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To be published as HC 72-ii

House of commons



Treasury Committee

Corporate Governance and Remuneration in the Financial Services Sector

Tuesday 12 June 2012

Mr John Lee, Mr David Pitt-Watson, Mr Anthony Watson and Mr Daniel Stilitz

Evidence heard in Public Questions 54 - 121



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Oral Evidence

Taken before the Treasury Committee

on Tuesday 12 June 2012

Members present:

Mr Andrew Tyrie (Chair)

Stewart Hosie

Andrea Leadsom

Mr Andrew Love

Mr Pat McFadden

Mr George Mudie

Jesse Norman

Teresa Pearce

Mr David Ruffley

John Thurso


Examination of Witnesses

Witnesses: Mr John Lee, Managing Partner, FIT Remuneration Consultants, Mr David Pitt-Watson, Chair, Hermes Focus Asset Management, Mr Anthony Watson CBE, Senior Independent Director and Chair Lloyds Banking Group Remuneration Committee, and Mr Daniel Stilitz QC, High Pay Centre, gave evidence.

Q54 Chair: Thank you very much for coming to give evidence this morning on a subject that seems a hot topic almost every week. Could I begin by asking you, Mr Watson-as opposed to Mr Pitt-Watson-whether you think there are any conclusions we might want to draw from what has just been announced on chief executive pay? It is on the front page of the Financial Times this morning.

Anthony Watson: I have not read the actual report; I have read the report in the FT. I think it is important to think about how those figures are constructed. Looking at the chart in the FT, it seems to me that the biggest increase of the various components of chief executives’ pay in that survey comes from the expected value of the LTIPs. One of the overriding difficulties in what people get paid, or how the media report what people get paid, is that they use the expected value of these LTIPs as opposed what they actually received in terms of the LTIPs. The way the thing works is that an award is made and then it is discounted back to an expected present value, and different companies use different discount rates. So you can end up with rather perverse outcomes on that.

Q55 Chair: So it is not just opaque, LTIPs, on grounds of complexity but also a perverse outcome?

Anthony Watson: I think so because you do not really get a sense of what most people are interested in, which is how much did this individual receive either in the form of cash or shares. I think the thoughts that have been around in terms of producing a single figure from what chief executives get paid, or what executive directors get paid, would be much better based on what they received in terms of the LTIP payout or the bonus payout and aggregating those, provided that one could get some measure of consistency between the timing of those payments between different companies and what is included in that.

If it all works out in the way these expectations have been built into the arithmetic, then there will have been an increase-in other words, the headline that chief executive pay has gone up by this amount will, in three years’ time, have turned out to be correct. Against that I think profits went up considerably during 2011, around 13%, and the problem of course arises from the fact that share prices went down over that period. So again, the difficulty that everyone would have with this is that pay has ostensibly gone up while share prices have gone down. That can happen, as we all know from studying the stock market, where share price and profits and pay are not consistent.

Q56 Chair: Anything anybody else wants to add on that before we move on to systemically risky institutions?

John Lee: Just a couple of brief comments, if I may. Every firm’s survey produces slightly different data, but at the basic salary level it just helps to look at the components of pay. The median level of salary increase for chief executives in the FTSE 100 last year was 2.5%, broadly consistent with the wider workforce. Some 27% of FTSE 100 chief executives got no salary increase last year. So in terms of fixed pay we are not seeing 10% or any other figure quoted in the FT today coming through there.

I think it is also slightly pleasing to note that bonus payments as a percentage of maximum were lower last year than the year before; that is the first fall we have seen since 2008. As Tony Watson said, the figure that we have seen the increase in is regarding the expected value of LTIPs.

Essentially, there are three parts to pay: there are basic salaries; there is an annual bonus that for FTSE 100 companies is up to about two-times salary; and there are these LTIPs which are awards each year of free shares linked to performance conditions over the next three years. In terms of that survey, what they have tried to do is value those awards on an expected-value basis and typically will put a value of around 50% to 60% of the value of the shares awarded. In terms of whether that is delivering ultimate value, that depends on whether those targets are met over the next three years. That survey-let’s be clear, executive pay has increased significantly over the last decade, so it is broadly true. I think there is always a danger when you get into the detail of those sorts of numbers and certainly my feel for executive pay is that this year was largely unchanged from the year before. I am not seeing massive inflation pressures there.

Q57 Chair: Everyone now wants to pile in on what was just a preliminary, but I will go to Mr Stilitz.

Daniel Stilitz: Just very briefly, I would just make a more general point, which is that it is to be noted that even in this year where there has been extremely close focus on executive pay and there have been so many studies showing how historically that has risen and risen, it is interesting that even this year it has gone up, on the face of it. One can look at the detail and see why that was, but on the face of it it has gone up by a substantial amount-substantially more than the general workforce’s pay has gone up and inflation. It seems to me that, notwithstanding the shareholder’s spring and so forth that is talked about, the general trend does not seem to have stopped.

Chair: So there is something amiss. Mr Pitt-Watson.

David Pitt-Watson: I think that is right. I think the Committee might be interested just to think through how it is that we are getting this inflation in executive pay. I do not think anyone would deny that we have had very considerable inflation in executive pay. That is despite the fact that over the last 10 to 15 years there has been a big focus on trying to achieve something called "alignment"-some sort of economic deal between the very top management of the company and what it is that the shareholders might be looking for. These processes of alignment have become ever more complicated. One of the things, for example, you will see in the FT today is we have been talking a lot about long-term rewards, so which is the bit of people’s pay that is inflated the most-it is the long-term incentive plan part of it. We have talked a lot about payment for good performance, so it is the bonus bit that is rising much more than the salary bit.

I think just from the debates we are having in the International Corporate Governance Network, which is a group of professional governance people from around the world, we are beginning to ask the question, does this alignment stuff really work? If you have a situation where the board of directors and the executives themselves know so much more about what it is that good performance is than do their shareholders, is it sensible to think about them as people to whom you are giving some specific prize, some specific incentive, or do we need to go back and think about how we treat them the way that we would treat most employees-pay them well to do the job if we can afford so to do.

But the nature of that employment relationship is the nature of a fiduciary relationship where we are expecting them to do the best that they possibly can for us rather than something where they are chasing a prize through these complex alignment systems that we are setting up. I think there is a large feeling globally now, particularly looking at the experience in America where alignment has gone to an extreme degree in its logic, that perhaps we should be moving away from those sorts of things, trying to create a different culture altogether.

Q58 Chair: While you are on these questions, perhaps I could ask you one of the core questions we are wanting to look at, which is whether you think that with respect to systemically risky institutions, mainly banks, there should be special arrangements or enhanced arrangements for corporate governance?

David Pitt-Watson: There are the Walker Report findings on the banks for governance overall. What is good for the systemically important institutions probably is good for everything but it is more important in the systemically risky institutions because they are systemically risky. I would observe as well that with institutions like the banks they do take very high risks. So a typical industrial company might have 50 pence of borrowing for every pound of equity that it has. For every pound of equity that a bank has, it will have £25 in borrowings-hugely more risky. Therefore, being absolutely sure that the way in which that is governed and the way in which its executives are incentivised becomes hugely important and I think one could look very closely at whether they are incentivised on a return on equity or earnings per share. That would seem to me to be something that one should raise concerns about because it encourages more borrowing, more risk taking. One should be concerned about the way in which profits are calculated and so on.

But what one is concerned about with the big financial institutions is something that is quantitatively much more significant, and maybe qualitatively, because they are systemically important. What would be good for them generally is probably also good for other institutions as well.

Q59 Chair: Does that justify a higher level of intervention by regulators in the remuneration aspects of corporate governance where it is alleged, with a good deal of evidence to support it, that bonuses and the bonus culture drove some of the high risks that we are subsequently all paying for?

David Pitt-Watson: I think my answer to that would be to say, "It depends". If you are saying would it be a good idea for a regulator to decide what people’s pay was in those institutions, that sort of tight regulation, I am not sure that that would be a good idea at all. However, if you are saying should regulators have huge and continuous anxious vigilance about the process by which those remunerations are decided and think about how it is that you nudge the system towards something that was safe, I would say, yes it is far more important that you do that with the systemically important institutions such as the banks than it would be with an ordinary manufacturing company, because they are systemically important and because they are hugely highly geared and therefore risky.

Chair: We will be looking at that in a bit more detail this morning. Andrea Leadsom.

Q60 Andrea Leadsom: It seems to me that any form of self-regulation around reasonable remuneration is just impossible. We have had the chief executives of some of the big banks in here telling us that they would not do the job for any less and yet notably we have had chief executives of investment banks take a half pay cut from £20 million a year to a mere £10 million for the privilege of a promotion to the chief executive of a banking group.

So blatantly that is not the case-there is a level beyond which it does not matter whether it is £5 million or £15 million; you are still interested in doing the job. I say particularly to Mr Lee that we do have a problem. I worked in remuneration, the other side of the coin from you, taking advice from remuneration advisers who are absolutely incentivised themselves to give you the mean and the median, the top decile and the bottom decile and to encourage you towards the top decile wherever possible. Certainly that was my experience for 10 years of determining compensation-there always was that pressure. So what is it possible for the industry to do, realistically, to ensure that remuneration reflects performance and is not just a continual upward spiral?

John Lee: I think there are a couple of points there, one relating to the industry itself. I think the most important point is to be clear on who you are advising, to be clear who your client is. I think historically that was probably more blurred than it should be. If we look at the world today it is very clear, I think in almost all cases, who the client is. So in my own particular firm we only advise remuneration committees to avoid any perception of conflict. Our role is to assist remuneration committees in implementing their strategy, and it is important to say it is the role of the remuneration committee to set the remuneration strategy.

Q61 Andrea Leadsom: Can I interrupt you there?

John Lee: Of course.

