Examination of Witnesses (Questions 161-179)|
15 JULY 2003
Q161 Chairman: Good morning, Mr Cridland,
perhaps you would introduce your colleague and yourself and then
we will get started.
Mr Cridland: Thank you, Chairman,
we are delighted to be here. My colleague, Rod Armitage, is the
Head of Company Affairs at the CBI and a lawyer. I am John Cridland
and I am the CBI's Deputy Director-General.
Q162 Chairman: Thank you very much.
We are dealing with aspects, you might say, of the post-Higgs
debate in the sense that we are looking at what the Government
has defined as reward for failure (question mark, I think) and
yourselves and the TUC are the last of the "usual suspects"
that we have today. I think the question that we have started
with is there have been some high profile cases of directors being
rewarded for failure and what we are not clear about is (and perhaps
you can put it in some kind of perspective for us) whether this
is a genuine problem or whether it is something that is attracting
unfavourable publicity at annual general meetings in one or two
companies. How do you assess it over the top, say, 1,000 companies
Mr Cridland: I certainly think
it is a minority problem but that should not underestimate the
seriousness that exists for those companies that have not adopted
prevailing best practice. If we look at trends over time we see
more and more companies adopting practices which would be considered
acceptable by their shareholders and we would see this summer's
events as something of a success for shareholder activism in that
we are not seeing the results of a failure of policy but the results
of a success of policy because shareholders are now able to challenge
practices that they consider unacceptable in that minority of
Q163 Linda Perham: It has been suggested
to us that proposals to limit the size of "golden parachutes",
if I can call them that, would lead to perhaps an increase in
higher basic pay when somebody is appointed and even "golden
hellos", so it would be at that end that there would be the
large package of remuneration. Do you agree that would be a problem
if this were tackled?
Mr Cridland: I do agree that there
is a risk that it shifts the attention from severance to remuneration
at the point of joining the business, but I think that reflects
a very genuine and inherent tension in this debate which is that
CBI members are fighting a war for talent to attract the best
chief executives and senior directors from around the world. They
are mainly global businesses we are talking about and at the end
of the day the remuneration committees have a duty to the shareholder
to make sure that they attract the most suitable person. It is
unsurprising that there will be this tension between the level
of reward and the nature of reward and the nature of protection.
If you weaken the protection, namely what somebody might walk
away with, then you might well need to pay more to attract them
in the first place. For us the really critical point here is transparency
and good practice on the terms of both of engagement and departure.
We think that where companies have got themselves into difficulty
is where they are not reflecting what shareholders would consider
to be acceptable and a lot can be done through shareholder activism.
It is now the turn of those companies that have not managed to
meet those expectations to do more by disclosure, by transparency,
by clarity of terms, as well as dealing with some of the issues
Q164 Linda Perham: But I would have
thought it does seem better to the public that if you have got
to get somebody, you have got to pay them a good remuneration
to attract them. That would be better than what seems like a reward
for failure if somebody is leaving a company where there are problems
and is seen to be given a huge payoff. Perhaps people would welcome
it that way round.
Mr Cridland: The CBI is convinced
that the problem can only be tackled at inception. Of course people
get very frustrated when they see these very large rewards where
they do not believe they are justified at time of severance, but
quite often it is already too late because the companies are dealing
with a contract that was signed a year or more earlier. We are
quite clear in the advice we give our member companies that tackling
this problem is all about the contract which is agreed when somebody
joins a business. It is too late to try to tackle the problemyou
have left it until the last minute.
Q165 Mr Berry: You are talking about
your members having to recruit chief executives from around the
world. Could you perhaps (not today but in a written submission)
give us some indication of what proportion of your members' chief
executives are recruited from other countries, particularly the
United States, because that is the high-salary economy. Off hand
what percentage would be recruited from outside the United Kingdom?
Mr Cridland: I have seen figures
that suggest that about quarter of leading FTSE company chief
executives are recruited from outside of the United Kingdom.
Q166 Mr Berry: From the United States?
Mr Cridland: I think the United
States would be a significant proportion of that but Europe as
well and I think sometimes too much of the debate focuses on the
United States because it is equally challenging to recruit senior
executives from Europe given that their remuneration arrangements
and disclosure arrangements are somewhat different.
Q167 Mr Berry: Any statistics on
that would be helpful. Could I turn to the Green Paper. As you
know, the Green Paper discusses a number of options. Could we
get your views on each of these briefly. First of all, although
the press this morning are full of Burberry's chief executive
being on a three-year contract and that is causing some debate
amongst its shareholders, one proposal in the Green Paper is to
move towards one-year contracts, which is increasingly common.
Do you think that can help address the situation? Are they of
Mr Cridland: I think we have seen
a steady but impressive move towards one-year notice periods in
contracts among senior executives. There has been a remarkable
trend in that direction and we think that does reflect best practice.
