some default text...

Business Innovation and Skills - Minutes of Evidencehc 460

Oral Evidence

Taken before the Business, Innovation and Skills Committee

on Thursday 28 June 2012

Members present:

Mr Adrian Bailey (Chair)

Katy Clark

Julie Elliott

Rebecca Harris

Ann McKechin

Nadhim Zahawi


Examination of Witnesses

Witnesses: Rt Hon Dr Vince Cable MP, Secretary of State for Business, Innovation and Skills and President of the Board of Trade, and Caroline Normand, Deputy Director for Corporate Governance, Department for Business, Innovation and Skills, gave evidence.

Chair: Minister, good afternoon and thank you for agreeing to speak to us on this subject. If you and your official would like to introduce yourselves, we can then go into our first question.

Vince Cable: I am Vince Cable, Secretary of State for Business, Innovation and Skills.

Caroline Normand: I am Caroline Normand, a deputy director at the Department for Business, Innovation and Skills, and I deal with corporate governance.

Q1 Chair: I am sure it will be no surprise to you that the focus of my opening question is the banking scandal that has hit the headlines over the last 48 hours. It is currently focused on Barclays, but we know it could well spread to others. Once again, the culture of this industry is under scrutiny, and I think it is fair to say that in the past you have had strong views and uttered them in equally robust terms. Could you tell us how your proposals might have prevented this had they been in place beforehand?

Vince Cable: You are quite right, it is an appalling scandal and it has created great damage to the reputation of Barclays and the industry. The Chancellor responded on behalf of the Government this morning. He explained how the current system of regulation of banks will make that kind of action less likely in future, and how that kind of regulation is an improvement on what went before. My involvement is more indirect: we are seeking to strengthen the system of corporate governance, particularly in relation to executive pay, including the chief executive of this bank. You will remember that a few weeks ago a substantial number of shareholders of Barclays-about 30%-expressed dissent over the chief executive’s pay. What that signals to me is that there is already a high level of shareholder engagement in the affairs of that bank, which is absolutely right; and they are therefore in a good position to take any follow-up action that is required. The system of bank regulation is not something which I have responsibility for, but the Chancellor made a very good case that we have significantly strengthened it.

Q2 Chair: You made the point, quite accurately, that there was a degree of shareholder dissent, but it was not a majority. While we all know Mr Diamond has forgone his 2012 bonus, he was handed £2.7 million in 2011, which pays out over three years. Given these events, should all these bonuses be clawed back, and do your proposals give an adequate mechanism for doing so?

Vince Cable: I think it is premature to decide what exactly should happen to Mr Diamond, whether in respect of his pay, tenure or any other aspect. The point made in Parliament this morning was that he has a lot of questions to answer, and some of those will be put by Parliament when he comes before the Treasury Select Committee, which is right. Depending on what those questions produce, the people responsible for his company can decide on the appropriate action, but it is seriously premature to decide now what action should be taken by the company.

Q3 Chair: Would you say that it reinforces the argument on binding annual votes? My understanding is that, under your proposals, in effect there is a vote on a three-year pay policy. In the event you get a three-year pay policy agreed and events such as we have seen unfold in Barclays happen subsequently, there appears to be no mechanism for shareholders-who may well, in the light of what has happened to Barclays’ share price, have a fairly strong reaction to it-to take immediate action against the salary and future bonuses of the chief executive. Do you not think that it strengthens the argument for shareholders to have an annual say, with a binding vote on remuneration, in the light of what has happened at Barclays?

Vince Cable: I do not think what has happened in Barclays today really changes in any way our judgments about the way top pay should be governed. There are mechanisms in the system to prevent abuse. You quite correctly said that the intention is that the forward-looking pay policy would be determined on a three-year basis unless the company decided to change it, in which case it would be annual. In addition to that, however, there is the existing advisory vote. If that were based on unsatisfactory practice in the previous year, we expect that the Financial Reporting Council will require the issue of a statement by the company-we cannot dictate to them, but that is the hope and expectation-and in addition the company will be required by law to have a binding vote the following year. So there is a feedback mechanism which is more short term.

You are alighting on one example, which is happening at the present time. I am dealing with legislation that, subject to the will of Parliament, will become law hopefully in about a year’s time and will affect future behaviour. Under that new system, assuming there is a new chief executive of Barclays in three years’ time, they will be governed very strictly by the terms of the pay policy agreed by the shareholders, and they cannot depart from it. We set out yesterday-hopefully, you already have it-in the rather precise terms described to you in this document, the kind of detail that would be required in seeking the approval of the shareholders, and any departure from that would be contrary to law, so a future chief executive of Barclays would be highly constrained on what they would be able to do on their pay and the shareholders would have very strong instruments to exercise discipline over it.

Q4 Chair: In the light of what you said, in the event of shareholders wanting to exercise rights to take action against the pay and remuneration of senior Barclays executives, what would be the earliest time they could do so under the proposals you are putting forward?

Vince Cable: Clearly, the board can act immediately.

Q5 Chair: I am talking about the shareholders, not the board.

Vince Cable: The shareholders as a whole would be able to take action at the first annual general meeting subsequent to these events, unless they convened a special general meeting, and there are provisions under company law to enable that to happen.

