Freedom with responsibility

The public perception of executive pay is that it’s too much, too easy to earn, and too complicated. The Investor Association set up its Working Party on Executive Remuneration last autumn to address these issues. Its interim report is published today, and is the start of a process of seeking input from a range of stakeholders. The report largely focusses on the question of simplification. The Working Party argues that the near-universal adoption of a single pay structure is overly constraining to business, prone to unintended consequences, and goes so far as to assert that the current model of executive pay in the UK is not fit for purpose.

The report sets out a range of models that they believe should be available to companies seeking to move away from the standard base-bonus-long term incentive model that has come to dominate in the UK. These are generally a variant on payment in restricted stock, released over a period of up to 5 years or more. Performance conditions could apply to determine the size of the award (in effect an enlarged deferred bonus), or the award should be of a fixed annual amount. These aren’t firm prescriptions but examples of the type of model that could be adopted.

The Working Party then sets out some of the conditions that might need to be met by companies wanting to take advantage of the freedom implied by the alternative models. These include full transparency of targets, increased shareholding requirements, reduced award levels, and lengthened deferral or holding periods.

We think that the Working Party has broadly put the right proposals on the table and asked the right questions (our own views on simplification, submitted to the Working Party earlier in the year, can be found here. Download Freedom with responsibility). However, there’s a lot of water still to flow under the bridge.

We’d expect business to be broadly supportive of the proposals put forward. The formidable challenge facing the Working Party is now to get investors onside. Even within the Investor Association investors have dramatically different views on the merits of what the Working Party is putting forward. That’s before you get to the American, European, and Asian investors that make up a significant proportion of the investor base of UK companies. And of course there’s ISS. Progress needs to be made quickly to give companies reasonable clarity ahead of the round of remuneration policy reviews in 2017.

The question is whether shareholders will demand a price for simplification (in terms of discounts, holding periods, shareholding requirements) that executives are prepared to pay. In our view investors are likely to demand more than the Working Group has put on the table. Of particular concern is whether simplified restricted models can pass the test of public opinion in the case of underperformance. The clamour for public retribution could lead to a ‘heads I win, tails you lose’ model for executives, where pay is reduced in exchange for certainty, but the reality is that awards have to be reduced further for underperformance.

The Investor Association Working Group should be congratulated for addressing a difficult issue head on. Rather than playing around the edges they’ve gone to the heart of the matter. I hope investors and remuneration committees engage with this opportunity to make executive pay simpler, lower, and more effective. We can’t carry on pretending there’s nothing wrong with executive pay. Here’s our chance to do something meaningful about it.


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