Executive pay: fat cats and stakeholders

Richard Willsher asks whether the current UK debate should not be far more wide-ranging

It is open season for 'fat cats'. The UK Government's current consultation, Rewards for Failure Directors' Remuneration - Contracts, Performance and Severance, has seen to that.

The final date for submissions is 30 September and, on the face of it, all that is needed to fix the problem, which the Government clearly feels exists, is to come up with answers to the issues it raises. But it is not that simple and the consultation could end up misfiring on a number of important issues.

'The Government fully supports high levels of reward for high levels of success,' writes Secretary of State for Trade and Industry, Patricia Hewitt, in the foreword to the consultative document, 'and has also made clear that setting directors' pay in individual companies is a matter for those companies and their shareholders.'

The consultation affects only 'the remuneration policies and practices of quoted companies'. It refers widely to shareholders and has little interest in stakeholders. The paper attempts to tiptoe carefully and politically correctly among issues of whether regulation or best practice is the way forward. It adds the views of the National Association of Pension Funds and the Association of British Insurers in an appendix to assuage City concerns.

A key fundamental of the entire debate though is that we are talking business here. Not politics, not stock market games but the ambition of executives who would be rich.

'I am very struck by the fact that people have a choice between a Plc or a privately held company,' comments Mark Byford, a principal at Egon Zehnder International, the global search firm. Some executives may prefer to take a path with less transparency to their personal enrichment towards privately held businesses.

You wouldn't blame them. The rigours of running a quoted company are onerous when it comes to Stock Exchange regulations and managing investor relations. The vagaries of stock market behaviour are entirely beyond the control of company executives who are charged with the duty of enhancing shareholder value, against which, a strong body of opinion is saying, they should be measured for better or worse. This side of the debate is not being much heard currently and quite a number of companies, especially smaller quoteds, have voted with their feet over the last couple of years, choosing to de-list rather than expend their energies on stepping up to the next FTSE index - a sure-fire way of enhancing shareholder value.

The trouble with trusting to shareholder pressure to regulate executive pay is that shareholder democracy doesn't work. So large and so diverse are the shareholder registers of major Plcs that getting consensus from shareholders on any issue is virtually impossible. The vast majority of shareholders never go to the AGMs of companies in which they invest. In practice shareholders have virtually no significant voice in how companies are run' unless of course they are large institutions with substantial holdings and wish to be active in the running of the companies.

But by no means are all institutions active. A recent report in the Financial Times quotes Tom Jones who heads the investment management business of Citigroup as saying: 'I've got to say that I've got higher priorities. I'm not a do-gooder. I want to do what I get paid for, and shareholder activism isn't what I get paid for.'

If what fund managers are paid for is maximising the return on their investors' money then this can mean trading shares, switching in and out of companies and dumping those stocks which don't perform. This is probably not the sort of institution one would want to be dictating aspects of managing a business, such as setting executive pay levels.

Another weakness of a purely shareholder driven view of how executive pay should be governed is that it places undue influence in the hands of relatively few fund managers at the bigger institutions. The recent Director Remuneration Report Regulations may go some way to assist with this concern. Where trained experts in remuneration sit on company remuneration committees they ought to be able to do a good job. Sadly, there aren't that many such people about and, as those who exist may be made legally accountable for their decisions, they may be dissuaded from taking on remuneration committee roles.

Employees also - is anybody listening?

A large and largely unheard voice in the debate over executive pay is that of employees. The TUC speaks up with regular broadsides on 'fat cat pay'. A TUC report, Executive Excess - Time to Act, published in March 2002, drew on research commissioned by the TUC into the annual reports of companies and found that 'the median annual salary and bonus for the highest paid director grew from £201,000 in 1994 to £416,073 in 2001, an increase of 107% over the seven-year period. The median of average employee pay in the same companies rose from £19,272 in 1994 to £25,223 in 2001, an increase of just 31% over the same period.'

Some may say that this is what you would expect the TUC to come out with. But research carried out by PIRC - Pensions, Investment and Research Consultants in July 2003 seems to suggest 'excess' as well. 'There have been sustained year-on-year increases in FTSE100 director salaries. From 1993 to 2002, the median salary of the highest paid director in FTSE100 companies rose 92%, from £301,000 to £579,000. The maximum level of annual bonuses has significantly increased. In 1999 the majority of FTSE100 companies offered annual bonuses of between 40%-60% of salary. For 2003, nearly half of companies offer 100% of salary or more.'

Such statistical evidence suggests that employees would be very well-placed to act as a moderating influence on executive pay. A counter argument is that employees could be driven more by envy and resentment than by making a balanced judgement capable of taking into account the going rate for top executives in the international marketplace. In any case, there seems to be little if any consideration given to the views of employees in the current debate.

Suppliers

At Tesco's shareholders' meeting in June this year, the company's executive remuneration behaviour was derided as excessive. It was reported that an angry farmer at the meeting, who had been given shares by Friends of the Earth, said: 'Tesco made profits of £1.4bn, whereas total farm income, not profit, was £2.3bn and farmers are going out of business at 40 a day.'

The company's chief executive, Sir Terry Leahy, reportedly replied, saying that is was not profiteering, adding: 'We could buy products abroad much cheaper than in the UK but we don't because we realise these are difficult times for farmers.'

Should suppliers have a voice in setting the rules of fair play with their clients and customers such as setting levels of executive pay? They certainly have an interest in the well-being of those customers and perhaps, it could be argued, have a moral right to a voice in the governance of the supply chain in which they play a part.

He who pays the fiddler'

Last of the stakeholders, but probably the most important, are customers - an increasingly vocal group. If customers are sufficiently organised they can wreak havoc on large companies by simply boycotting their stores or their products. If cash is king in business, then those who spend that cash are the king makers - or breakers.

This is not to suggest that the Government's current consultation should encourage wide scale stakeholder activism. But limiting the executive pay debate to one that includes only the company and its (largely institutional) shareholders may not be sufficient to produce a credible outcome. All stakeholders could potentially have a voice that could make a contribution in helping to moderate excessive executive pay settlements and other unacceptable corporate social behaviour.

Richard Willsher is a financial and business writer with a background in investment banking. He is former editor of The Investor magazine.