Q6 Chair: But they would not be able to exercise a binding vote at that meeting.

Vince Cable: They would have the advisory vote, as they do at the moment, and there would be a commitment to hold a binding vote the following year. We are talking about a different world here in which companies already have their pay policies embodied in law, so it would be very difficult for the kind of events you are describing to happen. What you may be considering, which is a perfectly legitimate question, is what happens in the transitional period when we have pay determined as it is at the moment, before these rules have come into effect. There will be a transition in which the additional powers will not be fully effective.

Q7 Chair: I am not sure it could not happen in the future, insofar as it is quite feasible for shareholders to agree a company pay policy and remuneration and then events that no reasonable shareholder could be expected to understand unfold, and they are locked into a process which, as far as I can see, means that, at the very minimum, it would be 12 months plus before they could take action on it.

Vince Cable: No. I am sorry if I have not explained it clearly. If some abuse took place, the chief executive in this case would be acting against a legally agreed pay policy. He would be acting illegally and there would be serious consequences in terms of penalties, so the protections that would be given to the shareholders are much stronger than they are today, and they would take effect very promptly if there had been an abuse of the agreed pay policy.

Q8 Chair: By whom would that abuse have had to be perpetrated?

Vince Cable: If it were the director of the company.

Q9 Chair: The point I am making is that it could happen on that chief executive’s watch and the shareholders, quite reasonably, want to hold the chief executive to account through his salary and remuneration.

Vince Cable: There is a protection which is the annual re-election of the directors. If the board does not take appropriate, effective and prompt action they will be subject to reelection themselves, and they know that threat is in the background.

Q10 Nadhim Zahawi: I want to take you back to the LIBOR scandal. You mentioned that the chief executive will have many questions to answer when he comes before the Treasury Select Committee, and those on the board will then have to make their mind up as to whether those answers were satisfactory. You have the power to deal with errant directors, so if those answers were not satisfactory would you be able to step in and exercise those powers?

Vince Cable: There are last resort powers of director disqualification, and many hundreds a year are subject to that action. If the facts suggested action-obviously, we would be subject to legal advice; this is a legal process-indeed that could well follow. That certainly is a sanction open to us.

Q11 Chair: Before we move off this subject, under your proposals how would you have expected a well-informed and reasonable shareholder to have voted on the remuneration decision on Barclays senior executives this year?

Vince Cable: I cannot put myself in their place, and I should not because it is their company, not mine. They did have a vote; they exercised their feelings, which were strong. There was significant dissent and, as a result, the remuneration committee has had to sit down with the chief executive and consider the terms of his appointment, which is how the system should work, but it is not for me to tell the shareholders and their representatives whether they made a good or bad call; that is not my job.

Q12 Chair: I quite understand that. What we really want to see is whether under your proposals they have an adequate mechanism to adjust their perspective, shall we say, in the light of changed events.

Vince Cable: They will have in future, when this system is in place.

Q13 Chair: But not at the moment.

Vince Cable: They have the existing advisory vote.

Q14 Julie Elliott: The Treasury Committee was told that pay transparency has led to, rather than prevented, the upward ratcheting in pay. How would you deliver fair and appropriate rewards to senior executives in the UK?

Vince Cable: That is the whole purpose of these reforms. As you imply in your question, we have had more transparency in the past, but that has not been accompanied by simplicity; it has been extraordinarily complex. It is often very difficult for shareholders and their representatives to understand what the pay package is all about. That is why we have given a pro forma and an indication under the regulations of what will be displayed, and it will be done on a comparable basis so shareholders can in future make an informed judgment. In addition, there will be a single number, a total pay package, which can be immediately accessed through the annual report, so in addition to transparency there will in future be much more simplicity and clarity, which will enable shareholders to express their judgment. I suspect that one of the reasons there has been pay ratcheting in the past-it is a deep-rooted cultural phenomenon, as you know-is that executives have just got into the habit of chasing the top quartile, and I suspect that until quite recently shareholders felt they had very little power to stop it. They have demonstrated in the last year that they have a good deal of authority, and we are trying to reinforce that.

Q15 Julie Elliott: It has been argued that the practice of benchmarking is a cause of ratcheting pay. Why did you decide not to introduce changes to benchmarking and incentives for members of remuneration boards?

Caroline Normand: Benchmarking is the practice whereby executives’ pay is looked at in comparison with similar types of executives in similar companies either in the same country or around the world. It is widely practised on the advice of consultants and others. One thing that the reforms do bring in is greater transparency about the use of consultants and the fees for consultants to the extent that pay is an element of that advice, so there is stronger control over the whole piece about advice and benchmarking that is brought in with the greater transparency through these reforms.

Q16 Julie Elliott: Did you look at whether benchmarking should be removed as a method of assessing pay?

Vince Cable: It is difficult to know. Clearly, there have to be comparisons; that is how pay is set. What we now feel, with the benefit of hindsight, is that that kind of decision making did lead to a ratcheting of pay, so we are creating more simplicity. People can now know more immediately what the impact of the pay award is and act against it. In response to your first question, I explained how we were trying to get a fundamentally better system, but what Caroline has suggested is also the case: remuneration consultants may, through benchmarking, perhaps rather lazily, have allowed bad practice to creep in. All we can do in practice is make sure that everybody knows who the remuneration consultants are, what their fees are and what their interests are in it, and thereby enable the shareholders to form a view about whether they have given unhelpful advice and have a conflict of interest.

