Monday, January 9, 2012

Executive pay is out of control

Executives of large companies are a classic example of the agency problem. They are in place to serve the owners of the company, i.e. the shareholders, but it is all too easy for the directors of large companies to put their own interests first, and line their own pockets with remuneration packages that frequently bear little relation to their performance or what a genuine free market would offer them if shareholders had their say.

Its certainly true that the difference between a good manager and and bad manager can make a significant difference in terms of absolute value to a large multinational company. Trouble is, the senior management team are only one part of the equation, and paying a sizable part of the income of a company that may have a vast income generating asset base seems to be no guarantee that you will get management that is even adequate, let alone high performing.

Over the last few years, executive pay seems to have risen out of control. Managers are paid for high performance, and paid off handsomely when they fail. This has come about as the selection and remuneration of senior management has become ever more the decision of other senior managers, and less and less something that shareholders have any serious say over. Remuneration committees benchmark pay according to whatever other companies are paying and then a little bit more to recognise just how special the new managers that the same people have just appointed are, which can provide a self perpetuating cycle of higher pay. As many councillors have discovered, having an 'independent' panel review pay, where that panel is not actually paying the price itself, can often also have an upwards only impact on reward.

Both the Prime Minister and Labour want to see something done about this. I dare say most of the motivation for this sudden interest is political expediency. The gap between rich and poor, and a few managers on extraordinary salaries whilst western economies are floundering are not unimportant - but we never hear similar concerns raised about the income of Premiership footballers or lottery winners. Ultimately Executive pay is mostly the concern of shareholders - but that still means it is the concern of large numbers of people, for example most people with private pension savings. For a a number of reasons shareholders do not currently have a proper voice in setting Executive pay, and government action is now long overdue.

Labour as ever miss the point, in calling for extra transparency. Annual reports for listed companies have no shortage of detail on executive pay, it doesn't need more taxpayers cash being squandered tabulating this information.

It remains to be seen what the Government has in mind in terms of empowering shareholders, but the first step to a proper solution is to understand the problem. Large plcs usually have a very diverse shareholder base - so it is hard for a group of shareholders to get enough support to block excessive pay. Many individual shareholdings are now held in nominee accounts - where by default shareholders are often denied invitations to vote on executive pay and attend AGMs. The situation is worse for investors in unit trusts or pensions, where decisions are taken on behalf of investors by scheme managers - who may be rather closer to the executives of companies, than they are to their investors.

So I have a suggestion for government for how to tackle executive pay excesses. With the ready availability of online account servicing from most providers, it should be made compulsory for the 'beneficial owner' of every shareholding in listed companies to be given the opportunity to vote electronically on all company resolutions via the fund or nominee account manager. It should then be compulsory for senior executive remuneration to be subject to approval by these beneficial owners, and it should be possible for small groups of shareholders (say any group with the support of 5% of the shareholders) to propose alternative remuneration schemes.

This would not just apply to shares held in nominee accounts, but also to shares held in pension funds and shares held in unit based investment funds. The fund managers should be required to make the beneficial owners aware of all the companies that their funds are or may be invested in, and give them the opportunity to indicate how they would like to vote on any resolutions, which should be binding on the fund manager for the part of any shareholding attributable to the beneficial owner. This would do away with cosy block votes for fund managers, and herald a new age of shareholder activism.

It might be that shareholders continue to support large executive pay packages that seem to pay out regardless of the long term fortunes of the company - its would be their choice, and it may be in their interests to do so. But more likely I think it would result in executive pay being reigned in, and more importantly, becoming much more aligned to long term shareholder interests.

No comments:

Post a Comment