Conclusions and recommendations
Recent developments
1.Taken as a whole, since 2014 companies have continued to share the rewards of their success largely with their shareholders, in the form of dividends, and with the senior management in the form of multi-million pound pay packages, rather than sharing the proceeds more evenly amongst their workforce, who sustain the business, through pay and pension contributions. Huge differentials in pay between those at the top and bottom remain the norm. Executive greed, fed by a heavy reliance on incentive pay, has been baked in to the remuneration system. With that comes a public perception of institutional unfairness that, if not addressed, is liable to foment hostility, accentuate a sense of injustice and undermine social cohesion and support for the current economic model. (Paragraph 10)
2.We are fully supportive of the case for a more empowered, aggressive and proactive regulator that has the ability to take decisive action, where necessary, on executive pay and its reporting. We look forward to the establishment of the new regulator as soon as possible. (Paragraph 11)
3.We welcome the revised Corporate Governance Code’s improvements on remuneration guidance, such as the requirements to consider the long-term remuneration across the whole workforce and potential reputational risks. But the Code alone is unlikely to be an effective driver of change. We recommend that the new regulator clarifies and strengthens its guidance on executive remuneration with a view to exerting significant downward pressure, avoiding unjustifiable payments and ensuring that, if they are made, they can be readily recovered. (Paragraph 15)
4.We welcome the new reporting requirements but are not convinced that they alone will lead to greater alignment between remuneration and company objectives. We recommend that the new regulator monitors how remuneration reports and better reporting against section 172 of the Companies Act meet the aims of increased transparency and alignment of pay with objectives. (Paragraph 16)
5.We recommend that the new regulator monitors companies’ compliance with the Corporate Governance Code with a view to making an assessment of which method of engagement proves most effective and recommending changes. (Paragraph 17)
6.The explanations on workforce engagement sought by the revised Code are an improvement, but they are not an adequate substitute for the permanent engagement achieved by remuneration committee membership. We recommend that companies should be required to appoint at least one employee representative to the remuneration committee to ensure that there is full discussion of the link between executive pay and that of the workforce as a whole. (Paragraph 19)
7.We welcome the introduction of new requirements to publish pay ratios, which will allow meaningful comparisons to be made, at least within sectors, and require companies to explain when and why they have chosen to pay above reasonable expectations. Over time, we expect sector norms to develop, potentially with the active intervention of the regulator. By highlighting the link between executive and employee pay, the gap between them should, with public and peer pressure over time, reduce. To assist and broaden this objective, we recommend that pay ratio reporting requirements be expanded to include all employers with over 250 employees and that the lowest pay band be included alongside the quartile data required. (Paragraph 23)
8.There is no reason why companies, including major legal partnerships, that can readily calculate these pay ratios should not report them first in their 2019 annual reports and we recommend that they do so. We further recommend that the new regulator takes to task any company or firm that fails to explain adequately how they have taken into account pay ratios when determining levels of remuneration, particularly when pay ratios significantly exceed sector norms. (Paragraph 24)
9.We welcome the development of the Public Register by the Investment Association as it provides greater transparency for investors on how companies engage with their shareholders. It has demonstrated that remuneration remains a key source of discontent for shareholders. We agree that the focus should remain on those companies which ignore shareholder concerns on pay and recommend that the new regulator explores more effective sanctions than a letter from the Investment Association. (Paragraph 27)
10.We welcome the publication of the corporate governance principles for private companies as a foundation upon which the new regulator should build robust and more enforceable guidance on pay and other matters. We recommend that the new regulator takes on responsibility for monitoring the impact of the Code and examines the case for greater disclosure around remuneration and for expanding its application more widely. (Paragraph 29)
11.We cannot understand why the Secretary of State would want to block the publication of an independent study and recommend that the review of share buy backs is published without further delay. We further recommend that remuneration reports include analysis of the impact on executive remuneration of any share buy backs during the reporting period. (Paragraph 30)
Structure of pay
12. In principle, we believe that there should be greater certainty in executive pay. This should be balanced by a significant reduction in the maximum that may be earned and that the rewards from good performance should be more evenly shared: there should be a stronger and more visible link between rewards at the top and bottom. (Paragraph 32)
13.We recognise that most listed companies will not be putting new pay policies before shareholders in a vote until 2020. However, without external pressure before then, and given the different views on the use of incentives in pay packages, any reform is likely to be slow. (Paragraph 35)
14.We believe that executive pay should be simplified, more obviously geared to promoting companies’ long-term objectives, and be linked more closely to that of the workforce as a whole. Greater transparency and simplicity will help shareholders hold boards to account. We favour a simple structure based on fixed basic salary plus deferred shares, vesting over a long period, but subject to conditions to avoid “rewarding failure”. Care needs to be taken to ensure that reforms are coherent as a package and do not permit gaming. We also support the greater use of profit sharing or other schemes designed to share profits more evenly. Over time, the proportion of variable pay (including bonuses, share options and profit sharing) should be reduced substantially. The increase in certainty associated with proportionately more fixed pay should, if well managed, lead to a reduction in total remuneration awarded. As a matter of practice, and to reduce the risk of Persimmon-type awards and associated reputational damage, we recommend that Remuneration Committees should set, publish and explain an absolute cap on total remuneration for executives in any year. The new regulator should be more prescriptive and interventionist, where necessary, in pursuit of these objectives and be prepared to publicly call out poor practice or behaviours. (Paragraph 37)
15.Chief executives, and shareholders, should be stewards of the long-term and broad interests of their companies rather than pursuing short-term financial goals: they should be rewarded accordingly. We believe that the performance measures governing the payment of annual bonuses should be aimed at encouraging and rewarding increased productivity and also support the company’s wider responsibilities under section 172 of the Companies Act to have regard to the interests of its customers, suppliers and workforce. We recommend that the new regulator engages with investors to develop guidelines on bonuses to ensure that they are genuinely stretching and a reward only for exceptional performance, rather than being effectively an expected element of annual salary. (Paragraph 42)
16.We welcome The Investment Association’s announcement in February 2019 that it will monitor and flag up any company that pay pension contributions to new directors in a way not aligned to the majority of the workforce and we recommend that the new regulator seeks public explanations from any company that fails to deliver alignment on pensions contributions. (Paragraph 43)
Engagement by companies on pay
17.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. (Paragraph 47)
18.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. (Paragraph 51)
19.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. (Paragraph 56)
20.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. (Paragraph 58)
21.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. (Paragraph 60)
22.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. (Paragraph 61)
Published: 26 March 2019