Q17 Julie Elliott: Your proposals make no changes to the actual structure of remuneration committees or the way they operate. Why is this?

Vince Cable: Because we have taken the view that what is necessary is for shareholders to have effective control over decision making, which is what we are strengthening, and to have access to proper information. Were you raising the issue about diversity on remuneration committees?

Q18 Julie Elliott: No, the whole structure and the way they operate has not been addressed.

Vince Cable: I don’t think anybody is making recommendations to us that they should operate in a fundamentally different way. The one issue that we are pursuing through the review of corporate governance is the cross-fertilisation, if you like, of remuneration committees. There have been some cases where executives of one company have been sitting on the board of another and there has been a reciprocal exchange-when we looked at this there were a very small number. In the consultation that is now taking place we are looking at whether that should be barred or there should be some kind of control over it.

Q19 Ann McKechin: Today you have relied quite a bit on the issue of shareholder behaviour and pressure at AGMs. Evidence produced to our Committee by one corporate governance advisory group questions whether the level of dissent is actually unusual this year. It says that the average level of dissent registered in all explicit votes on remuneration was 11.7%, which was up from 9.6% the previous year, but significantly below the dissent levels of 16% and 12.4% in 2002 and 2003 respectively. The events that have occurred in the last 24 hours may have an influence on other major boards, but I would suggest that perhaps the jury is out as to the extent to which shareholder behaviour and pressure is going to see a major reform in remuneration at the top.

Vince Cable: We start from the premise that shareholders are the owners of the company. That is clearly the mechanism through which we have to operate. In terms of levels of dissent, I think we have had six cases in the last few months where there has been a level of dissent of over 50%. From recollection, there are 14 or 15 cases where there has been over 20% dissent, and those have been major and very high-profile companies involved. Although that may be a relatively small percentage of the total number of companies, the very high visibility of that dissent undoubtedly encourages others. I would expect, therefore, that the momentum that has been achieved will be sustained, and our legislation is to make it easier for those companies that currently have fairly dormant shareholders to be more actively engaged.

Q20 Ann McKechin: You are right, there was a lot of press last year about remuneration, but just this month it was reported that the chief executive of Thames Water has been rewarded over £400,000 on top of his annual salary of £425,000 despite the perception that he has got lower profits, worse customer satisfaction and a hosepipe ban. That message does not seem to be coming across to every board yet. Have you made any studies about why remuneration boards appear to reward failure so easily? What consultation have you carried out?

Vince Cable: I do not know the details of Thames Water. You are suggesting that somebody has been given, or has awarded themselves, a large bonus despite deteriorating performance. That could not happen under this system, because under the binding vote system the company will be required to set out not just the maximum pay level under the pay policy but the performance metrics that will be used, and, if a chief executive does not meet them they would not be able to give an award; it would be against the policy that the shareholders have voted for; it would be illegal. It would be a much stronger safeguard than currently exists against that kind of behaviour.

Q21 Ann McKechin: You have talked about the parameters in terms of how you would measure performance. There has been evidence about the difficulty of accurately measuring performance with outputs in a company when it comes to the chief executive of a major plc, as opposed to a smaller company where personal influence is much more direct. What consultation have you carried out with business and shareholders about how they are going to be able accurately to calibrate performance against output and profit levels?

Vince Cable: This document is the consultation on whether we are asking the right questions and getting the right documents and layout. That is exactly what we are trying to achieve. We got agreement and consensus in principle that this is the right approach, but you are quite right that this is a complex area. We have to formulate this in a sensible way that is not overcomplicated but none the less captures all the relevant dimensions. I do not know off the cuff how you would capture the effects of a hosepipe ban on consumer satisfaction, but obviously it is highly relevant if you are talking about a water company.

Q22 Ann McKechin: Presumably, you might be considering different criteria for different sectors.

Vince Cable: Yes, but there are certain basic requirements from the shareholder point of view.

Caroline Normand: Exactly that, and within the pay policy the company will need to put out the performance criteria it is going to meet, and shareholders will need to vote and say they are happy with that in order to approve the pay policy, so it will all be set out very clearly.

Vince Cable: In the case you have mentioned, which is a regulated monopoly, the performance criteria regarding the level of service the company provides will also be set by Ofwat. Presumably, there would be penalties on the company if they failed to meet them, and the shareholders would have to decide as part of their policy what rewards or penalties exist for the chief executive if they fail to meet their regulatory standards.

Q23 Ann McKechin: You would then expect Ofgem and Ofcom also to have the ability to give guidance on pay.

Vince Cable: They have a system of rewards and penalties for the company, and the company’s job is to decide how that is translated into rewards or penalties for their executives.

Q24 Rebecca Harris: We have heard an awful lot about the shareholder spring, but the report shows that shareholder dissent levels remain quite low. How confident are you that the shareholder spring exists and there is really an appetite out there?