Andrea Leadsom: Who do you actually deal with? Is it the HR person, the remuneration committee, the non-executive directors, or the chief executive of the company? Who do you actually give your report to? When I was doing this job it came into HR and therefore they were an instrument of the people that were being remunerated. They were not an instrument of any independent body at all.

John Lee: It can vary from client to client. We would certainly agree with the chairman of the remuneration committee the process that should be followed in that organisation. For any sensitive pay, I would say the majority of our papers are sent directly to the chairman of the remuneration committee rather than to HR. It is not true in every case-

Q62 Andrea Leadsom: When you say "sensitive pay", what does that mean?

John Lee: In particular I think there are two aspects. One is quantum. So, for example, if we are producing benchmark data regarding a chief executive, that would typically go to the chairman of the remuneration committee directly and not via HR. If we were benchmarking positions for other roles, the chief executive would typically build a recommendation based on data that is also presented to the remuneration committee. So would we work alongside the chief executive for other less senior roles? Yes, quite often, but for the chief executive that data would not be seen by the company first.

In terms of design of bonus or LTIP arrangements, that is typically-and increasingly, I would say-driven by the remuneration committee chairman. I am not sure if it is as a result of the shareholder spring but it has certainly come over the last couple of years-we are seeing the remuneration committee chairman take a much more proactive role than was the position seven or eight years ago.

Q63 Andrea Leadsom: Are you saying then that now bonus schemes are in place that mean that an individual would get clawback in the event that they did not perform one year but the previous year they had done extremely well? Are we at the point now where actual remuneration reflects performance over a medium term, over say a three-year period, with clawback? Is that what remuneration committees are moving towards?

John Lee: Remuneration committees are certainly moving towards introducing clawback, yes, but I am not sure it has the result there that you may feel. If last year’s profits were good-whatever "good" means-and a bonus is earned, clawback would typically only arise if there was something invalid in respect of those accounts. The fact that the subsequent year is a less good year, and therefore you do not earn a bonus in year two, does not necessarily mean you would be clawing back on year one.

Q64 Andrea Leadsom: No, of course not, but if year one is a good-performing year, year two is a poor performing year related to year one’s positions, which is often the case in a long-term trading environment, is there then clawback reflecting the fact that now mark to market the trades you did so well last year have now gone bad? That is what I am getting at-is there now the ability to look at the medium term not just the short-term performance?

John Lee: Yes. I think the answer to that is very clearly yes. Clawback has been introduced at probably the majority of FTSE 100 companies, certainly in virtually all of the financial services organisations over the last couple of years. We are still in its infancy of applying these rules and of course what clawback means is it gives the remuneration committee a power to claw back bonuses in the situation you have there. The risk is then that a commercial judgment is to be made as to whether it is appropriate in all cases to apply clawback.

Q65 Andrea Leadsom: What you are saying is whether the person will leave if you dare to claw back some of their bonus because they did not perform as well as we all thought they did last year?

John Lee: I think it is slightly more colourful than that. There is a broader judgment as to what led to a position where this year’s numbers are lower than last year’s numbers. If it is simply part of the normal economic cycle, I would not expect clawback to be applied. If it is because you have attributed a value to a trade which turned out to be illusory, then yes, you would expect clawback to be applied.

Q66 Andrea Leadsom: I would completely disagree with that, but I do not think there is time to pursue it; it is a very technical point. Mr Watson, as a non-executive director yourself, what level of compensation would you consider should come to the non-executive directors of the board? Is it a matter of amounts over £1 million or the top 10% of staff? How would you personally view that?

Anthony Watson: In Lloyds’ case we have a very clear identification of those people whose individual compensation we look at. We look at FSA designated code staff; we look at everybody whose total compensation package could be in excess of £750,000. We look at people who control very important functions like risk and internal audit. So there are a number of categories that we look at.

What is important, though-and is often missed-is that the remuneration committee is responsible for overall remuneration policy and overall remuneration outcomes. When one is looking at overall outcomes, you have to make a judgement on how much is actually going to the staff and how much is going to the shareholders. In Lloyds’ case, for example, last year our bonuses were in total 8% of the total staff costs. We paid £375 million out of a total staff cost of about £5.5 billion. That, I think, is a really important issue to focus on because otherwise the thing gets distorted from a bottom-up basis, without having the awareness of what the top-down costs.

Q67 Andrea Leadsom: One very last quick question.

Chair: A very last quick question and a quick reply, please.

Andrea Leadsom: Are you concerned about the increasing fixed costs of employment where bonuses are being restricted so individuals are getting much higher salaries than they were previously?

Anthony Watson: Again, at Lloyds we absolutely held out against the pressure that was apparent in banking 18 months ago to increase fixed salaries because of the pressure on bonuses. I would be very deeply concerned if our fixed costs went up. I think it is very important for the Committee to recognise that risk and remuneration and strategy are all part of the same thing. Our job is to think about what fixed costs might actually be as a percentage of our total costs and the overall outcome in terms of our duty to promote the company’s interests. So, yes, I would be very concerned if there were an introduction of a fixed cap, because I think the outcome of that would be that salaries would go up.

Q68 Jesse Norman: In recent work, the Nobel Prize-winning economist Daniel Kahneman has referred to the financial industry as sustained by the illusion of skill. What he means by that is that the average returns to, for example, fund managers are almost precisely as we know equivalent to normal returns minus the management fees and yet these people are being paid enormous amounts of money for exercising what, on a net basis, is no skill at all-both no skill across the piece and also no skill almost invariably across the institution over time. We also know from other work that bonuses reduce creativity because they fixate people on certain outcomes. So the question, Mr Pitt-Watson, is for you. Why are senior executives in financial services, and in particular the banking sector, so highly paid compared to other professions?

David Pitt-Watson: I think it is a good question and it is also a good criticism. There are a number of people that have made the criticism: Taleb in "The Black Swan" would say a similar thing; Simon Lack in a very interesting piece that looks at whether the hedge fund industry has ever had any value. So it makes you take a step back and say, "Gosh, this doesn’t look like market forces working the way they ought to". If someone were to ask me why that is, I think it is because it happens through the contracting between your pension and where it is that it ends up in the running of a company. So you give your money to the pension fund, the pension fund is a fiduciary and that does control this a little bit but I am the fund manager and I go to you and I say, "Hey look, I’ve got this great deal for you, I will charge you X. If I don’t do well, I won’t charge you any more than X, but if I do really well, then we will all be quite happy so I’ll take a proportion of what it is that you get." That then goes through the system and it seems seductive, that logic-

Q69 Jesse Norman: For the banking sector?

David Pitt-Watson: Again, it is the same thing, isn’t it? You are a trader, as Tony says-importantly we would like to keep those fixed costs low and it is important that the bank does keep the fixed costs low but if we make a profit that year then you can have a very large bonus. That is the logic. But if you take the helicopter view of that, of course for everyone who is making money there is probably somebody who is losing money as well and you have to be extraordinarily cautious that what you are not doing is giving an average salary to everybody and to the people who outperform you are then giving them their performance and the people who underperform you are not getting any money back from them. But that is through the system.

Q70 Jesse Norman: Just cutting through this, if I may, what you are saying is that this is not a reflection of a market that is effectively operating?

David Pitt-Watson: I think you need to think very carefully about how you get the structures of markets to work well and that some degree of bonus ability seems to me not to be entirely foolish. But the degree to which we have managed to construct salary packages, thinking that they were bringing about alignment, because I was talking alignment to you there-in fact, what we have done is just to allow the people who are employed to have more and more salary and more and more remuneration. That would suggest to me the market does not work.

Jesse Norman: I am sorry, but we are desperately short of time, and there is a bunch of things to talk about.

Anthony Watson: If I could interrupt you there. I think what happened was that prior to the crisis banks were over-geared, the return on equity was very high and they were therefore dispersing quite a lot of that excess return in the form of bonuses that were then morphed into fixed pay. So a lot of bonuses were not bonuses-i.e. a share of the extra added value; it became part of the fixed remuneration package. As banks de-gear and become a smaller part of the economy, that would probably diminish.

Q71 Jesse Norman: Mr Watson, if we took everyone in this room and gave them trading positions in charge of the Barclays Treasury operation, 50% of them would make money and 50% of them would lose money if they threw darts at a board. It is slightly different but let’s assume that.

Chair: We might all lose money, you know, Jesse.

Jesse Norman: Not on average, if we threw darts at a board randomly not relative to the market. So the point would then be that half of those people would be paid a lot of money and the other half would not be fined for losing money, and that is just for the trading floor. For management talent there is not even that kind of direct accountability, so the question is this: the financial sector often justifies its high pay on the grounds that it is necessary to recruit and train top talent, but there is lots of evidence that the market in top talent is extremely thin, virtually non-existent. How self-serving is that argument from your perspective, having seen these operations from the inside as well as the outside?

Anthony Watson: There is a distinction between traders in a proprietary sense and fund managers managing other people’s money. Traders in a proprietary sense, to take a bank’s proprietary trading activities for example, are different because they have an inherent advantage in that they have a spread to work with and they also see the deal flow. So the game is loaded in their favour-at least 50% make money and 50% lose money. In the fund management-

Jesse Norman: If you recall the Goldman case, they were treating their clients as muffins rather than-

Anthony Watson: Yes, and that is why a lot of them make money. Fund management is rather different because you do have an absolute benchmark in the form of the index to beat and you would be quite right in saying that net of costs most people lose money. The index is usually a second quartile performer over time so that is a tricky thing. In many cases, it is the triumph of hope over expectation.

Q72 Jesse Norman: The top-talent argument is a pretty empty one?

Anthony Watson: There are definitely people in my experience who are very good at fund management over the long term.

Jesse Norman: No, but within banks, as it were.

Anthony Watson: Banks have fund management activities and other fund managers stand alone, and there are definitely people who are good traders, but there are rafts of people who do not add any value.