We have also noted a proposal in the consultation document to
bring down the legal limit from five to three years and that is
something that business would also support. I think what is critical
here is we would adopt the same approach to this as we would adopt
to the Higgs debate and the combined code. What is important is
"comply and explain". There are always exceptions, there
are always circumstances where the only way a business can win
somebody to add shareholder value is on slightly different terms.
What is important there is the company explains satisfactorily
why that is the case and that is accepted by shareholders. Rod,
do you want to add to that?
Mr Armitage: I think that is absolutely
right. I was reading through the reports of one of your earlier
hearings on 1 July with the ABI and the NAPF and I forget the
percentage but in the last two or three years there has been quite
an impressive increase in the number of FTSE 100 directors on
one-year contracts. That is already happening and that is one
of the best points of best practice. We do not think the answer,
other than perhaps a reduction in the general three years, is
to tackle it in company law because law is necessarily restrictive,
lawyers find a way around it and you cannot introduce a new law
every year or so, whereas best practice is continually evolving
and we agree with the ABI that there has been a big move. It is
not necessarily to one year; some companies might find reasons
for reducing it below one year.
Q168 Mr Berry: It could be argued,
could it not, that yes this has happened, there has been an increase
in one-year contracts but over the same period there has been
a dramatic increase in executive pay and evidence of payments
for executive failure so some might sayand I might be tempted
to be one of themthat this is a complete red herring. To
cite this as progress, as you have just done, is to fly in the
face of the evidence that over exactly the same period the problem
Mr Cridland: We come back to my
answer to the Chairman's initial question which is there have
been some high profile examples of whom have clearly failed standards
that we would want our members to adhere to but they are a small
number of examples, whereas the evidence you had from the ABI
and NAPF indicated that for the majority of companies, the ones
who do not get themselves into the headlines in this way, the
move has been steadily in the right direction. The other thing
I would say is that the question of notice periods is only one
element of a complex package of measures that deal with this.
We start with the nature of the contract, the terms within the
contract, we then move to disclosure, and having got disclosure
we then move to the regularisation of the contract of somebody
who is appointed into alignment with the other members of the
board. You may need to appoint somebody for the particular circumstances
you explain to your shareholders on a two-year contract if you
are bringing somebody in from the States or from Europe but we
believe over time that should reduce to a one-year contract. There
is then the question of what would be included in severance payments.
I would not suggest for a moment that one-year contracts with
notice periods are a sufficient answer but I would argue they
are one element of a package of answers.
Q169 Linda Perham: Is it not likely
that if you are offering somebody a contract for just a year they
are going to want a larger payoff at the end because they will
not have job security?
Mr Cridland: Are you thinking
in terms of a first appointment when somebody joins a board?
Q170 Linda Perham: Yes.
Mr Cridland: We believe that where
somebody joins a board and in particular is attracted from other
countries that it may well be necessary to appoint them on more
than a one-year contract but we think our members should reduce
the length of that contract to a one-year contract within, say,
two years of that individual joining the business.
Q171 Mr Berry: Phased payments has
been quite a popular solution with some of our witnesses, although
there are obvious disadvantages as well. What is your view about
the phased payments proposal?
Mr Cridland: We are still consulting
our members on the DTI document but so far phased payments have
received quite a thumbs up from CBI members. I think it is part
of a concept of mitigation which our members believe is at the
heart of dealing with this issue at times of severance, namely
we really ought to be encouraging both parties to work on the
basis that the departing executive only receives payments for
the period in which they are unemployed. There is an onus on the
individual to seek employment and if you add to that, say, monthly
payments then it influences the incentive structure.
Q172 Mr Berry: And liquidated damages?
Mr Armitage: On liquidated damages,
I think the point on them is that they are getting to be less
of a feature. I think they came to prominence about four or five
years ago because companies had difficulty satisfying the mitigation
issue and it was thought this was an elegant way round. I think
the attraction of liquidated damages is that there is a sum certain
to be paid but that is also the disadvantage because it is the
same sum regardless of the circumstances of failure, regardless
of whether an individual can get another job or not. Our members
are very keen on the emphasis on mitigation, which is part of
the general law already, but it should be emphasised. Of course
mitigation is something which is purely a judgmental factor. If
I am dealing with someone and severing their contract, what is
appropriate mitigation is a judgment on both sides and it is a
judgmental factor if it is a lump sum payment. Who can say whether
it is right or wrong. When it comes to phased payments of course
you do get the mitigation right because phased payments are for
whatever is the period of notice is, 12 months or so or until
the individual gets a comparable job, whichever is earlier. The
attraction of phased payments is that the company does not have
the publicity of paying out a huge amount of money regardless
of whether the individual falls into another attractive job the
next week or so; that is right.
