'Highly Motivated' - Approaching the Challenge of FTSE100 Executive Remuneration
by Dr James Corah
Posted: 7 Nov 2011
'Most notably, financial services professionals in London tend to think that bankers, stock brokers, FTSE 100 chief executives, lawyers and city bond traders are being paid too much.'
'...around 2 in 3 [financial services] professionals (64%) say that [salary and bonuses are] their number one motivation and a further 21% say it is their number 2.'
(Value and Values: Perceptions of Ethics in the City Today, St Paul's Institute, 2011)
The current level of executive remuneration at FTSE 100 companies is a matter of much contemporary debate. In a recent Discussion Paper, released September 2011, The Department of Business, Innovation, and Skills (BIS) noted that, 'the median total remuneration of FTSE 100 CEOs has risen from an average of £1m to £4.2m for the period 1998-2010'.
Further contributions to the debate have been made by organizations including, but not limited to, investor groups (including the Association of British Insurers and work commissioned by the Church Investors Group - CIG) and the High Pay Commission (operated by Compass and funded by groups including CIG member the Joseph Rowntree Charitable Trust). Furthermore, whilst each of these organizations represents quite different stakeholders there is a high degree of commonality in their messages; three key points are reiterated in each:
· Levels of executive remuneration have increased significantly of late and have become de-linked from wider remuneration structures both within the companies in question but also within wider society.
· Executive remuneration should be linked to long term shareholder return and that current levels of remuneration suggest that this has not been adequately achieved.
· Pay should incentivize long-term behaviour rather than short-term returns based upon risky activities.
The report released today by St Paul's Institute highlights the crux of the debate (albeit from a narrower financial services perspective); financial services professionals believe that they are paid too much, but their key motivation is that of financial reward. For shareholders, and asset owners, this can be interpreted as the need to adequately motivate and reward executives whilst not exacerbating inequality to the levels where capitalism loses its 'license to operate' (as David Blood, of Generation Investment Management, warned at a recent St Paul's Institute and CIG event). This position is perfectly paraphrased by Vince Cable in his foreword to the BIS Discussion Paper:
'Of course, generous rewards are justified where a company has shown strong long-term performance. However, over the last ten years the link between median CEO pay and performance of the FTSE100 has been hard to discern. Although concerns about executive pay are not new, the recent financial crisis has made shareholders, the public and Government more acutely aware of the issue and more critical of perverse incentives or excessive levels of reward. Shareholders and wider stakeholders, such as employees and customers, want to see executive pay that is proportionate and justified and are rightly concerned when it is not.'
As a specialist investment manager of Church and charity assets CCLA, on behalf of our Church of England Parish, School, Cathedral and Diocesan as well as other Christian clients, joined a growing coalition of Church investors (including the Central Finance Board of the Methodist Church) in adopting common principles for voting upon executive Remuneration Reports at UK company AGMs (the CIG template is administered by UK proxy voting agency PIRC).
This initiative takes a two-track approach representing both our Christian clients' ethical concerns about 'excessive' executive pay whilst also, as a responsible investor, assessing whether the company's pay structure adequately motivates executives to generate sustainable long-term returns. The initiative thus addresses each of the three points identified in the wider remuneration debate. In 2010 the bespoke voting template only supported 8% of FTSE 100 remuneration reports that were assessed.
A further element of the CCLA approach to remuneration over the past year has been to actively engage with the companies in our portfolios about the contents of their executive pay plan. As per the two-track 'ethical and responsible' approach identified above these letters contained details of our clients' concerns about excessive executive pay and also tailored details of our concerns, should any exist, about what type of behaviour each particular pay plan was motivating and whether it was adequately linked to shareholder return. (In addition to this, on behalf of the wishes of some of our United Reformed Church and other Christian charity clients, this engagement also encouraged FTSE 100 companies to consider paying all directly and indirectly employed staff a minimum of the national living wage as part of their wider remuneration strategy).
The engagement was predominantly undertaken by letters sent to the Company Secretary. The replies received were somewhat indicative of some of the corporate behaviours identified by BIS, amongst others, as being drivers in increasing executive pay. The most evident of these was the tendency amongst companies to, not only, legitimise their executive remuneration by comparing themselves to both UK and international peer group companies:
'[COMPANY A] uses a comparator group of similar multinational companies, not all of which are based in the UK, to benchmark our executive remuneration. We are satisfied that the levels of executive remuneration are not excessive, and that there is a very strong link between the performance of the group and the individual.' (Company A, reply to engagement letter)
'As part of the recent remuneration review, the Committee undertook a detailed benchmarking exercise comparing reward for executive directors to companies of a similar size and complexity. Total remuneration opportunity is positioned at around median compared to this group which the Committee considered to be appropriate in the context of the experience of our executives.' (Company B, reply to engagement letter)
but also to seek to 'out pay' theirpeer group so as to secure the most talented staff:
[Company C] implemented a policy of being in the top quartile of FTSE 100 companies in terms of executive pay in order to retain key staff, reflect the company's position in the FTSE 20, and reward executives for the company's continued growth. (Company C, extract from engagement meeting minutes).
Consequently, by seeking to pay executives packages that are either at or above the median levelof their benchmarked peers,these executive remuneration policies act as a ratchet constantly raising average levels of executive remuneration. The report released today by St Paul's Institute highlights the crux of the debate (albeit from a narrower financial services perspective); whilst financial services professionals believe that they are paid too much, their key motivation is that of financial reward.By acknowledging that they are both paid too much but also that they are motivated by financial return the polled financial services professionals show the need for outside organizations, such as governments, shareholders, and bodies such as St Paul's Institute, to constantly monitor the balance between motivation and reward.
The opinions expressed in this article are those of the author, and do not necessarily represent the views of St Paul's Institute or St Paul's Cathedral.