Q73 Jesse Norman: Thank you. Final question for Mr Stilitz. We have heard from Mr Pitt-Watson about the failure of alignment, the near impossibility of aligning economic forces in a way and that points to what you might call a cultural agenda-controlling banks through governance and culture rather than through purely economic means.

We have seen a shareholder spring, but how could we toughen that up? Could we improve the indirect controls on financial institutions by toughening up enforcement on shareholders, for example, firing shareholders or enforcement actions from Government on shareholders who have inefficiently-I am not talking about Hermes, but people who are Hermes-like.

Daniel Stilitz: I think of the ranges of steps you could take that is quite a long way down the list of things of what one might try first.

Q74 Jesse Norman: So what would you do before that?

Daniel Stilitz: It seems to me-this comes back to the Chairman’s opening question-that what we are seeing is a steady and ineluctable rise in executive pay. Notwithstanding economic conditions in 2010, FTSE 100 pay went up by 49%, and we are seeing again today that last year it went up again.

What that, for me, points to is structural problems. The structural problems are to do with the one-way ratchet that applies in all sorts of ways in terms of getting into the top quartile-in terms of your example, the football manager who takes credit when he wins and blames the ref when he loses and so on. To break that is quite difficult. There are a number of ways one can do it: first of all, look at membership of remuneration committees and boards more generally. Certainly the evidence the High Pay Commission found was that there is a very narrow range of people going into remuneration committees, often ex-executives, people of that sort-very little diversity.

More fundamental things: one of the things that has been put forward is having employee representatives on remuneration committees because that would bring a completely different perspective to the whole thing and change the terms of the debate in ways that might be quite helpful.

Another area is transparency. At the moment, there is still very little pay transparency. Obviously, there is transparency at the very top for the executives, but below that there is none at all. It seems to me that if there was a greater degree of pay transparency throughout companies that would have a quite fundamental effect on how pay was looked at. So I think those kinds of structural things are what need to be put in place. I think with shareholders obviously there have been a number of high profile revolts against remuneration reports but there is also talk of binding votes and so forth. It seems to me that if one goes down that route it would be quite a long way before one was penalising the shareholders, many of whom only hold shares for a very short period of time-overseas and so forth. That seems to me quite difficult.

Q75 Chair: Is there anybody who disagrees with the point there? There are a lot of controversial points in there, but is there anybody who disagrees with the view that there is a ratchet and if we could find ways in which shareholders could be more active in arresting it or reversing it, we would have remuneration set at more sensible levels?

Anthony Watson: I think in general we would all probably support the notion of transparency. However I think we would all probably agree that disclosure has led to ratcheting.

Chair: Okay, it is the disclosure that has led to ratcheting.

David Pitt-Watson: If I could just add to that. I think in all the evidence I give in a personal capacity I would agree with you, but I would just alert you that there are other voices out there, who I respect, that would disagree with that view. For example, the Norwegian Oil Fund, which is a very good shareholder of a sovereign wealth fund, would say, "Look, we don’t want any more votes about executive pay. If we can’t trust the executives to pay themselves properly, what can we trust them to do? We need a new settlement in the way that this works".

Q76 Chair: Surely there is nowhere where there is a greater conflict of interest than when people set their own pay? Therefore that point should be turned on its head-it is one issue where we can expect not to trust them.

David Pitt- Watson: You can, but I think where they are coming from would be to say, "I wish to make sure that we put back into the system the trust that is necessary between the shareholder and the board of directors."

I was listening to Andrea Leadsom saying that this is all impossible. Adam Smith thought that it was completely impossible to run public companies because they were running other people’s money and you may remember his famous phrase "negligence and profusion will therefore prevail in public companies". I think what the Norwegians would be getting at is, "Look, we need a culture that is not the shareholders trying to control negligence and profusion but a level of trust from the board to the outside world that that negligence and profusion will not exist".

There is Tony’s point as well, which was that the declaration of pay may have caused a ratchet. I think you would discover that people like John Plender, who is just one of the most insightful people on governance in the UK, would agree that there had been a ratchet effect on that. I am kind of with you that shareholders can do something. I do not think it is just shareholders, by the way. Shareholders on their own I don’t think are going to be able to solve this, but I would just be aware a little bit that if it is going to work for shareholders it does need to be in the context of something where being the chief executive of a company is viewed as much as a privilege as it is a prize.

Chair: We have heard that heavy qualification. Thank you.

Q77 Stewart Hosie: Why have overall executive pay packages become more complex in the last 25 years? What is the reason for that?

John Lee: I think it is a good question. Over the last 15 years, things have got more complicated and it is time to step back and take stock. I think the first thing to say is that by and large the pay deal 15 years ago was quite different from what it is today. You had a salary; you had a very generous final salary pension arrangement. Overall, has pay inflation gone up at a faster rate than the work force generally? Yes, of course it has. It is not applied to every element; I think it is just worth remembering that the final salary pension schemes have declined over that time. The gains that people make out of bonus and LTIPs are now in part having to fund pension arrangements. I am not asking you to feel sorry for chief executives; I just point that out. If you look 10 years ago, the median value of a pension scheme was 50% of salary. It is now below 30%.

What we have seen over the last decade is more pay for performance. There has been a general consensus that pay for performance is a good thing. If you want to take banks as an example, if you go back to just into the last decade, for maximum performance, however it was made up, the variable component was about 1.5 times salary. Now it is about 7.5 times salary, depending on which bank you look at. We have seen a profusion of variable pay. That is clearly added to complexity. Once upon a time, you used to get an annual bonus payable in cash, probably in the order of 50% to 100% of salary, and you had market-value stock options. Essentially, if you are a company trading at £1 a share, I will grant you an option that you can buy the shares at some point in the future at £1 a share and if the share price goes up you benefit.

That was the most common vehicle. Those have ceased to be popular and what we have seen over the last decade is annual bonuses have gone up from something in the order of 50% to 100% of salary to something in the order of three to four times salary. It has been coupled with deferral into shares. We have seen an ability to enhance that bonus if you are buying extra awards of LTIP, and we are seeing LTIP awards that are awards of free shares subject to ever more complex performance-

Q78 Stewart Hosie: We have this hugely complex structure in place. Has it aligned senior executive pay with the performance of the business?

John Lee: I think there are three comments that I would make. Now is a time for a greater simplicity in all that. Secondly, we can debate cause and effect, but I think the more that executives are shareholders, the better. Where we have failed, if you want to use that expression, is that the amount of pay delivered in shares was increased for good reason, but the amount of shares that executives have been required to maintain through their period in office-and indeed for a period into retirement to ensure alignment with long-term shareholders-has been insufficient. The amount of share ownership we encourage executives to hold could usefully go up.

The third point is that we have all hidden, to some extent-whether shareholders, consultants, remuneration committees-behind formulae. You have had bonuses and LTIPs that say, "If you achieve X you get Y", and the reason for that is that we have not had enough faith in remuneration committee members to apply judgement. Sometimes it is right to look at that formula and say, "Do you know what, given X, Y and Z we should reduce the bonus payout", and sometimes it would be right to say, "Given X, Y and Z, we should increase it".

Q79 Stewart Hosie: Just on not trusting the remuneration committees, I am surprised in the discussion so far by how many of them employ external remuneration consultants. Why do they not just decide what the package is and see if someone is happy to work for 140 times the average employee wage?

John Lee: If the remuneration committee applies more judgement, that can help restore trust in the system. In terms of the role of consultants, I think it is the same in all walks of life; the area in which we advise is complicated. We enable the remuneration committee to consider all the issues and we make sure our clients’ remuneration committees are as well informed as possible.

I do not accept, by and large, that we are acting as a ratchet effect on pay and certainly if I look at my experience in remuneration committees over the last five years, I have at least as often as not acted as a brake on pay inflation as an accelerator pedal, in my experience. Tony Watson made a point about disclosure. Let us be clear, disclosure is part of the modern world, and I absolutely support transparency in that regard, but it clearly has added to pay inflation-the ability of executives to come along and say, "I am aware that X earns more than me". People assess their worth in many ways on a relative basis, so there is a cost to disclosure.

Q80 Stewart Hosie: If I can just go back to the issue of complexity rather than transparency. Is there an argument to suggest that the complexity of executive packages has contributed to the perception of reward for failure?

Anthony Watson: If I may jump in, I think the complexity point by and large, and there is a "by and large" here, stemmed from remuneration committees attempting to get into the measures-and we will come to the metrics in a moment-those things that they felt the executives could control: profits, funding, revenues, or things that they could control as opposed to the share price that they can’t control.

The "by and large" point that I think has some traction, but not very much, was a feeling that if you build in all these complex things there is bound to be something that they are going win on. There are some measures that are going to pay out. Certainly in the committees in which I am involved, particularly at Lloyds, we have tried to overcome that by saying that all bonus payments, both short and long-term, will be discretionary. There is nothing that is going to drive us in a contractual sense to pay out if we think the overall result-

Q81 Stewart Hosie: You have perverse incentives to work to a given target?

Anthony Watson: If there were any examples where some of the metrics had been such, and the measures based on those metrics had been such, that there was a guaranteed payout or it proved much softer, we reserve the right now because we have discretion not to pay under that particular-

Q82 Stewart Hosie: I am aware that time is short; I have one final question for you again, Mr Watson.

The Government are keen to publish a single figure for total remuneration for individual board members. Is that feasible, first of all? Is it desirable? What would it tell us? Would a single number provide a more accurate picture of senior executive pay, or would it actually confuse things if the component parts were not broken down properly?

Anthony Watson: I think you could have a single figure broken down. In principle, as I said right at the beginning, I am not against that at all, provided it is done on a consistent basis across companies. You do get the complications of what do you include in that. Do you include, for example, the payout in the March of the subsequent year in the earnings of the previous year? Provided you could get all that, I don’t think it would be an impossible thing to do, provided the consistency and the time thing is correct. However, to take your other point, I am not sure what it would add to anything, but if people feel it would be valuable then I would personally have no trouble with declaring that.