Vince Cable: The last question from Ann McKechin was in a way the same point about the low level of dissent. A fundamental change, as opposed to a change at the margin, is that in future companies will have to get the support of a majority of their shareholders to get their pay policy approved. It is a much more proactive process. They cannot continue to rely on inertia, because in order to have a legal pay policy they have to get their shareholders to agree to it; they have to get a majority of them to vote. They now have to get endorsement; it is not a question of waiting for people to object.

Q25 Rebecca Harris: There is also the issue of how much shareholders are actually engaged rather than ticking boxes every year.

Vince Cable: They will have to be engaged in order for this new system of laws to operate, and good companies already do engage.

Q26 Rebecca Harris: Do you think that some of the concerns about executive pay and shareholder discontent might be reflected in the wider economy, in that when there is an upturn in the economy shareholders are much more relaxed and unconcerned?

Vince Cable: I am sure you are right. What is particularly jarring over the last year has been the decline in real pay because of wider economic conditions. You have had a 10% increase in senior executive pay and no improvement in the basic FTSE index. Clearly, the conditions play a part, and partly because of difficult economic conditions people are reacting very strongly to abuses or extremes in the pay system. You may well be right that in happier times there was less pressure, but that is why we are trying to bring in a system which creates a long-standing discipline. We are trying to get behaviour to change in the long term, not just encourage spasms of interest in difficult conditions. We are trying to introduce a systemically stronger, better way of doing things.

Q27 Katy Clark: You propose to bring in measures to give shareholders a binding vote on companies’ pay policies. How satisfied are you at the moment that shareholders have the information they need to be able to make such decisions?

Vince Cable: They are not satisfied; indeed, the information is often inadequate, over-complicated and inconsistent. We are trying to deal with all those things systematically, and the purpose of the regulations, which we have seen, is to create a system of providing information that is easily understandable, is reduced to consistent metrics and, in the extreme case, can be reduced to a single figure. You are quite right; the background is not a satisfactory one. We are trying to reform it.

Q28 Katy Clark: What additional advice and information do you think shareholders need to be able to make these decisions?

Vince Cable: As we have set out here, they need to understand exactly what are the strategic objectives of the companies, what is the maximum level of pay both in aggregate and in relation to its components-pensions and bonus schemes, as well as basic salary-and what the performance is being measured against, because there are different ways of measuring the performance of senior executives, so they are absolutely clear and explicit about what those are. We have set out what we think are the categories of things shareholders need to understand in order to make a judgement and explain through worked examples what it would look like in practice.

Q29 Katy Clark: You will be aware that we hear an awful lot about people who will leave the country if attempts are made to control executive pay. What work has your Department done on this, particularly to quantify the risk of executive flight?

Vince Cable: I do not believe in it. Whenever the Government suggest anything controversial, whether it is on tax or pay, they always get the cry from some people, "We’re going to leave the country." I do not believe that is credible. Indeed, what is happening is that the kind of actions we are taking are now being mirrored in other countries. The kind of regime that we are recommending has been introduced also in the Netherlands. You can argue about whether the European Commission should be involved at all, but, to the extent it is involved in corporate governance, it is recommending a very similar system to ours. There are separate actions in the United States, though not quite in this form. I think all major western countries now recognise that there has to be stronger corporate governance in relation to top executive pay. I think we are going to be regarded as one of the international leaders, and it would be highly improbable that we get a flight from Britain on the back of it.

Q30 Katy Clark: The Office for National Statistics tells us that 40% of UK equities are now held by foreign investors. What do you think the consequence for corporate governance is going to be in terms of having more diverse and dispersed share ownership? Do you think it will have an impact?

Vince Cable: It is a good question and an important issue, and it is certainly one of the factors we are looking at in terms of the wider reviews of corporate governance, which for example John Kay is undertaking, and long-termism. Who are those investors? Are they short or long term? How do they change corporate behaviour? In practice many of those overseas investors will exercise a vote through nominees; that can happen. Many of them simply do not vote. We have had quite high levels of participation in the last year or two from British-based institutional investors-various surveys have been done that suggest it is probably about 75%, and there is a TUC survey that suggests it is about 65%, but in either case it is quite high, so most of the voting is done by British institutional investors. If foreign owners do not want to vote, that is their choice.

Q31 Katy Clark: Would you say similar things about hedge funds where people hold shares for a relatively short period of time? Do they have the interest or the incentive to engage with the companies they invest in? Do you think your proposals will have any impact on how they behave?

Vince Cable: We would hope that they would think in future in a somewhat more long-term way. The Chairman started asking me about three years versus one year. Depending on the way companies operate their remuneration policy, it could be one or three years, but one of the advantages of having this three-year system is that it encourages long-term planning, in this case of remuneration, and hopefully that would engage potentially speculative short-term investors in a longer time horizon, which is what we want to see in Britain. Britain has been done a great deal of damage by too much short-term thinking among investors, and we want to try to change that.

Q32 Chair: Following on Katy’s question, if a substantial shareholding was held by a foreign company and they did not exercise their vote on remuneration, how would your proposals deal with that in terms of framing a pay policy?

Vince Cable: I do not know if this totally answers your question, but the regulations we are talking about apply to companies that are listed here, but are also British-registered. So if it is a genuinely foreign company in terms of registration these rules would not apply; they would be governed by the rules of their own countries.

