Select Committee on Trade and Industry Minutes of Evidence


Examination of Witnesses (Questions 161-179)

MR JOHN CRIDLAND AND MR ROD ARMITAGE

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 in Britain?

  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 companies.

  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 of quantum.

  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 problem—you 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 any value?

  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 say—and I might be tempted to be one of them—that 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 has worsened.

  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 our members.

  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 or convention?

  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' notice—I am sorry, 12 months' notice—

  Q178  Mr Hoyle: Do as I say not as I do!

  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.


 
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