Daniel Stilitz: It seems to me that it would be very valuable for this reason. If you have a single figure, and we are talking about two single figures here-either what you are paid in a particular year, what you are awarded in a particular year, and then another figure of what you receive in a particular year; one does have to distinguish those. But if one can bring it down to a single figure, then one can see very clearly what the pay ratio is within a company.

As things stand it is very difficult to tell what senior executives are paid and very difficult to see precisely what the ratio is. I suggest that that obfuscates what the issues around fairness and excessive pay really are.

Q83 John Thurso: Mr Watson, can I come to you first? This is a big question but could you briefly set out your view on what the strengths and weaknesses are in the current operation of remuneration committees?

Chair: Just in a couple of sentences, you know.

Anthony Watson: Yes. The strengths, and I hope they are a real strength as opposed to potential strengths in the ones that I am involved with, is that there is a great deal of independence, a significant amount of challenge, and a high level of intellectual capacity and experience. The weakness potentially is, of course, that the RemCos can get captured either by history or by management. Both of those would be very damaging. I mean history in the context of saying, to take the point that was made earlier, "let’s tinker with this plan, let’s incrementally add a bit here and a bit there to try to change this". That generally stems from everybody playing the amateur psychologist. People think, "Well, if we do this that will incentivise people a bit more", and so on. That is a potential weakness, and we should try to avoid it.

The other point is about being captured by management. If it occurred in the past it probably occurs much less frequently now, not least because of the shareholder spring media attention and the fact that we are discussing it here this morning. Although I did not say anything at the time, it has been my experience that remuneration consultants, the ones that work for the committees that I am on, are absolutely working for the committee and they would get fired if I found that they were having discussions of which I was unaware with management, which allowed them to be a voice for management as opposed to being an adviser to the committee. Whether that happens in other RemCos I am not sure, but it is, at least theoretically, a potential weakness. If it does exist, it exists a hell of a lot less now than it did in the past.

Q84 John Thurso: Clearly, there are two separate circumstances. There is the circumstance of, "We have a vacancy and we need to recruit", and at that point there is a degree of what is available on the market. There may well be a discussion with an executive whom the company wishes to acquire who may say, "I’ll only come for X", or whatever, and the market establishes itself that way. Then there is another circumstance where you are looking at people who are ongoing and may have been with the company for some years and you have to make an assessment second-guessing what the market might be. In that latter circumstance, how does the RemCo assess the performance of the executive and place value on what they have contributed?

Anthony Watson: I think most companies-big companies, and if they are not doing this they jolly well should-would have a rigorous assessment process of the performance and of course what metrics you use does depend on the role that the individual plays. But quite clearly business success in terms of customers, franchise, profits, liquidity, funding or whatever are measures to indicate whether the individual has done well or not.

Then of course we have to assess whether the person is being paid at market or above or below market, and we have to assess whether or not the individual is under threat and might leave us, and at the end of the day come up with a judgement as to what that person is worth. How you deliver that worth does vary. As I said earlier, I am not keen at all on increasing base salary because of the ratchet effect it has through the annual bonus and the LTIP and to the extent that it is a profit generating activity I would like to see more of their compensation delivered for genuine value added as opposed to simply giving them big salary increases.

Q85 John Thurso: Typically, how much of the variable component is based on hard numerical data that can be proven-in other words profitability, earnings per share, whatever-and how much would be on the more subjective or even discretionary elements? Broadly.

Anthony Watson: It varies enormously on the job that is done. The higher up you go in the organisation the more the hard economic facts dictate the bonus, so at chief executive level virtually everything is based on what the outcome is. When you get down to executive director at GEC level, it can vary between 50 and 75. We, for example, have a balance score card.

Q86 John Thurso: But typically 75% of a bonus would be attributable to auditable data?

Anthony Watson: It should be.

Q87 John Thurso: Just on that last point, at which point in the deliberations would you, as chair of the remuneration committee, seek to gauge the views of the shareholders? At what point should you? Two slightly different questions.

Anthony Watson: As to what might be paid, or the structure?

John Thurso: What I am after is the engagement with the shareholders. Do you make your best efforts to arrive at the right decision and then go and tell them, consult with them, do you consult with them prior to engaging in the process or you do it during the process?

Anthony Watson: What you describe is what we would do in setting up the individual remuneration plans for forthcoming years. So in the autumn and in the winter of any one year I would probably have two visits to each of the important shareholders-sometimes three-to say, "This is how we think and what we are thinking about the bonus plan for the next year, and this is how we are thinking about the LTIP. Have you any input?" What we would not do is say to them when we get to the end of the year or the beginning of the subsequent year, "We are thinking of paying Mr Snooks a £100,000 bonus; do you think that is okay?"

Q88 John Thurso: Can I turn to-

Chair: Before we leave that, would you mind, John, if I just ask a question?

John Thurso: As long as it doesn’t trample on my next question-but feel free, Chairman.

Chair: Just illustrating the general point you made about when you engage with the company and on the link between PPI provisions and the bonus clawbacks, when did you first become aware of the size of the PPI redress provision of over £3 billion that was announced on 5 May?

Anthony Watson: We became aware of that after, in I think about the February of 2011, and it came in two bits-the judicial review piece and something that we were going to do ourselves anyway, so it came out in the February and then it extended into the March. That was after we had settled on the bonuses for individuals, which then-if I am anticipating where you are going-became apparent that the bonuses that we had settled on for a number of the executive and executive directors were inappropriate. Had we known at the time what we subsequently learned, we would not have set the bonuses at that particular level. Hence the clawback mechanism that was then operated.

Q89 Chair: You are happy with the actions taken throughout this period?

Anthony Watson: Very.

Q90 Chair: Will you be asking for an additional clawback in the light of the fact that in May Lloyds announced an additional provision of £375 million on top of the £3 billion?

Anthony Watson: That will affect the 2012 results and we have not made any decisions on that yet.

Q91 Chair: But you are considering it?

Anthony Watson: Of course we have to consider it because overall the profitability of the business will be affected by that provision of £375 million.

Q92 Chair: So you are looking at that question?

Anthony Watson: We are looking at the question-well, we haven’t looked at it yet because we don’t have the final result, but I can assure you that it will be part of the deliberations; otherwise, whatever profits we make for 2012 would have been £375 million higher.

Chair: Sorry to interrupt, John, but I felt that was an appropriate moment.

Anthony Watson: But if I could just be clear on that, I am not at this point saying anything about whether that would affect the size of the bonus pot or individuals.

Chair: That will have been heard as well.

Q93 John Thurso: I want to go back to this question of the ratchet. When I chaired a remuneration committee, New Bridge Street would come in and tell us that we want to be in the upper third or the bottom end of the upper third, and they would look at our FTSE 250 comparators and our sectoral comparators and say, "You’ve got to pay this increase to get there". It seems to me logical, if the same advice is being given throughout the year as it all goes around, that when you get to the other end of the year they will come back to me again and say, "Well, you now have to do another per cent". Is there not, if that is the mechanism, which it was then, a built-in ratchet that is totally unreliable?

John Lee: Yes, I think that is right. The price of transparency is the ratchet effect. I absolutely accept what you are saying, but I think there are a couple of points that it is worth just spending half a moment on there.

Q94 John Thurso: Can I just explore that? The fact that we all know what is happening does not mean it has to happen. You just said the price you pay for transparency is the ratchet. We could all use our judgement-I think earlier on you said you had faith in RemCos to make judgements-and simply say, "No, we are not giving anyone an increase because we did a three-year contract or a five-year contract and the boy is on £750k or whatever it is, which is quite enough to be going on with, and there is the bonus and the LTIP and that is where he will get his extra remuneration so let’s just leave it alone". We don’t; we just ratchet it up every year.

John Lee: Yes. I think that is right. Let me make the comment I was going to make, if that is okay.

In terms of the strategy, I think what you said there is very helpful. Firstly, it is the role of the remuneration committee to set the strategy. In your particular case, you said they wanted to set it at a third along the spectrum in terms of where to position it against their benchmark data. These days most companies are aiming for the median not the upper-quartile third, but whether it is median or whatever there is always somebody below that benchmark who is trying to jump over it, so I think that is right.

It is also true to say, and this goes back to the previous question of what is the role of a consultant, that the danger is inappropriate choice of comparator groups more than whether it is one third, upper quartile or median. For example, if you take joining the FTSE 100, some of the starting market caps, depending on volatility, were close to 3 billion; the median FTSE 100 company has a market cap of about 12 billion-whether those data points are quite right does not really affect the story. If a 250 company joins the FTSE 100 and the chief executive says, "Could I now benchmark against the FTSE 100 and could you pay me against the median?" you are paying against a company of a totally different scale. I think it is true to say that not sufficient attention has been given to choosing the right comparator groups. I think we are getting better at that. That is role of the consultant, "So let’s just step back, because is that an appropriate comparator group?"

You have to overlay data with judgement, and I absolutely agree with the comment you have made. Last year 27% of FTSE 100 CEOs took no salary increase. I think that is applying judgement and having regard to austerity in the outside world and so on. Do I think we need to look at data, we need to reflect on that, we need to take a wider judgemental approach? Absolutely.

Daniel Stilitz: May I just briefly add on the suggestion that the ratchet is purely a function of transparency? I would suggest it is a function of the selective transparency where only the board’s pay is transparent. If one had a less selective transparency where pay across the company was transparent, then that would be a force that worked in another direction, and it is the select nature of the transparency, if anything, that perhaps has fed the ratchet.