Q33 Chair: But presumably there could be a majority foreign shareholder in a British-registered company.

Vince Cable: There could be, yes. How would we deal with that?

Caroline Normand: The question was how the regulations would deal with substantial foreign shareholdings. The first point is that we would encourage this. A lot of foreign shareholding is managed through UK investment managers, and it is very important that voting by institutional investors has gone up.

Q34 Chair: There is an issue about that which I want to raise later.

Caroline Normand: That is the asset management piece. There is also work to continue to encourage foreign investors to exercise their votes. The other point the Secretary of State has alluded to is that, in parallel with the legislation we are taking through, the Financial Reporting Council is going to consult on amendments to the corporate governance code, such that when there is a substantial vote against either the binding vote or the advisory vote, the company should issue a statement saying what those issues are and say something about what they might do about it, but the detail of that will be subject to consultation. That is a way of bringing pressure to bear on companies where there are substantial foreign owners, or people who are not exercising their votes but there is still concern, and you can see that through the voting pattern. That is another way these reforms will impact.

Q35 Chair: But is there anything that could prevent a foreign majority shareholder effectively sabotaging, or indeed reinforcing, a remuneration package, irrespective of the wishes, if you like, of maybe a substantial minority British shareholder?

Vince Cable: The question you ask raises a wider issue about whether foreign ownership is desirable or undesirable in itself. If you have dominant foreign ownership that affects a whole lot of things, not just remuneration; it affects long-term investment decisions. We can have a debate about whether we regard foreign ownership as healthy or unhealthy. Our broad view is that it has been beneficial to the UK. We do not want to discriminate against it, but it could have the consequences you describe.

Q36 Chair: Would it be fair to describe it as work in progress?

Vince Cable: We are not proposing to reopen the question of foreign ownership in corporate governance, but you have raised a perfectly valid point that there are certain contexts in which UK institutions would not have a dominant role in the setting of pay policy. There are probably not many, but there would be some.

Q37 Chair: Can I come on to some procedural issues? I understand you are tabling the changes to shareholders’ votes through primary legislation. However, for the reporting rules you are replacing schedule 8 of the Companies Act by secondary legislation. Why can’t you put all of them through primary legislation, where everything could be open to a higher level of scrutiny?

Vince Cable: I am not sure about the primary versus secondary issue. What has happened with the regulations is that we are taking out an existing set and replacing it, so in a sense there has already been parliamentary scrutiny of the basic legislation; we are just replacing an existing set of regulations with another. That is correct, isn’t it?

Caroline Normand: That is right.

Q38 Chair: But is that a reason for not opening it up to a higher level of scrutiny?

Vince Cable: We believe there will be a high level of scrutiny of the legislation. Indeed, my colleague is going to present the reforms, the new clauses, to detailed scrutiny in the Standing Committee of the House very soon. We are very open to scrutiny; we are perfectly happy to have these things scrutinised. I think it is just a question of the level of detail. Where we are dealing with very detailed regulations the normal practice is to do this through the secondary route. We are certainly very happy to answer questions on them.

Caroline Normand: The straight answer is that we have power to make the amendments to the regulations, and our legal advice is that we should use the existing powers where we have them and amend by primary legislation where that is the appropriate route.

Q39 Chair: My understanding is that statutory instruments cannot be amended, so you are replacing them by regulations which, while you say they are subject to a high level of scrutiny, are not amendable.

Vince Cable: We are consulting on it. If there are aspects of it that trouble you and other members, we are very happy to answer questions on them. We are not trying to evade scrutiny of them. There will be a public consultation with the people most affected by them, and that will be very transparent and reported.

Q40 Chair: You are open-minded about it. Would that be a fair comment?

Vince Cable: We are acting on legal advice as to what is the best way of progressing this, but if there is discomfort about some of the detail of the regulation we are very happy to field people who can answer the questions.

Q41 Chair: On remuneration reporting, consultation is taking place. I think it is fair to say that both you personally and your Department have a fairly clear direction of travel on this. What happens if the consultation comes in with a converse reaction?

Vince Cable: We do listen. We have had a whole succession of consultations so far. The question you started asking me about-the one year versus three years-was taken in response to the existing consultation process. It was the institutional investors who argued that that would be a better system, and we listened to them. Similarly, the 75% rule, which we had originally discussed, we have modified somewhat in the light of the consultations we have had, so we are listening and trying to respond as best we can. I do not think that in the existing consultation process we are likely to come across a fundamental challenge to the principle. If we are asking, for example, what is a substantial minority, we are asking for guidance as to a number. I do not think there is any challenge to the principle here.

Q42 Chair: Can I go on to remuneration packages? They are notoriously complex. You propose the introduction of a single figure of the total pay directors receive for the year. What guidance will you give to ensure companies provide consistent and comparable statistics for their shareholders?

Vince Cable: The document you have is designed to guide companies. It is quite extensive and detailed. I do not know whether the Committee has had time to look at it, but it is designed to be as helpful as possible in identifying the elements that need to be in the report, in particular how the single number should be compiled.

