44.Whilst responsibility for devising policy on executive pay rests with the board, ultimately the approval of investors is required through votes on policy and annual reports at each AGM. For their part, investors want to ensure that decisions taken by the board are in the interests of the company and therefore their own investment and ultimate beneficiary. The challenge for the board is to align their objectives with those of investors, or at least to engage sufficiently to ensure that its proposals will not be defeated. The reforms of 2014 were aimed at improving the ability of investors to engage and to give them more influence. In the era of what have been called “ownerless corporations” the challenge on pay is how best to secure a commitment across all players in the investment chain (asset owners, asset managers, advisors etc) to a goal that not only meets the objectives of the company, but also delivers on the company’s wider social responsibilities that the public expect them to meet. To put it simply, if the company’s owners (shareholders) agree that paying the CEO £25 million a year is in the best interests of the company, how and why can this view be challenged? We explore below the roles of different players in the decision-making process on pay in the context of meeting the objectives of the 2014 reforms.
Under the reforms that took effect from 2014, premium listed companies are required to have votes on remuneration policies every three years. These votes are binding. The policies establish the structure of remuneration packages and set out how they will be implemented throughout the business. Most companies had this remuneration policy vote first in 2014, and then again in 2017, but around one third of the current FTSE 100 companies held a policy vote in 2018.
Companies are required to hold a vote on remuneration reports every year. These set out the decisions on remuneration and their outcome made during the year, under the overall policy. These votes are non-binding. The reports set out the results of the implementation of the policy during the year and how much performance-related pay has been achieved. Any discretion applied may also be mentioned. These votes on pay reports can be used by shareholders to signal dissatisfaction with performance or the implementation of pay policy more generally.
45.The evidence we gathered suggests that there has been an increased focus on executive pay amongst shareholders since 2016, in part caused by parliamentary pressure. We heard that that they were now seeking simpler pay packages, with lower proportions of variable pay, and are now making clear that excessive pay increases—above inflation or company-wide increases—are not acceptable.
46.Most stewardship goes on behind the scenes throughout the year; it does not just materialise at AGMs. This perhaps explains why the anecdotal evidence of increased shareholder engagement does not translate obviously into an increase in significant dissenting votes since 2014 (See Figure 6). The spikes of dissenting votes in 2014 and 2017 reflect the fact that for most companies there were votes on pay policies as well as on annual pay reports in these years.
Figure 6: shareholder dissent on remuneration
Source: Minerva Analytics
47.Whilst we found that in general stewardship is not working as well as it should, but that there is evidence that increased activity is having some impact. The Purposeful Company argues that 75% of companies receiving a dissenting vote of over 20% in a given year took action the following year and achieved an average vote of 94% in favour of pay reports. The proxy agent, ISS, agreed that institutional investors are becoming less tolerant of excessive pay and more likely to challenge boards. The Investment Association notes higher levels of dissent in the FTSE 250 than the FTSE 100. Dissent is by no means always effective: we referred earlier to the 15 companies that have experience significant dissent on pay for two consecutive years. It is instructive that whilst there have been many significant displays of dissent on pay reports (which are non-binding) there were only two pay-related resolutions actually defeated in 2018. We welcome the increased attention on executive pay but recognise that much more than engagement will be required to drive a more enlightened and acceptable approach on executive pay.
48.We traced in Chapter 2 the new requirements on the remuneration committees to have oversight of workforce pay and to provide more rounded reporting of pay policy throughout the company. In the light of some of the controversial pay awards listed in paragraph 7, we explored with witnesses, including both Royal Mail and Unilever, the processes that led to the proposals being put before shareholders in the first place. The consensus in the evidence we received was that remuneration committees have largely been unwilling to curb or challenge excessive pay awards, and some have simply not engaged well enough. One investor told us that “[i]t is the company executives themselves in many cases” who were responsible for raising pay–they can be “successful and proficient negotiators”. The Investment Association’s Principles of Remuneration advise that schemes should avoid “excessive remuneration pay out” but do not provide any indication as to what excessive might be, nor on pay structure. There are no effective sanctions: remuneration committees can award what they wish. Given historic trends and recent excesses, we cannot help but agree with the verdict of Catharine Howarth, Director of ShareAction, that “remuneration committees have failed in practice and failed, in a way, as a structure.”
