What we should do about executive pay

I suspect that a good many people at the top of the UK’s big banks and listed companies hoped that if they kept their heads down, eventually the issue of executive pay would just go away. After all, as far as they are concerned, it isn’t even a real issue: according to the FT, 81% of those on FTSE 350 boards do not feel that “there is a problem with excessive executive pay”.

However, I am pleased to say that they are almost entirely alone in their sentiments: not only has the issue not gone away but the weekend papers were full of the news that some of our biggest shareholders are finally stepping up to the plate, pointing out that the UK has somehow returned to Victorian levels of income inequality, and demanding action.

Hermes, one of the UK’s largest shareholders (it manages the BT pension fund, for example) has just told us that, along with another 40 or so members of the National Association of Pension Funds (NAPF), it has delivered a document to a number of FTSE companies outlining some proposals for pay reform.

The document makes the basic point that it is time for the directors of our companies to start thinking more about long-term prosperity for the companies they lead (and by extension our economy as a whole) rather than just about long-term prosperity for the directors.

It also – and this is really interesting – draws attention to a growing body of academic research that shows that performance pay does not work. This, as Anthony Hilton points out in The Independent is a “heresy of heresies” in the corporate world.

It also appears to be true: “when people are doing manual tasks, the prospect of a bonus improves performance, but in intellectual jobs, bonuses seem to inhibit performance and the more demanding the intellectual challenge, the more damaging it is to have a bonus dangling in the background.”

So bonuses don’t just enrich the few at the expense of the many, they also actively inhibit the long-term performance of our companies.

Who’d have thought it? Certainly not the remuneration committees that allowed the average FTSE 350 directors total earnings to rise 108% between 2000 and 2010, a time in which pre-tax profits rose only 50% and average share prices actually fell 5.4%.

So what next? If we know (and Hermes knows, and the NAPF knows) that excessive boardroom pay does exist and is a very serious problem, what do we do about it? How do we get boards to even understand the problem? How do we then make it less extreme – bringing levels of pay down and making the ratios between those at the top and those at the bottom better?

Hermes has a few thoughts. The government has proposed a few ideas too, as has Sir Mike Darrington, the ex-CEO of Greggs. He’s not shy of having a go at specific payments (Bob Diamond, Stuart Rose and Sir Terry Leahy all come in for well-deserved flak) and goes so far as to say that if all board pay was cut in half, most members would “still be overpaid”.

Finally, I’ve just received a list of ideas on the subject from Mark Slater of Slater Investments. He points out that “management incentives for executives running quoted companies decoupled from performance many years ago and show no signs of moving back in line”. There are some good ideas here – the ones I think will work are below.

No more remuneration consultants. Why does a company need to be told what to pay someone? Surely you just find the right person, offer them what seems about the right salary and see if they say yes or not? A bit like offering anyone else a job – the idea being to drive the price down as low as possible.

No more complication. This is related to the above. Consultants, says Slater, “adore complex and often multiple incentive schemes”. There are salaries, bonuses (some of which are often linked to nonsense criteria such as ‘personal development’), LTIPs, performance share plans, ESOPs, endless option deals and so on.

Let’s dump the lot and just have salaries. And if we must have bonuses, lets make them very simple – aligned to very demanding performance targets in such a way that performance can not be confused with luck

Make those bonuses paid in shares that can’t be sold for seven years. At least.

No more special pay rises. Hermes suggests that directors should get the same pay rises as everyone else (“why should the rate be 6-8% for executives and 2% for everyone else?”). That doesn’t seem unreasonable.

• Create a very powerful remuneration committee chairman – preferably one who is not part of the old boys’ club and so not someone who has benefited or is benefiting from the high pay environment around her. Mark Slater suggests we guarantee this by making it a woman, but any strong outsider should be able to do the job.

Create shame. There was a suggestion that non-director employees should sit on the remuneration committee in order to keep pay down. I don’t think that is quite the right answer. But it might make sense to have employee observers sitting in a corner somewhere. If the board chairman knows there is someone sitting in the room making a top whack of say £30,000 a year, she/he might be less likely to allow someone else £3m.

• Shareholder approval. Right now companies can ignore shareholders if they vote against remuneration plans. That’s just silly. On the plus side, changing it is already in the government’s proposals.

I’ve written here before about just how important all this is (you can make an excellent argument to suggest that income inequality has been the main cause of our financial crisis).

I’m glad to see that an increasing number of people seem to agree – and that the ideas about how to deal with it are now coming thick and fast. Any others welcome.