Caroline Normand: That is indeed the case. The single figure in particular is based on guidance that we received from the Financial Reporting Lab, which has done an exercise with investors and companies together working out the best way of calculating a single figure. The regulations will be clear about how that needs to be calculated so it is consistent among companies, and there will be guidance underpinning that.

Vince Cable: I think that on pages 21 and 22 of the report there is a detailed section explaining how the single figure could be derived.

Q43 Chair: Currently, the four big banks have to disclose pay packages of their five highest paid executives. The High Pay Commission last year recommended that all firms should publish the pay packages of the top 10 executives outside the boardroom. Why did you decide not to include this proposal?

Vince Cable: There is an issue about very highly paid executives who are not on the board, but our belief is that this is almost entirely in the financial services sector and in the banks where you have extremely highly paid traders who are not necessarily board members. The Treasury has separately consulted on regulation which requires greater transparency among that group. We believe that for the 1,000 listed companies that we are concerned about, other than the banks, that is not an issue, and almost all of the highly paid executives will be captured within the framework we have set out.

Q44 Chair: I suppose the question is: unless you demand that this package is published you do not really know.

Vince Cable: No, but we know enough about British companies to know where the high pay is, and the vast majority of companies are fairly hierarchical and it is the chief executive who is best paid. The situation we have had in recent years in the investment banks is very particular to that industry, and that is why separate financial services regulation has been developed to deal with greater transparency there. We did not wish it to be assumed that every British company operates on the same basis; it does not.

Q45 Chair: First, I cannot understand why, if there is a process by which the banks will be obliged to publish it, there is any problem with other companies. Secondly, if as you say it will not affect most companies, what is the problem with implementing it anyway?

Vince Cable: If a hypothetical situation arises where this regime proves so draconian-I do not think it is-that people stand down from the board to enjoy a high salary without the same degree of scrutiny, there may well be occasion for coming back and having a look at it, but our current understanding is that the situation you are describing is a banking phenomenon; it is not a phenomenon for British business as a whole. One of the reasons this operates within the banking system is the risk profile of the banks, and therefore it has to be captured in financial services regulation rather than in overall corporate governance reform.

Q46 Rebecca Harris: I want to go back to the difficulties sometimes in reporting executive pay accurately, and the High Pay Centre have outlined some of those. Their solution was that two figures should be produced: the pay received in any one year by the executive and the pay awarded, and the predicted pay-outs to the executive based on performance. Did you consider disaggregating them rather than having one in putting together your proposals?

Caroline Normand: The proposals for pay looking backwards are that there will be a single figure on the pay awarded, which is effectively awards received that year and also LTIPs (long term incentive plans) vested, but in addition companies will need to show what LTIPs have been awarded as the forward-looking piece separate from the single figure, so you will get a complete picture of both pay that has been awarded but also prospective awards that have been made.

Q47 Rebecca Harris: It is quite difficult, therefore, to address and evaluate the true cost of remuneration.

Caroline Normand: There is a choice whether you look backwards at what has been awarded into your pocket that year or whether you put the figure together by looking at the LTIPs that might pay out over the coming three years. The way we have constructed the single figure, on the advice of shareholders and companies when they joined together in the work of the Financial Reporting Lab, was that it was better to construct the single figure so you could see what was actually awarded in-year, and that was a better and clearer figure.

Q48 Rebecca Harris: What was guaranteed to be awarded.

Caroline Normand: Yes, what was guaranteed to be awarded, with supplementary information about prospective LTIP awards that might pay out over future years.

Q49 Rebecca Harris: That is, for example, remuneration offered in the form of share options, grants and that kind of thing-stock-based compensation-which might not materialise for several years.

Caroline Normand: That still needs to be set out. It will not form part of the single figure, but there will be information about it.

Q50 Chair: To a certain extent I have covered the area I want to question you on: the binding and advisory votes. If I could come back to one aspect of it, is it correct that you decided against allowing individual companies to adopt binding votes by amending their company articles?

Vince Cable: The suggestion has been made that we try to do this without changes to the Companies Act. We did not want to encourage that for several reasons. It is a much weaker approach; it would require voluntary action by companies. We are trying to set a general set of rules for everybody. It could well emerge in a highly inconsistent way with different companies changing their articles in different ways. It would be very difficult to make the kind of comparisons you invited us to make earlier, so we decided against it on those grounds. The other point is that, in order to change the articles of association, you need a 75% vote at an annual general meeting. It would be quite difficult to mobilise the level of engagement to achieve that. I think the approach we have adopted, which is fairly standard and is certainly supported by institutional investors as well as companies, is a better route.

Q51 Chair: You have also touched on the issue that, when a significant minority vote against a pay resolution, companies have to make a statement. There are two issues: how would you define "significant minority", and what would you expect to be in this statement?

Vince Cable: How we would define it is precisely what the Financial Reporting Council are talking to the various stakeholders about. I have said that personally I do not see why we should not have a 75%/25% split. I think that would be appropriate, but that is my own view and we are not directing the Financial Reporting Council. They will administer the stewardship code, and they are consulting about it. In terms of the exact contents, I do not know whether Caroline wants to add something.

Caroline Normand: The idea about content is that, as best practice now, it should say something about what the shareholder concerns are and what the company intends to do about it.

