Challenging incumbent directors

A pessimistic view on this:

"[Shareholders], instead of constantly exercising their franchise, all it to become on all ordinary occasions a dead letter; retiring directors are so habitually re-elected without opposition, and have so great a power of insuring their own re-election without opposition, and have so great a power of insuring their own re-election when opposed, that the board becomes practically a close body; and it is only when the misgovernment grows extreme enough to produce revolutionary agitation among the shareholders that any change can be effected.

As the language may suggest, that's quite an old quote - from an article on the mid-19th century railways, published in 1854. (from this, which looks marvelous). Out of date now, of course, given the huge strides forward in governance, as evidenced by the regular removal of board directors by shareholders...

A bad argument against a 75% threshold

One of the elements proposed in the BIS package of reforms relating to shareholder powers over executive pay is raising the threshold needed to pass a pay vote. Though (if I remember right) the consultation does not actually specify what it ought to be, 75% has been knocked about.

One argument that has been put forward against this proposal is that it would effectively allow controlling shareholders to hold companies to ransom, and the example of Stelios at easyJet has been used as an illustration. It does sound convincing, and certainly Stelios has been a pain for the easyJet board. But....

If you think about it, a 75% (0r whatever higher threshold) actually empowers minority shareholders in their ability to reject inappropriate pay policies where there is a controlling shareholder. After all, isn't it more likely (knowing what we do about the typical relationships in place) that a controlling shareholder would be in favour of whatever pay policy was proposed? Think of companies like Xstrata or BSkyB where minority shareholders have had concerns about the pay policy but, because the company only needs 50% to get it through, they can effectively assume they will never get defeated.

In the case of Xstrata I think that for at least the last couple of years a majority on minority shareholders have opposed the remuneration report, but have been unable to defeat it. With a 75% threshold in place they would have been able to do so.

In practical terms a 75% threshold for the backward-looking advisory vote might not matter - the company might be able to ignore a defeat if it could demonstrate to independent shareholders that it was the controlling shareholder messing about. (Essentially easyJet did ignore its defeat in 2011 I think?) A defeat of the forward-looking binding vote would prevent the company from making changes, but in that case existing arrangements would be kept in place (I admit this might be difficult in some cases).

But it is striking, when you think about it, that some folks immediately cotton on to one example that demonstrates a potential problem with a 75% threshold, rather than equally valid cases where it would be empowering. Almost like there was some kind of inability in my corner of the world to see anything other than (negative) unintended consequences from any reform.

PS - if this controlling shareholder misusing a 75% threshold is a real problem, there must be numerous cases of authorities relating to share structure getting blocked, right? That's a much more fundamental way to frustrate a company, and plenty of special resolutions to get stuck into.

A few more behavioural snippets

I'm going to delve a bit more deeply into the theory of performance-related pay in my reading over the next couple of months, in order to a) be able present a fair description of what proponents believe (and what most corporate governance folks also implicitly accept) and b) develop a theoretically stronger critique of it. (If anyone is interested, two books I just managed to get cheap second-hand are this and this).

As such I'll be posting up chunks of text as and when I find useful nuggets. I'm still plugging away with Aubrey Daniels' Performance Management, which is all about using positive reinforcement in the workplace. So below are a few interesting (to me) fragments. Bear in mind this is coming from a behaviourist perspective.

If their wage (or salary) is the only incentive, then we should expect the very minimum level of performance, just high enough to avoid being fired. Performing below that level has a very clear consequence: they get fired. Performing above that level has no consequence at all, so there's no incentive for increased effort.

...

Remember that things that were reinforcing at one time or place may not be reinforcing at another time or place. This means that managers must constantly monitor performance to ensure consequences are still effective. [Does any rem comm do anything like this? As in test the behavioural effects of incentive pay?]

And pointing to other reinforcers -

Money is necessary, but not sufficient, to produce outstanding performance, especially over a long period of time. The best job you will ever have is one that you leave every day, feeling that you made not only a financial profit but a psychological one as well.