Q95 John Thurso: I must say that when I was on a board before, Cadbury, when there were no RemCos, nothing ever went up because the chairman used to keep us all down. It is a very interesting paradox that the more corporate governance we have the more we have increased. Somebody ought to do a dissertation on that one day. If you have what you suggest you may find that lots of people say, "Good Lord, I never realised the chap in the other company doing my job got twice as much as I do; I’ll have a double salary". Isn’t that just as much a danger?

Daniel Stilitz: It is in some circumstances. If there is general pay transparency, that just means that the labour market will work better and you will have a more efficient labour market. If people are being underpaid, why shouldn’t they go and work somewhere else? But the point at the moment is that it is just focused on the board where naturally the non-executive directors, the remuneration committee, are very worried about people moving elsewhere, and it is quite easy for them to be frankly spooked into putting it up just in case. Whereas if you were looking at the overall pay structure of the company, a wider perspective, I would suggest that there would be more sense in the whole debate over pay that goes on.

Q96 John Thurso: I want to very quickly ask Mr Lee one last question; I know the Chairman wants me to shut up and move to someone else.

Mr Lee, to what extent do you feel, with your long experience of advising RemCos, that RemCos depend far too much on the advice of consultants and allow them to make the judgements because in this tick-box world it is far easier to agree with your adviser than to turn around and say, "Rubbish, I don’t agree, I’m not giving the increase"?

John Lee: I can’t talk for how every other consultant has worked, but the relationship that I have with the remuneration committees I advise is much more in partnership than that. I can’t think that I have ever gone along to a remuneration committee and said, "You really must give your chief executive an X per cent salary increase", and frankly I don’t think the non-executives would be doing their job if they were overly persuaded by that.

It is the role of the remuneration committee to set the strategy; it is our job to ensure they have considered all the options and to challenge the remuneration committee but it is their job to decide. It is our job to supply data. But I think it goes back to our previous discussion; data has to be done in the context of judgement of wider circumstances. If I was to say to Tony Watson, "Why don’t we give your CEO a 10% salary increase?", he would bring 40 years of business experience to bear; he isn’t just going to follow a consultant from some abstract statement. So I don’t think the advice I give is as directive as that.

Q97 Chair: If there were no consultancies operating at all, would pay go up or down?

John Lee: If there were no consultants operating at all and we had the level of transparency we currently have, I think pay would go up. Certainly if we leave salaries to one side, which is a relatively small part of the overall package, I would say as often as not the challenge I am giving on how you assess bonus outturn has been a pressure downward rather than upward.

Q98 Teresa Pearce: Mr Lee, earlier on in answer to a question-I think the question about who you work for, who is your client-you said historically that was blurred. I do not quite understand how that could have been blurred. Surely you would know as an organisation who you pitched to, who your terms of reference were with, who paid you. How would it be blurred?

John Lee: It is a very good question. My own firm only advises remuneration committees. We are a relatively small firm so there is no ambiguity here. I think we are the only UK house that only advises RemCos. Enough of advertising. I think if you look at the past, the amount of work and who commissioned work wasn’t as clear. These days I would say in virtually all cases the remuneration committee sets the agenda for the RemCo. If you go back 10 years ago that wasn’t the case; papers could come from management, from HR, and we as consultants could submit papers without pre-clearing them with the remuneration committee.

The role of a RemCo chair has grown much bigger. In the days when there was less clarity about who was responsible for setting the agenda, it could be less clear who your client was. There are other firms out there who would simply say they act for the company. I don’t think you can take the view that you act for the company. You are either acting for the RemCo or you are acting for somebody else. I don’t think you can sit on the fence.

Q99 Teresa Pearce: With your organisation, who would you be accountable to? Just to the remuneration committee?

John Lee: Just to the remuneration committee, correct.

Q100 Teresa Pearce: When you do your paper for them, do you take any account of tax planning as to how the remuneration is structured, as to the cost of salary bonus over share options or whatever? Do you report on that?

John Lee: Yes, I would say pay design is rarely driven by tax in our experience.

Q101 Teresa Pearce: Do you not think that is one of the reasons for complexity in the last 10 years, whereas a bonus is quite an expensive way for the person to receive the money and for company to pay it?

John Lee: I think this is the issue of regulation generally-that it always leads to unintended consequences. If you roll back the clock to 15 years ago, the accounting rules changed. That was one of the principal reasons why we moved from market value share options to so-called LTIPs these days or to free shares because they are more efficient than options became. I think these things can have unintended consequences.

Is it our job to ensure that the remuneration committee is as informed as possible regarding tax consequences, accounting consequences? Yes. That tends to be a relatively small part of the job. I think it is much more about, "Okay, guys, how do we align this to strategy? How are shareholders likely to react?"

If I could give one very quick example in respect of complexity; I think we have more plans now than is helpful. Because of the change in the top rate of income tax, which is due to go down from next April, as you know, a lot of LTIP awards have been structured as nil cost options. So whereas on the third anniversary if performance targets were met shares automatically came out, we have given executives choice as to when they want to trigger their tax liabilities. Has that added to complexity? Yes, it has. It is part of a system where we try to take account of the round. Isn’t that in shareholders’ interests to ensure you get the most incentive from the cost you are spending?

Q102 Teresa Pearce: Two more short points.

One is that the failure, as the public would see it, of the banking industry has been put down to the structure, practice, but also culture. Do you not think that the culture of working towards your own indicators and bonuses, rather than working towards the good of your company and responsibility of your staff, has been a key failure of that culture?

John Lee: I think that is a fair comment. Others can probably talk about culture within banks at least as well as I can.

Q103 Teresa Pearce: You are part of setting the pay.

John Lee: Well, we live in a world that focuses on rights rather than responsibilities and I think the more people think about their responsibilities and stewardship the better. So I would make two practical comments. One is more use of discretion by remuneration committees in viewing bonus outturn-certainly if we are focusing on senior executives, I think the more shares that people hold, and the longer they hold the shares, the more that will create more a sense of stewardship and bring back that sense of responsibility.

Q104 Teresa Pearce: That is purely for self-interest again because they would lose money otherwise.

John Lee: But I work in a world advising on pay, and therefore I am bound to think of pay in terms of how to try to address a solution to the issue. Clearly, there are wider cultural issues. My own expertise is going to focus on pay.

Q105 Teresa Pearce: Just a final thing, not talking about your consultancy but the remuneration consultancy world in general, we on his Committee have taken evidence previously in another inquiry from rating agencies. They charge significant fees and give advice, but they also say that they can’t bound by that advice and that that advice should not be solely relied upon. Do you think that is a description that also fits the remuneration consultancy world?

John Lee: No, I don’t think so. I don’t. I think our clients can and do rely on our advice. I think the advice we give-and there are some very technical bits, so if we are implementing a set of plan rules, do the rules have the leaver clause that you are intending them to have-you can get sued for that, and that is right and proper. But in terms of the focus of this interview today, what we are doing is offering judgement. So I think it quite difficult for a client to sue us, to be honest with you, because most things have a variety of views.

Q106 Teresa Pearce: You are more like an expert witness?

John Lee: You are more like an expert witness. Ultimately, what the remuneration committee is doing is saying I see more of these cases than they will do, I have more time to think about it than they do, because they are obviously looking at broader strategy for the company, and therefore what I am doing is assisting them to get their thought process up to a level where they can consider the important issues. The business decision is then the decision of the RemCo and I think that is right and proper. We are enabling them to, at the risk of being repetitive, make as informed a judgement as they can.

Q107 Mr Love: In light of experience on executive pay over the last 10 years and, indeed, the survey that appears in the FT this morning, I think we would all have to accept to some extent there is a market failure in this area. I hope we can be in a consensus about that at least. The question I want to ask is, does that necessarily mean therefore that we have to increase regulation and, if you like, Government intervention in this area? Perhaps I could ask Mr Pitt-Watson first.

David Pitt-Watson: We have had quite a lot of chat about cultures and how you get all of that to work. I am very struck when I talk to regulators that they actually say, "Look, us doing more ‘do this and do that’ to the market won’t work; people just find their ways around that". I could give you many examples of people saying that. I think, therefore, if you are thinking about how to resolve this you need to turn your attention to how we trigger systems that get this all back under control. How do we create a culture where people get paid fairly, even well, at the top of organisations?

I think there are lots of debates going on. I think they lack some leadership but, for example, there is a debate about fiduciary duties through the system and how we can have people explicitly understanding that their job is as a fiduciary for the original saver, and maybe even people that advise RemCos that, "This is someone’s pension, whose money you are dealing with". How do you make sure that you have the duties there? I think we should be thinking seriously about measures and how it is that profits are determined, particularly in systemic organisations. We should have a concern about people being paid on return on equity, because one of the ways of pushing up return on equity is by borrowing more money, and that is risky for the system. Yet we still have that, and we have very high targets for return on equity by many of the banks. I think the sort of issues that Lord MacGregor and Lord Lawson are looking into in terms of the way that profits are determined-again, this is something that I think it would be worth paying some attention to.

Clearly, the bonuses that were paid before 2008 were paid out of profits that were not profits. Now, there are changes to accounting laws that took place before then. Some people think that they are very significant. Again, it is about making sure that if any bonus is going to be paid, it is paid out of profits that have been very prudently determined before the money leaves the institution. You might prefer to do that before you set up clawback mechanisms so the money does not go out in the first place, until you are absolutely sure that it is there.

There is lots that Government and you, as the legislature, could be doing. We need vigilance of this system. The fact that you are having these inquiries makes a difference. It was not greater powers that brought about the shareholder spring, it was the fact that this issue was something that the Prime Minister talked about that made a shareholder spring and gave strength to the elbow of people that would do something about that.

Q108 Mr Love: Let me just break in, because we are limited in time. Because of the frustrations Government face in this whole area, the Secretary of State brought forward the idea of mandatory voting for shareholders, either on an annual basis or, as he suggested more recently, on a yearly basis. How would institutional investors look on that?