Q52 Chair: You have quite rightly pointed out that in effect you have delegated this to the Financial Reporting Council. I can recognise arguments about doing this through an independent body. How will you deliver on the promise if the FRC’s consultation rejects the proposal?

Vince Cable: If they comprehensively reject it we would have to think again, but the starting point is that the CBI, which is the spokesman for most of Britain’s large companies, specifically requested that the Financial Reporting Council do this, so it would be very difficult to imagine the circumstances of a complete rejection.

Q53 Chair: To go back to the issue of the annual or three-year vote, you have claimed that having a pay policy with a vote every three years would encourage companies to set out a clear long-term pay strategy. What made you decide that three years was the appropriate time scale?

Vince Cable: We discussed this. We had a consultation process with business groups, institutional investors and others who expressed an interest. The consensus among the institutional investors was that this would be a much more sensible way to do things. They argued, "Why would you necessarily want to do this every year if you’re simply going through the motions?" There is a relative scarcity of good analysts in the investor community. They wanted to focus their attention on areas where there was a problem rather than just go through the motions every year because it was a requirement. If the policy was unchanged they argued this was not a terribly good use of their resource, so they thought they could exercise more effective scrutiny on a three-year time horizon. There was the additional benefit that this would encourage the companies themselves to think in a more long-term way. That was how the idea was derived.

Q54 Chair: How would you get around the problem that companies may produce a somewhat elusive and broad pay policy and effectively, having conned the shareholders into agreeing it, it is now in place for three years?

Vince Cable: This was raised with me when I made the statement to the House. This is anything but elusive and vague; it is very specific. It explains in quite considerable detail every aspect of pay: maximum growth rates; performance targets; the strategic objective of the company. It simply would not be possible under this system for any company to get away with something that is fuzzy and cannot be properly judged by the shareholders. We have tried to make sure of that.

Q55 Chair: On the surface, that looks like quite a detailed and impressive template, if you like. However, many shareholders will not necessarily read it in detail and exercise the diligence they perhaps should. What other scrutiny and oversight is there as a failsafe mechanism to ensure that this elusive and broad-based policy does not get in by default?

Vince Cable: Government cannot do everything, and law cannot do everything. You are quite right that there may always be people who stretch the situation. The way this will be reinforced is that the institutional investors-we are talking here about the Association of British Insurers and the National Association of Pension Funds-are setting out their own guidelines about what they expect, which are consistent with what we have asked, that will give very precise guidance to their own analysts as to what to look for. In a way, there is a double lock here; it is what is established in the regulations, and it is what the institutional investors themselves decide is best practice.

Q56 Chair: On the surface, it seems to impose quite a few additional burdens on businesses. Have you made any assessment of it, and will it apply to every business in the UK?

Vince Cable: It will apply to 1,000 listed companies-obviously not to very small companies. We do not think it imposes significant regulatory burdens. We have a system of regulatory impact assessment, and it has not been judged to be onerous. The whole purpose of the consultation is to get consensus among the companies and institutional investors. They themselves acknowledge that this is not a burden, and we are producing regulations that are not additional but replace the existing set. There are good grounds for believing that no one could argue this is adding to red tape on business; it does not.

Q57 Rebecca Harris: In your ministerial statement you said that employee views were important and that companies will be expected to report on whether they have taken steps to seek the views of their work force. How will you judge the quality of their employee involvement?

Vince Cable: I hope this is something that might emerge from the Financial Reporting Council’s work. We are not probing in detail exactly how they consult their workforce; we simply ask them to acknowledge whether this occurred. We judged that this was not a very productive route to go down in any event, because when I was pushed in the House to explain why we were not having compulsory employee representation, for example, I had to explain the difficulties of trying to apply these rules in a multinational context.

As a result of legislation in the last Parliament, there are at the moment mechanisms by which employees can formally request to consult, not just on their own but their boss’s pay. There is a mechanism for them to do that. They do not need any new rules or regulations to make that possible. What we are asking is that companies should simply explain, not in detail, whether or not they have sought the views of their employees.

Q58 Rebecca Harris: So, will you be encouraging best practice, or minimum best practice, on that?

Vince Cable: We are not setting it out in a prescriptive way, but I happen to believe that it is good practice to talk to your employees and would like to see more of it. I have said that I think having more employees on boards is a good idea. We are not mandating it, but we think it is good practice and want to encourage it.

Q59 Rebecca Harris: Can I give you the opportunity to explain again why you are not proposing employee representation on remuneration boards?

Vince Cable: It is pretty much the same as the reason I gave to the House. There are two reasons. One is potential conflicts of interest and difficulties of reconciling the legal responsibilities of directors with being a worker in that company. If you change the arrangement, as you would in an employee-owned company, that is fine, and we ought to encourage that. But I think the main reason is that, when you have large companies with an international reach, as probably most do these days, how do you ensure that the labour force as a whole is properly represented? It is very difficult in practice. This may mean that a relatively small group of British workers exercise a view that ignores the views of the majority of the labour force who are overseas. It is very difficult to see how you could make this stick if it were done in a very prescriptive top-down way, but I am not trying to dismiss the idea. The more companies talk to their workforce, engage them and talk to them about pay at all levels the better. I would want us to do as much of that as possible.