49.Some of the dissenting votes at AGMs have been the result of inadequate engagement and misjudgement by the board of the potential reaction to pay proposals. This was clearly the case at Royal Mail: the Chair of the Remuneration Committee, Orna Ni-Chionna, acknowledged that it was “a big mistake” not to have engaged at the right level with investors, so the 70% vote against the pay report came as a “huge disappointment and indeed a shock to us”. Investors complained about the difficulties in securing meetings with companies to discuss these issues—one witness referred to a “breakdown in communications”—and most agreed that companies should do much more to engage earlier and more extensively to test out new pay policies or potentially controversial pay awards.
50.The Chair of the remuneration committee is responsible for the quality of the information provided in the annual report. We heard that “few companies seek to provide insight by going significantly beyond the minimum regulatory requirements” and nor do they disclose sufficiently useful information on pay, for example in relation to the metrics around bonuses. Too often, lengthy remuneration reports appear designed to obfuscate more than inform. For example, the payment of £5.8 million by Royal Mail to the new CEO as a “golden hello” was included only in the notes to the consolidated financial statements instead of being included, more transparently, in its remuneration report.
51.It is clearly up to the boards to set the overall tone on matters of remuneration throughout the company but equally, it is up to the Non-Executive Directors, including those who are also members of the remuneration committee, to challenge robustly where necessary. We heard conflicting evidence about the extent to which remuneration committees are prepared to exercise restraint but, overall, we are far from convinced that they do so. The incentives to bear down on pay are simply not there. The pressure from shareholders is weak and unpredictable and all too often members of the remuneration committee will be board members of other companies or will have served in executive capacities enjoying similar remuneration packages to the ones they are supervising. They are not a diverse or representative group. There is a circuit of self-serving excessive generosity. Remuneration committees have helped fuel the excessive levels of executive pay we see today. We recommend that remuneration committees engage early and meaningfully with major investors on executive pay, be prepared to make the case for pay reform and restraint in the interests of avoiding reputational damage. We recommend that the new regulator seeks to ensure that these activities are properly explained in remuneration reports.
52.The role of asset managers, who handle the day to day investment decisions of their clients, is central to executive pay reform. We have concerns about how they fulfil their role under current arrangements.
53.We heard that levels of engagement by the best asset managers with large companies is generally good but also that too few institutional investors such as pension funds are active enough. For most asset managers, remuneration will simply not be a priority, compared to the other reasons on which investment decisions are taken. Given the complexity of executive pay and the difficulty of securing a consensus for change, there are understandable practical disincentives to engagement. We cannot rely on shareholders to exert pressure. One witness told us “they care about levels of executive pay a little less than the public probably does” and therefore will apply less pressure here than the public might like.
54.This is not just a matter of priorities. Asset managers are extremely highly paid and tend to be rewarded with large bonuses based on performance against a benchmark index on a one or two year basis. Investment decisions made by companies may generate returns after one, two or more decades. In these circumstances, it may be awkward, if not hypocritical, for them (or the corporate governance teams which engage directly with companies) to criticise pay policies for prioritising short-term financial incentives. But it is by no means impossible for institutional investors to take a principled stand, and we heard from one who voted against the Persimmon remuneration report on grounds relating to the reputation of the business and its position in society.