David Pitt-Watson: Look, it probably helps a little bit, but if you do that on its own and then walk away from the problem, I think it will re-emerge. We have had a vote on pay from 2002, I think it was, and that on its own I don’t think was enough to be able to get this under control. I think it probably helped, and I think some greater powers might indeed help, but as I say, the thing that caused the shareholder spring was not that we had those powers; it was that this was an issue that people were debating.

You were changing the culture among shareholders so that they felt able to exercise their votes against. That would be really important, and there are many things that you could do to try to trigger those sorts of responses. I do not think they are one piece of legislation, though. This has to be a continual debate that we are involved in and continual pressure. Look, at the same time as the Government is talking about this, I think the unit in the Treasury responsible for oversight of governance has been run down as part of the cost cuts. I would have thought that that might not have been a sensible thing to do if we want to keep some focus and pressure on this.

I know that two or three years ago, the IMA and ABI made promises to the Government about institutions that they would set up that have not yet emerged. Again, it is about having somebody who just says, "Okay, we have not done this so far. Can we manage to move that sort of thing forward?" I would have thought that those sorts of actions would be helpful, so not just one piece of regulation and one set of powers for shareholders, but a sort of what Adam Smith called, "anxious vigilance" just to make sure the system is working properly. Why couldn’t this Committee ask the Treasury and BIS once a year to provide it with a report on whether the relationship between companies and their shareholders was working well? Do you see what I mean? We are trying to change the culture here, rather than have one regulation that will knock it on the head.

Mr Love: No, I do understand the importance of culture. I was interested to hear that a former Cabinet Secretary was suggesting ways in which we could bolster activity in the Treasury. Whether that will go down very well, I wait to see.

Mr Watson, as an independent director, what is your view on whether further regulation would help you to achieve the aims that both you and the Government wish in this area?

Anthony Watson: Well, it would obviously depend on what the particular regulation was, but in general I do not see a place for greater regulation. I mean, I think that people do forget that directors are up for annual re-election, and if anyone doesn’t think that they take that seriously, I think they are mistaken. We take it extremely seriously; I take it extremely seriously. Anyone who does not take the vote on, for example, the directors’ remuneration report seriously, even though it is only advisory, is not doing well in my view, and their shareholders do have the ability to get rid of them should they choose to do that.

On culture, any bank that operates on any other principle than that profits are a lagging indicator of success-particularly a bank like Lloyds, which is basically a retail bank, profits are a lagging indicator of success. What really matters is how we are doing with the customers, and if the customers think we are providing a good service and delivering what they want, they will come back and the profits will reflect all of that.

Q109 Mr Love: Can I just interrupt you there? In terms of both culture, in a sense, and customers, Mr Stilitz earlier on spoke-I thought rather warmly-about an employee representative as an independent non-executive director. How do you look on that and how does the, if you like, banking industry look on that as a prospect?

Anthony Watson: Well, I think the original suggestion was about whether employees should be on remuneration committees. I would not be keen on that, simply because the remuneration committee, as indeed the risk committee and the audit committee, are committees of the board, and therefore that would involve board membership. The point I was also trying to make earlier was that risk and remuneration and audit all form part of the totality of the responsibility of the board. If shareholders wanted to elect an employee representative, that would be fine. However, it is very important to remember that a unitary board has responsibility to promote the success of the company, not-

Mr Love: Sorry, let me-

Anthony Watson: No, sorry, let me finish the point. Not a particular group of stakeholders, and I think if they came on to the board and thought that that was their job, that would be a mistake. I think there is evidence from Europe that employee representatives have not actually felt very comfortable when sitting on remuneration committees, but should the shareholders care to elect one and that person took on the responsibility of being responsible under the Companies Act for the promotion and success of the company, so be it. But at that point, they cease to be an employee representative.

Q110 Mr Love: Let me press you, then. There has been a lot of discussion about the very narrow base from which most non-executive directors are chosen. Isn’t there a strong argument to widen that experience, and particularly since you mention customers, to get that experience, if you like, from the grass roots of an organisation? Now, whether it is an employee representative or some other way of widening, do you have some sympathy for that as a proposition?

Anthony Watson: I have absolute sympathy for the proposition that what boards really need is diversity of thought based on skill, experience, intelligence and attention to detail-absolutely that would be the case, and I think inevitably it will lead to more diverse boards. We now have 30% women on our board, which is a very different position from, say, 10 years ago.

Chair: I think we will have to move on.

Mr Love:Just one more.

Chair: One more, but quite a quick one.

Q111 Mr Love: It is particularly about independent non-executive directors. Perhaps I can ask you, Mr Watson. In theory, they are meant to represent the shareholder interest, but there is a lot of criticism that the minute they get on to the board, they go native. Do you accept that as a danger and how do we ensure that it does not happen?

Anthony Watson: Well, that has not been my experience. In banking, clearly we have to have FSA approval and the FSA does look at which directors to approve and which not to approve in terms of what they see both in what they will bring individually and how they will add to the board collectively. So what we want is directors who are independent, fearless and curious about what goes on, and again, we get challenged. I could produce my own case or the board as a whole could produce examples where the NEDs have actually challenged and overcome, overturned, decided upon doing things differently from the direction that management might have suggested.

Mr Love:Can I ask you, because I am going to get stopped-

Chair: No, I think we really do need to move on, Andy. Did you have a further remark you wanted to make there, Mr Watson?

Anthony Watson: I just wanted to say that in contrast to what I just said 30 seconds ago, boards do not operate on the NEDs on one side of the table and the executives on the other. By and large, big decisions are taken consensually over a period of time, but it is very important that the non-executives do pose challenge to the executives.

Chair: Particularly over remuneration, which can generate a great deal of tension.

Anthony Watson: Well, it is not a particularly pleasant experience to tell people-to keep saying no.

Chair: No. Well, I have had to do it myself. Pat McFadden.

Mr Love: Just not to speak.

Chair: Sorry, Andy.

Q112 Mr McFadden: David Pitt-Watson, I want to ask you more about this shareholder spring. We had evidence from voices in the City a couple of weeks ago that suggested that we should not read too much into this; it was a few isolated incidents and it was a feature of times of austerity and that it did not represent a lasting sea change in shareholder attitudes. Do you agree with that view or do you think there is something more fundamental going on?

David Pitt-Watson: Broadly, I would agree with that view, and I think it has been brought about by the fact that we have a really good debate going on that is particularly about remuneration. Of course, there are many other issues that shareholders need to become involved with, but in general I would say this is a one-off. So we need to keep this debate going so that indeed the flowers blossom and we have a summer rather than a quick frost in 12 months’ time.

Q113 Mr McFadden: If the shareholder movement is probably no more than a few isolated incidents, what more can be done? I would like you to think particularly about what the Chairman began the session asking about, systemically important financial organisations. These of course are different because they operate under an implicit taxpayer guarantee, which can change the calculus of risk in these companies, as we have seen. Is there a case for a different set of rules, including regulatory rules, for these companies compared to, say, a car company like General Motors or something like that, which, if it went bust, is an industrial disaster, but does not bring down the rest of the economy?

David Pitt-Watson: Yes, I think there is a different set of rules, I would say, for greater regulatory vigilance, if I can put it that way; I would say yes, absolutely there is. I think I would make two comments on that. I mean, one would be recognising that everything, indeed, most of what is done by the so-called shareholders, by the fund managers, may not be things that are adding to stability and to good governance.

I was very struck when I was on the Future of Banking Commission, which David Davis chaired, and we had evidence from Stephen Green. We were asking, "What did the shareholders tell you before 2008?" He said, "Questions would be asked by fund managers about why we weren’t gearing ourselves up more, why we were not buying more shares back, why we were not realising certain assets, all of which was short-termist in its focus". Indeed, it was the build-up of those sorts of actions by the banks that led us to where we are. So first of all, be cautious about the notion that shareholders can do everything here and all the activities of so-called shareholders are necessarily positive.

You can then say, "Okay, but they can do some stuff that is extremely positive; how do we encourage that?" I have given some examples. In law, can we manage to get fidicuary responsibility through the system? I think John Kay is looking at how that might be done. What could Government do? You know, a unit that just oversaw this, that sucked its teeth, that made a speech saying, "We think that there are issues here", asking the IMA and ABI, "Can we see the new unit that we are going to set up to try to do this? Can we have a plan for that to happen?" Can we keep this debate going? I think that would be useful.

Look, as well for fund managers, creating some sort of system where there is a benefit for them to do their duty as owners rather than to see that their primary responsibility is to play the game of being traders-that also would be very helpful. Now, none of that was a rule. Do you see what I mean? None of that was saying, "Nobody can be paid more than £1 million". It was trying to manage the system so that the shareholders do what they should do, which is to be good long-term owners of institutions, including BOFIs, and you need to do it on the BOFIs because they are systemically important. If a big manufacturing company goes down, it will be recreated, but if a bank goes down, it goes through the whole system.

Mr McFadden: This is what I am driving at. You are a champion of long-term shareholder engagement. The public thinks that is what shareholders are doing-

David Pitt-Watson: That is right.

Mr McFadden: -but they are often not. Why is it not happening more often? You have been at this for a long time. Why is it so rare?

David Pitt-Watson: Well, because of the questions that Jesse Norman was asking; the incentives through the system are incentives to trade shares rather than incentives to be good owners of shares. Tony and I have worked together-he is my old boss-at Hermes, and this was the constant thing. What happens is that for a typical pension fund, you are giving your money to another agent who is the fund manager, who is typically the person we are talking about, is the shareholder, and you are saying, "Beat the index", and the way they beat the index is by trading the shares, and trading the shares does not encourage you to be a good long-term owner.