Q60 Ann McKechin: You have mentioned this afternoon a number of reviews you are carrying out to take evidence and judge people’s opinion. I am right in thinking that it was the Government who set up the High Pay Commission. It was one of their specific recommendations that there should be employee representation on remuneration committees. You have obviously investigated this. They are people who have knowledge of corporate affairs and they have come to a professional and informed opinion about it, so why do you think they were wrong?

Vince Cable: I do not think we did set up the High Pay Commission. I have certainly found its work very good and interesting and have drawn on it, but I do not think we set it up. From recollection, they have 13 recommendations.

Q61 Ann McKechin: Yes, but they were supported.

Vince Cable: It is an organisation with good ideas. I recall that there were about 13 recommendations and we had no problems with 11 of them. We do not want to make the fixed ratio issue a mandatory point, though we think it is a good index to have, and we have not gone along with compulsory employee representation, but we have no quarrel with the spirit of it.

Q62 Ann McKechin: In other countries in Europe greater employee involvement in boards is the norm. This country is at the very low end of the scale. The fact is that in many industries and sectors-we have been talking about the banking industry today-there is organised trade union involvement. It would be very easy to find an employee representative to go on to the board of any one of our major banks.

Vince Cable: You can correct me, but I do not think it is common in Europe. It is common in Germany, because they have a system that requires it, and maybe in Holland. There are systems that have a two-tier board arrangement. The whole point of it is that in order for that to happen you would have to change fundamentally the way British companies are run. I have some sympathy for that. When I was in the Department back in 1979 we tried to introduce the Bullock report which would have incorporated German practice into British law, so I have been round that circuit, but it is more than just a question of incorporating workers on boards. The German system is fundamentally different, and you cannot just pick bits on an à la carte basis.

Q63 Ann McKechin: But it does have the benefit of greater diversity. We have spoken today about the lack of diversity on company boards and remuneration committees. Surely, all the evidence we have had over the last year, particularly this week, is that we need to change the way we operate our major companies in this new world.

Vince Cable: I completely agree with your argument. There is a lack of diversity and it has done harm. We are focusing at the moment on women representation and are getting some progress on that. I would certainly agree it would be desirable to have workers more actively involved and diversity in general, new as well as old. The only point of difference is the extent to which you make this compulsory and binding on everybody rather than encouraging good practice and trying to change the climate, which I think is happening in diversity in general.

Q64 Ann McKechin: Self-regulation still has a way to go.

Vince Cable: We are doing quite a lot of regulation on paper. On that particular one we have stepped back from making it binding.

Q65 Chair: Last year the High Pay Commission recommended that fund managers should be required to disclose how they voted on remuneration issues. Why have you not implemented this?

Vince Cable: The reason is that it is happening. As I understand it, there is already a provision in the law which would enable governments to force disclosure of how companies have voted. We and the previous Government have not used that power because the evidence suggested that it was happening. We have access to a couple of surveys: one by the Investment Management Association found that there was 75% participation, and the Trades Union Congress had another survey which came up with 65%. In both cases there was a progression to significantly higher levels of participation. The objective that the original legislation was designed to achieve is being achieved in practice. I made it very clear in the statement I gave to the House that, if this seemed to be stalling or going into reverse and there was a significant weakness in the transparency of voting, I would be very happy to return to the issue of legislative powers.

Q66 Chair: Those are encouraging noises. You may remember that I asked you a question when you made your statement. There does seem to be some dispute about the number of institutional investors that are conforming to this, because FairPensions report that the proportion is only 21%. I have seen another assessment that only 15% of asset management companies revealed their voting behaviour. Who is correct?

Vince Cable: We think that between the IMA and Trades Union Congress they have probably got it about right. We do not recognise those surveys. We have thought about this. We recalled the question you asked me and wondered if they were counting in large numbers of overseas voters or individual shareholders, but if it is in terms of the institutions themselves it is much, much higher.

Q67 Chair: I suppose the central point is that, given the power of institutional investors in determining company policies on vital issues like pay, there seems to be an inadequate and contradictory research base to say how they use their votes. Given the fact you are broadly in favour of them divulging their votes in effect, would you be prepared as a Department to carry out a robust research process in order to ascertain what the true level is?

Vince Cable: We can certainly undertake to go back to the data and surveys and see what is wrong and where the inconsistencies are. I would be very happy to correspond with you about that. Obviously, we need to get this right, and we have to have consistent evidence. I do not, frankly, understand why the two examples you have quoted are so far out of line with our figures, but you have issued a fair challenge and we will have to take it on.

Q68 Chair: That is fine. I am probing it because there would seem to be a discrepancy. If the figures that I quoted are right then potentially it could considerably undermine the point you are trying to make.

Vince Cable: I agree that if they are right it would undermine it and it would require action by us.

Q69 Chair: It has been an interesting session. I think there is a fair degree of agreement between the Committee and yourself, despite the fact there may have been some pretty probing questions. Would you think it fair to say that, in the words of Beecroft, we are all socialists now?

Vince Cable: As I said to Back Benchers on the other side of the House, I don’t think shareholder capitalism and socialism are quite the same thing, but if it is good policy I do not care what you call it.

Chair: Thank you, Minister.

Prepared 1st May 2013