responsible, they can be done for neglect too.) When we look back on this in a few years it will be obvious that this was a major corporate scandal. The cover-up took place when James Murdoch was in operational control. The scandal in turn blew up News Corp's bid for BSkyB. That should be enough for him to go, and if he isn't willing to do so voluntarily he should be forced out. Yet our unnamed fund manager says it would be a "bloody great shame" if this does happen.

Thinking wider, maybe this sort of mindset a sign that some (many?) fund managers, running portfolios with dozens of stocks in them, have a pretty narrow understanding of investee companies. They apply valuation models, look at the numbers, but don't necessarily think about the broader issues surrounding them. Note this fund manager thinks that a negative judgment is purely something that Ofcom does to BSkyB or James Murdoch, not some that arises from the behaviour of News International and its executives. Maybe when they're running a large portfolio they don't have the time/headspace to get into the broader questions, and so focus purely on the immediate numbers, unless they think a particularly large shock could be coming (though as I say I think BSkyB's current predicament has been obviously in the works since last summer).

Clearly it does take time and effort to keep on top of this stuff and if you only expect the impact to be limited (in valuation terms) maybe it just isn't worth the effort. Certainly my experience of the hacking scandal is that some investors have only given the issues raised by it a cursory look, which makes the comments from the mystery fund manager unsurprising to me.

But the scary bit for is for me is that this person is somewhere managing money, perhaps even my money, and getting a vote on the election of directors. With this kind of approach still out there in the investment world how confident can we be that stewardship - which will be largely carried out by asset managers - will deliver positive outcomes? If our fund manager can't even believe that James Murdoch deserves to held accountable, what do you think they do at all the other companies they invest in, where the wrongdoing is far less stark?

Thursday 8 March 2012

Solving the performance pay problem

There is a growing consensus that performance pay for directors is not working as advovates had hoped. There are a number of possible responses to this. For some, the focus ought to be on better carrot design, maybe tying carrots to the achievement of positive goals for example. For others, radical simplification is the answer. To me the latter approach seems best, I'd scrap as much of it as possible. But is there another way?

There was an interesting paper published last year by PwC on the psychology of incentives. This is an important battleground, because there is quite a bit of compelling evidence from psychological experiments that financial incentives are at best a limited tool. PwC admitted as such, and even pointed out that certain reforms (such as bonus deferral) might undermine the value of incentives.

They suggest that incentives need to be seen as fair, relatively simple (as complexity may deaden the incentive effect) and relevant to the recipient. They also stress the need for regular payouts:
The human propensity to remember bad news over good means that each year a plan doesn’t deliver has a disproportionate effect on perceived value. But of course if incentives pay out regularly, this needs to be recognised in total compensation – that is the trade: greater certainty in exchange for lower maximum reward levels.
I've though about this and come up with my own solution. My proposal is a simple cash reward. It would reviewed regularly, say, annually, with an uplift applied in certain circumstances. This would ensure that the fairness test is met. There might even be an opportunity to re-jig relative rewards between recipients if one is seen as doing particularly well.

In order to meet PwC's point about regular payouts, the payment of the award would be staggered throughout the year, my preference being monthly chunks. In order to meet the simplicity test it would clearly set out as one single figure that the recipient could expect to receive in the course of the year. This would result in the greater certainty PwC advocate.

I'm calling my proposal a Seasonally Assessed Long-term Adjustable Reward Yardstick. If it works in the boardroom, I could envisage it being rolled out to all employees.

Monday 5 March 2012

Union shareholder activists push for James Murdoch removal from boards

The US unions have been doing a rather heroic job in response to the hacking scandal, and are involved in moves by US investors to seek James Murdoch's removal from several boards. Obviously News Corp and BSkyB have seen the most focus, but he also sat (until recently) on the GSK board, and still sits on the Sotheby's board. Info below...

CtW Investment Group Demands James Murdoch's Removal From News Corp. and Sotheby's Boards

Wednesday, February 29, 2012

CONTACT: Michael Pryce-Jones, (202) 262-7437

Cites Sotheby's Own Governance Policy in Calling for Action

Washington, D.C. – In light of today’s announcement that James Murdoch resigned as Executive Chairman of News International, the CtW Investment Group renewed its call for Murdoch to step down, not only from the board of News Corp. (NASDAQ: NWSA), but also from his other directorship at Sotheby’s (NYSE: BID). The Group states continued service as a corporate director of any company is untenable given the serious concerns raised over Mr. Murdoch’s judgment, oversight and conduct at News Corp., and that this should not go unheeded by the other boards on which he serves.

In a letter to Sotheby’s Chairman Michael Sovern, the CtW Investment Group cites Sotheby’s own governance policy in calling for Murdoch’s removal, which states that any director whose principal occupation has changed is required to tender a resignation.

“Retaining Murdoch on the board would be a clear violation of Sotheby’s own governance policy,” said CtW Senior Policy Analyst Michael Pryce-Jones.
“It is incredible that the board would conclude, given Murdoch’s incompetent handling of the scandal at News International, that he possesses the ‘high ethical standards, integrity and sound business judgment’ that Sotheby’s demands of its own members.”

The CtW Investment Group works with pension and benefit funds sponsored by unions affiliated with Change to Win, which collectively hold over $200 billion in assets.