Anthony Watson: It is a very important point that David makes, that the shareholders, as are being described in this room, are really the agents of the true shareholders. The fund managers, generally speaking, don’t have a position in their own right. They are simply managing other people’s money, sometimes with over-delegation of what corporate governance policy they will pursue and sometimes not, and that has moved considerably in the last five or 10 years. Most responsible pension funds, for example, will actually demand, particularly under the Stewardship Code, of their fund managers how they are going to discharge their corporate governance responsibilities both in CSR and in corporate governance and various other things. Generally speaking, there is a report back to the pension fund, but it would be unequivocally the case that most fund managers, in my view, have not devoted sufficient resources to the thinking through of how to discharge their responsibilities as agents of the true owners of all of this.

Daniel Stilitz: There is a further problem with the atomisation of ownership of companies. Far greater percentages are overseas, short-term owners and so forth, and that means that the idea of a coherent body of shareholders who are represented in a sort of coherent way does not necessarily always apply.

One thing that the financial crisis has shown us is that there is a much greater range of stakeholders in institutions, companies like the major banks and so forth, and that is one of the reasons why I would suggest it is justified to look beyond merely the shareholders to hold them to account. There may be a role for stakeholders such as employees, also perhaps even those who own debt in them, who have got much a more long-term view-the bondholders and so forth. It seems to me that in such a crucial sector, one is justified in looking more widely.

David Pitt-Watson: Both those points are right. First of all, the incentives for the so-called shareholders are not the incentives to be good owners, and second of all, partly as a result of regulation and so-called risk control, pension funds have been encouraged-I am sure the House of Commons pension fund will be one of them-to invest in ever more companies in ever more asset classes, and so you have this atomisation of ownership that doesn’t bring it all together. Even in my few years in the City, this has been a huge move and a huge change, so although we have many more people who are trying to do this job of good owners, it is still quite a small number, and there are many tides that are moving against us. That has been an important part of remuneration getting out of control.

Q114 Mr Love: To go back to Mr Stilitz’s point, I think it was Lord Myners who described the banks as good, honest corporations, given the patter that you have described, but I just want to ask a different point of Mr Lee. We have had a lot of talk about this morning’s FT, and I am afraid I am going to return to it. There is an interesting table on page 3 of the FT which shows that there has been some growth in salary in the last 12 or 13 years, but the lion’s share by a long way in the growth in remuneration has been things like bonuses, deferred bonuses and long-term incentive plans. Someone who works as, say, a nurse or a factory worker in my constituency goes to work every day without any of these things. Why are they needed for wealthy people but not needed for constituents who do regular jobs?

John Lee: Yes, I think this is the crux of the question here in terms of pay, and we can throw around data and exactly what inflation rates have happened. I do not think that takes the debate further forwards. If we look at a nurse on an average wage of about £25,000, £26,000, the sums that senior executives earn are enormous. How can you relate the two? It is not the job of the capitalist system, I think, to look at the ratio between nurses and chief executives. I think if you look at the-

Mr Love: That is not the question I asked. I asked why the nurse is expected to do his or her job for a salary, but the very highly-paid person gets a long-term incentive plan, a deferred bonus, a bonus and all the rest of it.

John Lee: I think the reason for that is in all things and it goes back to regulation, "Be careful what you wish for". Ten to 15 years ago, companies were being told very clearly by shareholders that basic salary inflation should be brought under control, and broadly speaking, if you look over the last decade, salary inflation has been higher than it has for public sector workers, but it has been not that much higher, to be fair. If you look at the profusion of bonus and LTIPS, shareholders themselves called as much for this pay for performance culture that we have as much as companies did.

I remember not that long ago, before the recession in 2008, advising a company where we went in and said we would like to have LTIP of one-times salary, and it was the top three shareholders who all said, "I think you should apply for 2½. We think you should have more than that". So shareholders have not been reining in quantum. Let us just be very clear that culturally, the attitude was, "If it is performance-related, then we shouldn’t be constraining that quantum". That thinking has clearly moved on, but that is where it came from. The one thing we have not said today is whatever the quantum for senior executive pay, if you look against global norms-at the chief executives of privately-owned companies, the pay of our FTSE 100 directors-I do not think it is excessive against those equivalent benchmarks. They are big complex organisations.

So I think we could well step back and say, "Can we simplify this package?" and part of simplification I have to say is too many targets, too much complexity. Why don’t we give shares with fewer performance conditions or even no performance conditions that people have to hold for a long time and degear some of this package? I think there are some interesting arguments to explore, and I know Hermes, alongside some other shareholders, called for a variant of that in the press over the weekend. But I think we should look at those things. There is no single one-size-fits-all. What the market does require, I think, is that they pay the appropriate wage for the job, and culturally we have forced that into performance-related pay, and possibly the gearing is slightly out of kilter.

David Pitt-Watson: Just to say as well, in looking at that, one of my earlier comments was, "Be careful about how far alignments can take you" you know, this economic alignment. The nurse goes in and here she does her job because they are committed to being a good nurse and sometimes they are doing marvellous things, we all know because we have been in hospital, and they don’t need that big bonus. We have kind of legalised and economicised the relationship with the people that are running our big companies, and I think we need to be rather cautious about thinking how far we can take that. It has reached extremes in the United States, where the pay packages are extremely, extremely complex, and don’t yet have votes over them by shareholders either, and they are out of control.

Look, I am not against alignment. At some stage we want some form of alignment, but be careful in thinking that that will produce all the effects for you. We need to get our chief executive going to work. What you do have from most of them, which is they go in there to do a good job, just the same way as the nurse goes in to do a good job, and I am not sure that all this incentive pay is such a huge issue for them.

Chair: One last quick question.

Q115 Mr Love: It does strike me, and this is not so much a question as a sort of final comment, that a layperson reading this and looking at all these different elements that make up senior executive pay would almost conclude there is simply a salary level after which you get into this world and where you can pick these things off the shelf. Below that salary level, you are expected to do exactly what David Pitt-Watson said, which is turn up and do the job you are paid for for the salary you are given, and that is pretty much how it works.

Anthony Watson: The average salary in Lloyds Bank is £26,000 a year. Not a well-known fact; the same as in most.

Mr Love: Why do you think that is not a well-known fact?

Daniel Stilitz: Because there is no pay transparency below the board, and if I may say so, the fact that there is all this demand from shareholders for LTIPS and so forth, none of that answers the question, "Does it work? It is necessary?" and they seem to me to be the key points.

Q116 Chair: Do you agree, Mr Pitt-Watson, with what Lord Lawson said in the House yesterday when he said, "Bank regulations and supervisors should at least strongly discourage, if not actually forbid, the remuneration of bankers on the basis of the rate of return on bank equity"?

David Pitt-Watson: I think this thing about earnings per share and return on equity is something that we do need to think about. Now, I am always worried about forbidding, because when you get forbidding and someone writes a rule, somebody finds a way around it, Chairman, but-

Chair: Is Lord Lawson on to something here?

David Pitt-Watson: I absolutely think he must be, mustn’t he, because what we are trying to do stop is banks taking big risks, because they are systemic and they go down, the whole set of dominoes falls down.

Chair: That was the point you made earlier about gearing.

David Pitt-Watson: That is absolutely right. I don’t know what it is at Lloyds, Tony, but at Barclays the target is a 13% return on equity, and at the Royal Bank of Scotland I think it is even higher, but if we as pension funds were able to achieve a 13% return on the equities that we are investing in, all those problems we have about pension deficits by the way disappeared overnight and we can increase everyone’s expectation of what it is that they are going to be paid in retirement, because we would not believe, on the basis of history, that a 13% return on equity was possible. If you are then in a bank and somebody says, "Yes, but that is your target", how would you go about getting that? Well, one of the ways you could go about getting that would be by borrowing more and more and more.

Chair: Yes. Increasing the risk, yes.

David Pitt-Watson: You would try to get as much gearing as you could relative to whatever it was that the regulations said.

Chair: This is a very long answer.

David Pitt-Watson: Indeed-sorry.

Chair: I am trying to get a shorter answer, which is basically-

David Pitt-Watson: He is on to something, yes.

Chair: He is, okay.

Anthony Watson: Yes, but could I say, Chairman, that most banks, including Lloyds, will actually have as one of their measures something called economic profit, which is a key performance indicator on these longer-term plans. That includes or that is based on a certain level of equity multiplied by a return on that equity, and until that component of profitability has been met, there should be no payout. If I could also say, I think one of the things-

Chair: I am going to bring in George Mudie, and if you could finish your point on that-

Anthony Watson: Well, we need to concentrate on the structure of risk management.

Chair: Order, order. If you have an additional point there, do drop it on a piece of paper.

Anthony Watson: Okay.

Chair: George Mudie.

Mr Mudie: He is just trying to stop me speaking.

Anthony Watson: Not deliberately.

Q117 Mr Mudie: David, I thought you touched on this when you made the remark about Barclays and the 13%. That is very interesting, because he did not make his 13% and he still has these huge bonuses, and he is talking about not having a future target. So that takes you back to what Pat McFadden says. I don’t know where you are going.

For example, you and Daniel are at least aware of a problem. Mr Watson and Mr Lee seem to think the world is okay as it is, but let me ask you-the two of you-how do you define the problem? For example, David, I will just give you a clue about where I am going. When Pat said a nurse-I am married to a teacher; they can perform at a level, but it doesn’t matter. They get a wage. They look at this world, the executive world, where to get a person to do very well, you have to take a salary that a teacher or a nurse would never even dream of and give them a further incentive. Now, how do you define, you said, David, "under control" or "working well"-"We have to get this under control and working well"? What have we to get?

David Pitt-Watson: Look, if you were to say, "Is there a quantum average that the FTSE 100s should all have?", I don’t know the answer to that.

Mr Mudie: Sorry?