Finally, it's worth noting that there are warnings about using positive reinforcement in a manipulative or controlling way, and the negative feelings that may arise as a result. But, as I've argued before, the way agency theory theorises pay is explicitly about controlling directors - aligning their interests with those of shareholders, or 'bonding' them.

Gotcha! Our lads sink flagship chairmanship

Well, it took the best part of nine months, but finally James Murdoch as relinquished the chairmanship of BSkyB. This is, needless to say, welcome but now probably not enough. There is little sense in him remaining as a non-executive of BSkyB where he will continue to be a reminder of all things hacking-related.

The speculation is that that, by dropping the chairmanship, Ofcom might not be as interested in his role. But why stay on the board at all if the News Corp/News Intl influence is seen as problematic? Critics (ahem) may argue that he and other News Corp reps will continue to act as backseat drivers. This is especially the case when you consider that Nick Ferguson has been resolute in his defence of James Murdoch. (In fact, I can't believe Ferguson is a long-term option as chair. He has a generally good reputation, but this debacle hasn't done him any favours. So start thinking about the next chair.)

Staying on as a NED also means a few more hurdles to clear. First up, the DCMS committee's report into phone-hacking. There is a political fight going on here, with the Tories wanting to keep the language about Murdoch less critical. But if, as seems likely, it concludes he didn't lie to parliament it will no doubt censure him for failing to spot the problem (or read the email). Could a non-Murdoch NED survive criticism by parliament? Why should shareholders tolerate a renewed round ogf negative headlines? And there's Leveson of course.

Also bear in mind that it isn't just the evidence of phone-hacking that he failed to spot. He also missed the cover-up, where the criminal charges are potentially pretty serious. Given that he was in the habit of barging into the offices of other papers with a certain flame-haired NI executive, he can hardly say he wasn't close to the action.

So, all in all, a big step forward but not enough. If he tries to make it through another AGM he deserves to get a major vote against his re-election. More broadly investors ought to be thinking about a wider board shake-up, with more distance from News Corp.

Two bits worth reading, and a nice quote

1. An ace-a-tronic article by ex-Observer man Simon Caulkin on executive pay. This is great, as it delves a bit into the theory behind pay as currently structured, including the motivational aspects of it. A nice chunk towards the end:

"If after 30 years of tinkering the system still can't be made to work, there's something wrong with the initial premise. It's time to accept that both its central elements are fundamentally flawed. Researchers have been saying for years that pay for performance is a snare and a delusion, because the reasons for high performance can neither be isolated nor realistically linked to actions the CEO should be taking. In the FT, Lambert argued forcefully that the whole project is counterproductive, distorting executive behaviour, undermining intrinsic motivation and inciting risk. 'Is it right to think that senior managers are only driven by money and if they don't get what they want they'll go somewhere else?' he queries. 'I don't think so. And if they are, is that who boards really want to run the company?"

2. Some nice research (PDF) by the High Pay Centre on the make-up of rem comms. We're getting into really interesting territory now with folks like the HPC starting to look in detail at exactly who sits on rem comms. The next obvious step is to consider how this might affect their decision-making, which the HPC flags up:

when the majority of individuals on remuneration committees come from similar backgrounds it is not surprising that critics of remuneration committees have suggested that they fall victim to “groupthink” where individuals are reluctant to challenge the consensus view. It has been demonstrated by Cass Sunstein that group polarisation can occur, and more extreme decisions are reached, when groups are made up of like minded individuals. This may in part explain why we have seen such a gap between public perception of what is an acceptable level of pay and the current norm in executive pay awards.

Great stuff.

3. I like this quote (from here) from a guy at Cavendish Asset Management which illustrates the value of investors going public in their disagreements with companies (a subject which is close to my heart currently):

"The media was key. We didn't have a big enough stake in the company to vote down the move, but the deal looked so poor we had exert a much bigger influence by talking to the press. That influenced other shareholders and meant the deal didn't go ahead."

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.

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.