Thursday, November 24, 2011

UK Commission Urges Employee Membership on Compensation Committees and Forward-Looking Shareholder Vote on Executive Pay

The UK High Pay Commission urges the inclusion of employee representatives on company compensation (remuneration) committees. In its final report, the Commission also recommended that the current shareholder advisory vote on executive compensation be made forward looking. The Commission additionally recommended a standardized form for compensation reports that incorporates but moves beyond current best practices and includes a total executive compensation figure and a methodology for how it has been calculated. The High Pay Commission, a bi-partisan, independent body, is chaired by Deborah Hargreaves, and includes Lord Richard Newby, Co-chair of the Liberal Democrat Parliamentary Treasury Committee.

Currently, shareholders have an advisory vote on the remuneration report, which the Commission described as a backward looking vote on decisions already made and implemented on executive pay, which creates an atmosphere of box ticking. The Commission considered and rejected the idea of making shareholder advisory votes on executive compensation binding, instead urging that the shareholder vote be made forward looking. Thus, shareholder votes should be cast on compensation arrangements for three years following the date of the vote and these arrangements should include future salary increases, bonus packages and all hidden benefits, giving shareholders a genuine say in the remuneration of executives.

The Commission noted that, since the seminal Cadbury report on corporate governance, all the reforms aimed at tackling executive pay have empowered shareholders and given greater authority to non-executive directors. Yet this model has proved deeply problematic, said the Commission, and its effectiveness in tackling issues of executive pay is questionable.

In particular, the Commission found compensation committees to be a closed shop made up largely of current and recently retired executives. This model has failed, said the Commission, leading to spiraling pay. The Commission believes that greater engagement with employees may help restrain executive pay and help mitigate negative impacts on morale as well as encourage a greater engagement with the workforce. Thus, the Commission urged that employees be represented oncompensation committees as a first step to better engagement and accountability.

Compensation consultants advise the compensation committee on executive pay. However, there are widespread concerns over the role they play and potential conflicts of interest. While the UK voluntary guidelines for compensation consultants prohibit cross-selling services, noted the Commission, there is no evidence available to demonstrate whether this is the case or the extent to which it is being flouted. Thus, the Commission recommended that companies disclose the extent and nature of all the services provided by compensation consultants.

Most large shareholders, pension funds or institutional shareholders have a
large portfolio and they often have an investment in hundreds of companies. As a result it is often not feasible for them to engage meaningfully with executive compensation. The Commission called on all investments fund managers to fully disclose how they vote on all issues including those of remuneration.

The Commission believes that it is essential that the pay gap between highest paid and the company median should be open to scrutiny, including how the ratios of highest to median pay has changed over a three-year period. If companies produce a fair pay report it will allow them to state their principles in relation to pay, encouraging pay to be considered across the company when setting executive pay, as is required by the UK Corporate Governance Code. Thus, the Commission recommends that all public companies issue fair pay reports as part of their compensation reports.