Why we needn’t worry about excessive executive pay

What was OK a few years ago just isn’t considered so now.

Out-sized executive pay packets are a more contentious issue than ever before.

Salaries paid to some of Britain’s top managers are now so vast that demands are growing for ‘something to be done’ about them. The wage gap between the boardroom and the shop floor continues to widen. And I freely admit that some of the huge sums awarded to poorly-performing company bosses really wind me up.

But is this problem as bad as it seems? As I explain today, it could soon be sorted.

Politicians demand tough measures

You can often tell that something is peaking when politicians become desperate to get involved. And that’s happening right now.

Executive pay has been “ratcheted up” to the point where it is no longer linked to the performance of the business, says a report issued this month by the Business, Energy and Industrial Strategy (BEIS) Parliamentary select committee.

The committee reckons that the public’s faith in corporate governance has been shaken by scandals such as those huge BHS pension deficits. And it has called for tough new measures to bring boardrooms back into line, reports the Independent.

“Pay must be reformed and simplified to incentivise decision-making for the long term success of the business and to pursue wider company objectives than share value,” says BEIS committee chairman Iain Wright.

What’s really got the committee’s back up? Answer: long-term incentive plans (LTIPs), in which bonuses are paid in the form of deferred shares.

“Most of the big headline-grabbing rows over excessive pay have LTIPs, or a variant of them, at their heart”, says Nils Pratley in the Guardian. “That is because the system regularly generates rewards that are not only enormous but also perverse”.

LTIPs were designed on the basis that shareholders want to see executives chasing “share-based jackpots” that required demonstrable success over three years.

The result is a mess”, says Pratley. “LTIPs have been executives’ best friend and the biggest driver of inflation in boardroom pay. For the average FTSE 100 chief executive taking home £4.5m in 2015, at least £1.5m came from LTIPs, according to the committee’s report. As with annual bonuses, an executive now has to fail spectacularly to be awarded nothing.”

I reckon the BEIS committee is right about LTIPs. But while politicians are very good at talking, they’re generally much less effective when in action.

Further, do you remember all those dodgy MP’s expenses a few years ago? Add in recent observations by a former speaker that many House of Lords’ members “contribute absolutely nothing but claim the full [daily expense] allowance” and I’m hardly filled with confidence about trusting our politicians to control the corporate gravy train. The good news is that another group is much better placed to do the job…

How fund managers have failed

The real reason behind the executive pay explosion is very simple – the market hasn’t been working properly. And that stems from past failures by corporate bosses’ ultimate paymasters.

We’re talking here about the – extremely well-paid – fund managers employed by the leading financial institutions who own most of the shares. I suspect they haven’t wanted to rock the boat. They’ve been worried that if they moaned too much about industry fat cats, they’ll have highlighted how large their own wage packets are (even when they underperform benchmarks, though that’s a topic for another day).

Hands up, I’m sharing the blame here. Sure, when I was managing money in the City a few years ago, fund managers’ pay levels weren’t – sadly for me, anyway – at their stratospheric levels of today. But they were still very nicely above the national average. And I didn’t exactly feel like questioning the pay of the top management at the companies in whom I was investing. Nor did my colleagues at the time.

Change is on the way

But I’m now detecting a change in thinking. What was OK a few years ago just isn’t considered so now. The message is starting to reach fund managers that it’s part of their job to curb executive pay excesses on behalf of a wider group of stakeholders.

Last year, the growing gap between wages on the shop/office floors and large boardroom pay packages was already making many investors uneasy, according to Legal & General Investment Management.

At the start of 2017, the world’s biggest asset manager BlackRock threatened to set off another round of UK shareholder rebellions unless Britain’s largest firms curb excessive executive pay. This year about 50% of Britain’s biggest quoted companies face binding shareholder votes on their pay plans and BlackRock is demanding cuts to director pension schemes and an end to huge wage hikes, reports the Guardian.

In a letter to the bosses of more than 300 UK companies, the US fund manager said it will only approve salary increases for top executives if firms raise workers’ wages by a similar amount. That’s particularly important because BlackRock is a shareholder in just about every FTSE 100 stock.

“Executive pay should be strongly linked to performance, [meaning] strong and sustainable returns over the long-term as opposed to short-term hikes in share prices”, said Amra Balic, the company’s head of investment stewardship in Europe,

And boardroom remuneration is set to be top of the shareholder agenda in the 2017 AGM season, according to BMO Global Asset Management (EMEA).

In its Responsible Investment Annual Report, BMO says that in 2016 it voted on more than 93,000 resolutions at nearly 9,000 company meetings in 73 countries worldwide. Executive remuneration continued to be the most contentious issue dividing investors and management. BMO voted against management on 52% of these resolutions around the world, 8% higher than in 2015.

In the UK, BMO voted against 17% of pay-related resolutions, up from 16% in 2015. The main concerns were excessive pay-outs with a weak link between corporate strategy and key performance indicators used in pay plans, pay-outs that were inconsistent even with weak performance and excessive focus on the short-term.

Indeed, 2017 will be a particularly significant year in the UK for the approval of binding corporate remuneration policies, says BMO’s Head of Governance and Sustainable Investment Vicki Bakhshi.

Put another way, it looks like the market is at last set to sort executives’ mega- salaries. That’s likely to be a better way of resolving the issue than politicians’ posturing or media muttering. And if high-flying stock indices soon drop back as I expect, many of those “share-based jackpots” will be worth a lot less anyway!

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