David Pitt-Watson: I don’t know the answer, whether you should have an average £1 million or you should average £500,000 or all the rest of it. However, I think the evidence is that this has gone up by threefold relative to average salaries, and there is no evidence that the companies are being particularly better managed. Therefore I would say on quantum, "Do we have a problem and is it recognised globally that we do have a problem?" and the answer is yes. I think if you were then saying to me, "Okay, what is the solution to that?" I would say, "I don’t think there is a silver bullet", and I would worry about people who think about this as having a silver bullet-that there is some economic deal that we can do with people.

This is about the whole nature of how we run capital markets for the people that they are supposed to serve, which by the way is you and me and everyone’s constituents when they put their money into their pensions or their savings or all the rest of it. And as workers-that there is money being fed through so that the companies that they work in can prosper. Look, I have made some suggestions of areas where I think people are doing some really interesting stuff on fiduciary duty, on measures, on compliance and vigilance-

Mr Mudie: But they have not worked. David, I would welcome you sending to the Committee a thought-out list of your suggestions and any ones you want to add, and the same with Daniel, to focus our minds.

David Pitt-Watson: Okay, happy to.

Q118 Mr Mudie: But I still say that if you put an employee on the remuneration committee-it might be even better if you put them on the board, but that is maybe 10 steps too far for the present system. But you said it might have a very great effect. I take that to mean that it would bring some reality from the outside world of ordinary people, how they live. If they are employed in the same firm, and they are discussing these figures, that would bring the remuneration committee back to the real world. But that implies that you are accepting that the salaries that are out there, the system that is going on at the moment, has got totally out of control in the last 15 years.

David Pitt-Watson: Look, the fact that the ratio of salaries has gone up threefold I think is evidence of that, and I do not think any one of the four of us on this table would say that we think we have this under control.

Mr Mudie: We have two people defending it. But you see nothing wrong with it.

Anthony Watson: I did not say that.

Mr Mudie: Well, tell us what is wrong with it then. Oh great, come on. Tell us what is wrong where. Tell us which points David has made that you agree with. Do you think salaries are totally out of control?

Anthony Watson: I agree with-

Mr Mudie: Do you think the transparency is non-existent?

Anthony Watson: I am sorry-

Mr Mudie: Why do you think putting an employee on a remuneration committee-

Anthony Watson: George, look, I think-

Mr Mudie: Why do you think putting an employee of the firm, that is-

Anthony Watson: Am I able to answer the questions or-

Mr Mudie: The fellow you are giving a salary to from the FT, the gap between him and the fellow you are preventing going on the board to bring some reality-what is it, 139%, yes?

Chair: We have had the question. Now are going to have a bit of hush while we have the answer. Mr Watson.

Anthony Watson: But seriously, I am not preventing anybody going on the board. I do not think everything in the garden is absolutely rosy. I agree with a great deal of what David says. There is a sort of logic here. I would start with whether the staff overall are being paid a disproportionate amount of what is available to pay them, and are they doing that in a way which is systemically riskier than it should be? Within that, are individuals being paid a disproportionate amount of money? It is the job of the remuneration committee to ensure that there is a degree of fairness between what the shareholders get and what the staff actually get, and far too little attention has been paid to that aggregate, in my view-

Mr Mudie: No, no, can I just interrupt you for a second? You have missed something out. The FT was highlighting, for example, how unfairly you treat different people in your organisation; that the gap between the average pay of employees has gone up from 40% to 139% since 1998. Now, you have not mentioned that.

Anthony Watson: I haven’t come to that point yet.

Mr Mudie: Very good, very good. Just in case you were going to forget it.

Anthony Watson: So there is the aggregate, and I think that is very important. The really important issue as far as the systemic point is concerned is whether those profits were made and then distributed to people within the company in a disproportionately risky way, and I think if there is one thing that we have learnt, and particularly in the Lloyds case, we have a very, very effective-I hope-risk management mechanism. Will it eliminate all risk? No, it will not. We are in business. Business involves risk, and so we have done our very best to ensure as far as we can that the risks are controlled in a way that is ex ante and moderated ex post and clawed back if it goes wrong. That is fair.

Have individuals been paid too much in the past? Yes, probably that is the case, because a great deal of variable pay has morphed into fixed pay, and that is something that I am personally very against. I think, going back to the earlier discussion, we have had a situation where you get a salary for coming to work and doing a good job. You should get variable pay for creating extra value and have it distributed to you in a fair way with those who are the owners of the company, and I think that-

Q119 Mr Mudie: Sorry, Daniel, I know you want to come in. Can we just go on the record: do you think that it is morally justified to move from a 40% gap to 139% in 14 years?

Anthony Watson: I think that is-

Mr Mudie: Are you doing anything on the remuneration committee to say, "We must close that gap"?

Anthony Watson: Well, if you take Lloyds, for example, the executive directors have had no pay rises this year.

Mr Mudie: Sorry?

Anthony Watson: The executive directors have had no pay rises.

Mr Mudie: Very good.

Anthony Watson: I cannot cut salaries, as you know, because that would be constructive dismissal, but we can put pressure on fixed pay.

Mr Mudie: But they will let you do it soon. You will be able to sack them, no bother.

Anthony Watson: Well, but sacking is different than cutting pay.

Mr Mudie: You will not, then.

Daniel Stilitz: I do not know whether they received any bonus awards, but in any event, you asked at the beginning, "What is the nature of the problem?" It seems to me it is twofold, one specific to financial services in particular, which is the concern, a very valid concern, that the pay of senior executives and senior individuals within the banks have created perverse incentives which may have contributed to the financial crisis. The much wider problem is that if one looks at the history of pay, this has been a longstanding problem from 1979, when the multiple between the median and the senior staff was around 14, 13 times, where it has gone up now to 75 times, or in some cases 100 times. That is the much bigger problem, which does not confine itself to the financial services sector. Now, the High Pay Commission put forward 12 proposals to deal with that. Some of them were ones which I think are in line with what Anthony’s just been saying-for example, that all the publicly-listed companies should publish a distribution statement which shows how much they are allocating to wages and how much to other things.

Things that would perhaps have an influence on the ratio would be publishing a pay report each year which gave the ratio between the median and the top-paid individual, and there are other things such as binding votes from shareholders, changing the closed shop of the remuneration committee which could do this. A range of measures is necessary, but that is a problem not just because of the problems it might create for shareholders, but also more generally. If you have very disparate pay, that can have an effect on company performance, and if you have very disparate pay, that can have a wider effect on society generally and what kind of opportunities there are for social mobility and so forth.

Q120 John Thurso: Can I quickly pick up on your point in answer to Mr Mudie, Mr Watson, about variable pay morphing into fixed salary?

Anthony Watson: Yes.

John Thurso: Would you agree or disagree that a basic salary should buy you the best endeavours of the executive to fulfil his or her job in a reasonably competent manner?

Anthony Watson: Yes.

John Thurso: And that therefore the variable content payable over and above that is for doing an exceptional job, above and beyond the general call of duty?

Anthony Watson: In theory, yes. The marketplace within which we operate, as any one organisation, is that variable pay is a component of the overall package. I would like to move to a point where it is much clearer that the variable pay element is as a result of creating assets or creating value.

John Thurso: The point being that if you are hiring somebody to do a job, and if they are the chief executive, the job is to be the chief executive, and if the component of variable is more than 50%, let alone one, two, three or four times, then what you are saying is the base pay is just the sort of retainer rather than the actual salary, and you are into an entirely different concept of labour versus capital.

Anthony Watson: We are where we are, in that there is a going rate for salaries, however you define it and wherever you benchmark it. This is the obligation of the board, to set stretching targets. If they are met, the human capital will have a return on that within the financial services business, and also within other businesses as well. I think it is a mistake just to think that bonuses are unique to the financial services industry.

John Thurso: I mean, the point I am making is do we not have a much deeper problem-it takes the points that everybody here is making? We have gone from a culture where, broadly speaking, you turn up and do your job well and there is a provision for if you go the extra mile for a bonus or whatever, to a situation where effectively you have turned executives into traders and they get a retainer for appearing with lots of goodies and cars and lollipops and BUPA attached to it and then they really get paid on how much trading they can do, how much risk they can take, how much profit they can make. It is a whole different ball game to what the real concept of an employee should be.

Anthony Watson: Well, I am not sure I would agree with all of that. I think describing bank executives as traders is not appropriate, just as the executives in any other big companies you would not describe as traders per se. But I would, I think, take your point that there is a bonus culture which defines the competitive marketplace. What we have to do is to get back to a position where the bonuses are paid as a result of the creation of value over and above people coming to work.

John Thurso: Thank you.

Q121 Chair: Well, we can all agree on that.

You said earlier, Mr Watson, that your LTIPS at Lloyds were linked very closely to customer satisfaction. Our constituents are very dissatisfied with banks and there are historically very high levels of dissatisfaction, so one would expect, wouldn’t one, your measure to lead to there being no payments from LTIPS?

Anthony Watson: It would be fair to say that balance scorecard which talks about customer and franchise and complaints and all of that, is a very important part of what we do. Could it be better? Absolutely, yes. If you take customer complaints as an example, we are at the lowest or pretty close to being the lowest, and one of the metrics that we are measuring is to drive that customer complaint ratio down a great deal further.

Chair: Is that one of the metrics or the only metric that you are using to measure customer satisfaction?

Anthony Watson: It is one of the metrics. There are financial metrics as well.

Chair: What are the other measures of customer satisfaction?

Anthony Watson: Something called a net promoter score. It is whether people will be prepared to recommend you to other people.

Chair: Okay. I am very grateful. We are all very grateful to you for having given evidence today. I am sure that there are many things that we have not covered that you would have liked us to pose to you so that you could put it on the record. Do take the opportunity of writing back to us if you have further thoughts or if you want, on reflection, to add further points to the evidence you have given. We are very appreciative. Thank you.

Prepared 15th June 2012