55.The previous Committee recommended that the Stewardship Code should be revised to require investors to explain how they have exercised their stewardship functions and include more explicit guidelines on what quality engagement with investors should include. The existing Stewardship Code includes a provision for investors to disclose voting records, but compliance is patchy. An analysis by the High Pay Centre suggests that “significant numbers” of signatories to the Code are not declaring records, making it difficult to examine the extent and direction of investor pressure on executive pay. Under the revised Stewardship Code, investors will be expected to publicly disclose their voting records and also to provide a rationale for their decisions, particularly where they are not in line with policy. However, there are no sanctions for failure to comply with the voluntary Code. Recent history across many regulatory areas demonstrates that without active enforcement, we cannot expect good compliance. Asset managers may be signatories to the Stewardship Code, but they are regulated by the Financial Conduct Authority (FCA). The FCA is currently consulting on proposals to improve engagement with companies, consistent with the requirements of the EU Shareholder Rights Directive. However, the proposals only require asset managers to publicly disclose a policy on shareholder engagement, including on corporate governance issues, but there is no prescription on what such engagement should aim to achieve.
56.Whilst there are channels of communication, such as the Investor Forum, for investors to co-ordinate their views, such co-operation is not the culture and it is relatively rare for investors to go public with views on excessive pay, at least in advance of corporate collapses, as we saw at Carillion. The Minister made it clear that she sees the role of Government is to provide shareholders with the tools to hold boards to account. We do not have confidence that they will use these tools and create the competitive market in stewardship that should ideally develop. We understand that investors can exert valuable influence behind the scenes but we believe that their stewardship role includes a wider responsibility to help set the boundaries of acceptable practice on executive pay and to promote long-term performance. This should include a commitment to comment publicly when necessary and a requirement to explain their policies and voting records. The final Stewardship Code should make this explicit and be applied strictly and consistently by relevant regulators, including the Financial Conduct Authority.
57.Asset managers are accountable to asset owners: primarily the pension funds that invest our money for the long-term. They are perhaps the least visible but potentially the most influential player in the investment chain. They provide high level instructions for the asset managers—the mandate—on their investment strategies and objectives. These can include the types of companies to invest in, the degree of commitment to Environmental, Social and Governance (ESG) considerations and other factors associated with responsible investment, plus contractual arrangements. Ultimately, it is up to asset owners to give any direction on the stance to be taken by asset managers on corporate governance issues, including executive pay, and to hold them to account. However, these mandates are rarely made public and it is therefore extremely difficult for asset owners to be held to account for the way in which they direct our savings to be invested. Paul George from the FRC acknowledged that asset owners could engage better with asset managers and meet their responsibilities to think long-term. He said that: “We have not been very good at making that link between the ultimate beneficiaries—wider society, by and large—and the work of the fund management industry.” We agree.
58.Under the EU Shareholder Rights Directive, from June 2019 asset owners will be required to disclose certain information regarding the mandates they give asset managers, including how the mandate incentivises the asset manager to make investment decisions about medium to long-term financial and non-financial performance of the investee company, and to engage with investee companies in order to improve their performance in the medium to long-term. This is a welcome step forward. The proposed revisions to the Stewardship Code do not appear to reflect the ambition of the Directive. They require asset owners to disclose their “investment beliefs” but not to provide details of their investment mandates or the link between pay and long-term performance. The absence of such detail seriously constrains accountability and therefore effective stewardship. The voluntary nature of the Code is another weakness: we understand that less than half of asset owners are signatories. We believe that primary responsibility for changing the environment on executive pay rests with asset owners, rather than asset managers. In this context, we recommend that the guidance in the new Stewardship Code includes a requirement for asset owners to provide much more detailed information about their objectives, including those in relation to executive pay. Given that the Stewardship Code is only advisory, and that existing Code has been widely ignored, we recommend that the new regulator is given the necessary powers to take effective action against those asset owners that do not sign up to, or meet their responsibilities, under the Code.
59.Proxy advisors provide company performance analysis for a wide range of institutional and small shareholders and offer advice on voting at AGMs. It is difficult to track the extent to which their advice is followed but they are widely thought to be influential in the voting behaviour of many, if not all investors who use their services. They provide broad principles which underpin their advice, but these lack detail and are subject to the generic advice that decisions should be taken on a case by case basis. One such advisor, ISS, is alone thought to hold at least 60% of the proxy agents’ market. Whilst there is a debate over the extent to which shareholders are effectively outsourcing their stewardship responsibilities by using the services of proxy agents, and there are questions over the quality of their advice on pay, given their resources, few would dispute that their advice on pay is without influence. In this context, we welcome the warning by ISS that many companies have continued to award relatively generous bonus pay-outs even cases of “mediocre or poor performance”, and that the target for bonuses should typically be no more than 50% of bonus potential rather than the 75% that appears to be the norm.