Q173 Mr Berry: Finally, are there
any other solutions that you think should be considered that are
not referred to in the Green Paper?
Mr Armitage: One of the points
John referred to earlier and we are discussing with our members
is increased transparency. I think it has also been pointed to
by the ABI and NAPF. At the moment when there is a payoff of a
director, although some companies do announce the details, (largely
in response to press queries but some do it anyhow) the law does
not require that the severance details be published until the
report and accounts come out of the company, which can be 15 or
18 months later, and there is a point of view that increased transparency
on that aspect would be a good thing, which we are exploring with
Q174 Chairman: Before we go any further,
on the question of notice, why should notice periods be the same
as contract periods? Most people, even middle managers, serve
maybe a month to three months' notice. What is so magic about
extended notice for people or is it just part of the payment system
Mr Armitage: One has to look at
it partly in perspective. Like all things, where do you start
from? It was not so long ago that the average FTSE 100 director
was on a three-year notice contract. In fact before coming to
the CBI, I was on a three-year notice contract. As best practice
evolved, I and others brought our notice periods down. The firing
of anyone is a brutal situation if they have to look round and
find another job, but in jobs in the top echelon of companies
most of the advice is that on average for most people it can take
upwards of a year to find another job. There are exceptions and
some people go into another job very quickly, but for some people
it takes longer and that is the advice from a lot of people in
the recruitment industry. That percolates through to the people
they are talking to at the time of hiring and it gets reflected
in the contract. As I say, companies have been taking a downward
view on it and best practice is evolving, but that is what I would
say as an answer.
Q175 Mr Hoyle: Could I take you back
quickly to something you said to my colleague and something I
was interested in and I did not quite feel we got the answer to.
A one-year contract has been awarded but does that mean there
will be three years' payments of the money?
Mr Armitage: No, not at all. The
starting point of severance is what your contractual entitlement
is and you start off with a period of notice and then you look
at mitigation, can someone can get another job in six months or
nine months, and you apply it downwards. No, it would be a very
surprising contract if you had a contract which was one year's
notice but there was a liquidated damages clause with three years.
Q176 Mr Hoyle: It would not be dressed
up in that tone but in order for somebody to take the risk of
a 12-month contract would they not expect substantial payments
to ensure that they have got a run-in period for something later?
Mr Armitage: You can craft contracts
in lots of different ways. There have been contracts which have
been, say, over a 12-month rolling period but there has been an
18-month liquidated damages clause. That is to take into account
things like bonuses and fringe benefits. Those are becoming less
of a character of contracts but generally I would say that the
starting off period for the severance is what the notice period
is, just as with any other employer. There is nothing special
about directors' contracts except the notice periods and salaries
are higher because you are talking about the top people in a company.
The same applies to them as any other employee; you look at the
circumstances, you look at the contractual entitlements, and the
drivers are the notice period and the salary.
Mr Cridland: I think sometimes
within the popular debate people do confuse contract periods and
notice periods. For us what is important in relation to severance
is notice periods and we believe that the business community is
moving to a principle of good practice, with comply and explain
around it, of one-year notice periods or less.
Q177 Mr Hoyle: Just so I am clear
in my mind, where you are on three-year contracts is your severance
pay was whatever to three years; now you are on a one-year contract,
it is all pro rata, there has been no increase?
Mr Cridland: That is right.
Mr Armitage: If I am on a three-year
fixed-term contract with 12 years' noticeI am sorry, 12
Q178 Mr Hoyle: Do as I say not as
Mr Armitage: It would be a very
good contract! If it is a three-year fixed-term contract with
12 months' notice the driver is the 12 months' notice.
Q179 Mr Hoyle: We were talking about
the Green Paper and what is in the Green Paper. Do you think this
is an area that should have a legislative remedy to it?
Mr Cridland: We spent a lot of
time debating this with our members at the time of Mr Norman's
Private Member's Bill and I think the concern of the business
community was that legislation in this area would be a very blunt
tool. Rod has already made the point that legislation comes periodically.
We have seen best practice in this area evolving very swiftly
and the more we put into statute the less flexible arrangements
are. You can already see the impact of the ABI/NAPF guidelines,
which we are happy to support. We believe there is scope to move
the debate a bit further on as a result of this consultation.
If things are set in law they become very inflexible. In addition,
we have in our own membership debated at length how you define
failure in these terms. I am not saying it is impossible but it
is certainly extraordinarily difficult, and the last thing we
want is to have endless litigation around the departure of directors.
At the end of the day we believe that the business operates under
a licence to operate provided by the rest of society and it will
have to reflect what society is saying is acceptable. If it does
not, then ultimately Parliament will legislate, but we do not
believe that is necessary in this area. We think we have got a
small number of examples of unacceptable practice and that shareholder
activism (with more examples of what best practice really is to
aid remuneration committees) is going to be a much more attractive
and successful way forward.