60.There are differences in views amongst the proxy advisors on the best structure for executive pay, with some more favourable towards LTIPs than others. Whilst the major institutional investors should be engaging directly on pay, we recognise that many investors do not have the resources nor expertise to analyse pay proposals in detail, so will continue to rely on the services of proxy agents. We recommend that proxy agents tailor their policy guidelines and advice to individual investors so as to resist excessive and poorly designed pay policies and awards.
61.Investors need to help shift the bar on what is acceptable practice in terms of executive pay. This is all the more important in the context of a market that is shifting towards passive, index-linked funds: there is a much greater onus on the remaining active fund managers to send the right signals on pay with their votes. At present, we do not believe that the incentives of all those involved in the investment chain are sufficiently aligned and attuned to the wider social responsibilities of companies. Nor do we believe that it is realistic to expect better stewardship to be an effective driver of reform of executive pay. We agree with the Kingman Review that, even its revised version, the Stewardship Code is not fit for purpose. We recommend that the new regulator revises the Stewardship Code to ensure that it is able to not just encourage, but deliver, genuine and effective engagement between companies and their shareholders on executive pay in a way that requires both parties to discharge their responsibilities transparently and accountably.
134 See Box below for summary.
135 Lord Myners used this term to describe the UK’s large listed companies, characterised by fragmented shareholding which prioritises short-term, risky profit over long-term value, both financial and social. See Andy Haldane ‘Who owns a company?’, , 22 May 2015.
136 [Ni-Chionna] [Duguid], [Sears], [Stirling], [Williamson], Minerva Analytics Ltd ()
137 PwC (); [Chapman]
138 CIPD ()
140 Aberdeen Standard Investments ()
141 The Purposeful Company ()
142 Institutional Shareholder Services (ISS) ()
143 The Investment Association ()
144 See paragraph 26.
145 Institute of Directors (),
146 [George], ICAEW (); Association of Accounting Technicians (AAT) ()
148 Investment Association,
152 Minerva Analytics Ltd ()
153 PwC ()
154 See BEIS Committee website, letters between and , July 2018
155 For example, PwC (), CIPD/HPC, , review of FTSE 100 executive pay, August 2018.
158 [Howarth], [George]
159 [Williamson], [Howarth], from Clare Chapman, 15 June 2018
163 FRC, UK Stewardship , 2012
164 ; High Pay Centre ()
165 High Pay Centre ()
166 ; FRC, Proposed Revision to the UK Stewardship Code,
167 See Financial Conduct Authority, , January 2019
168 The EU Shareholder Rights Directive, due to be enshrined in UK law by June 2019, will require institutional investors and asset managers to be more transparent about their engagement with companies, voting actions and the way in which they align the interests of their clients with companies.
170 Second joint report of Session 2017–19, Carillion,
171 High Pay Centre (), Aberdeen Standard Investments ()
172 , [George]
173 Government Response to BEIS/W&P committees second joint report on Carillion,
174 FRC, Proposed Revision to the UK Stewardship Code,
175 Investment Association and the Pension and Lifetime Savings Association, , September 2016; no later figures are available.
177 Big Innovation Centre, The Purposeful Company ()
178 [MacDougall]; Purposeful Company, FRC’s Review of the UK Stewardship Code, February 2018; PwC, ISS: friend or foe to stewardship, January 2018.
179 ISS, UK and Ireland , December 2018. See Figure 5.
180 PwC (), Glass Lewis (),Institutional Shareholder Services (ISS) ()
181 [Newhouse], Hermes Investment Management ()
Published: 26 March 2019