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BIS Executive Pay Discussion Paper - TUC Response

Report type
Research and reports
Issue date

Role of shareholders

1. Would a binding vote on remuneration improve shareholders' ability to hold companies to account on pay and performance? If so, how could this work in practice?

The TUC supports a binding vote on executive remuneration. Some companies have responded with what can at best be called complacency to high levels of no votes against their remuneration reports, and we believe that a binding vote would force such companies to take the vote result more seriously.

However, we are also aware that, without other changes, notably to shareholder approaches to executive pay, a binding vote will make little difference in practice, as the number of remuneration reports that are actually defeated at company AGMs remains very low. A binding vote will only make a difference if shareholders start to use their votes on remuneration reports more critically than is currently the case.

We believe that one measure that would help to make a binding vote more meaningful, and would in fact also make the current advisory vote more meaningful, is for remuneration reports to be made forward-looking rather than backward-looking. This would mean that the shareholders were voting on pay proposals that were yet to be implemented, which would give the vote greater relevance and focus, and should help to improve the quality of dialogue between investors and remuneration committees about remuneration proposals.

We also believe that in order to encourage shareholders to use their votes more critically, institutional investors should be required to publicly disclose their votes at company AGMs. This is now recognised as best practice and encouraged by the Stewardship Code, but in practice many institutional investors continue to publish no voting information publicly. For more detailed discussion on the wider merits of this proposal, please see the TUC's response to the Kay Review, the TUC's response to the A Long-term Focus for Corporate Britain and the TUC Fund Manager Voting Survey 2011.

Even if UK investors were to adopt a more critical approach to executive pay, the changing nature of share ownership in the UK and the greater proportion of company shares held by overseas investors will limit the extent to which this alone will increase the number of actual defeats of remuneration reports. However, a tougher approach on the part of UK investors could have an impact on remuneration practices via engagement.

We note again, however, that under the current system it is shareholders and shareholders alone who have the tools to influence executive pay. This system has in its own terms spectacularly failed. Without a new approach on the part of shareholders, any further measures that depend on their engagement or votes are likely to have little practical effect.

2. Are there any further measures that could be taken to prevent payments for failure?

The TUC believes that directors should have the same notice periods as their staff, and that this should become a principle of the Corporate Governance Code. Company directors have a greater influence on decisions that affect the future of their company than their workforce, yet also have greater protection when things go wrong, despite also being more able to save given their much larger remuneration packages. There is no justification for this and directors and their workforce should have the same notice periods on the same terms.

3. What would be the advantages and disadvantages of requiring companies to include shareholder representatives on nominations committees?

We are not convinced of the merits of this proposal for two reasons.

Firstly, shareholders have shown themselves to be insufficiently critical in relation to executive pay to date and we see little reason to believe that giving them a greater say on nominations will bring about positive change. There is no evidence that shareholders are well acquainted with a range of potential non-executive directors who would be likely to take a different approach on executive pay from current NEDs. Indeed, one explanation for shareholders' ineffectiveness in relation to executive pay is that they are generally highly paid themselves and move in circles where high pay is regarded as normal. It is therefore unlikely that shareholders will be well-placed to promote the kind of independent voices needed to bring about change.

Secondly, as the consultation document notes, there are significant practical differences between the structure of shareholding in the UK and Sweden, with the UK's share ownership structure much more dispersed than is the case in Sweden. This would make it harder to identify which shareholders should participate in nomination committees, and for UK institutional shareholders that hold shares across hundreds or thousands of companies, the required time input could be very considerable.

In our view, the Swedish nominations model illustrates the wider corporate governance benefits of concentrated ownership structures, but in the absence of these we do not think that this proposal will work.

Role of remuneration committees

4. Would there be benefits of having independent remuneration committee members with a more diverse range of professional backgrounds and what would be the risks and practical implications of any such measures?

The TUC would support independent remuneration committee members with two provisos: firstly, that they should be in addition to, not instead of, worker representation on remuneration committees; and secondly, that they should be able to demonstrate that they would bring a genuinely different approach to executive pay than is currently the norm among remuneration committee members.

On the first point, independent representatives are not a substitute for worker representation, but could, if genuinely independent, bring additional value. While the best way of avoiding the lone voice syndrome in relation to worker representatives referred to in the consultation document is to include two workers on remuneration committees, a third independent voice could help to create a real culture of change.

In order to ensure that independent remuneration candidates would bring a genuinely different approach to remuneration, the TUC proposes that a genuinely independent nomination process should be established. This could be done by asking organisations that have a clear stake in tackling excessive executive pay - for example, the TUC, OneSociety, the High Pay Commission, relevant NGOs - to select a pool of potential independent remuneration committee candidates from which companies could select. We would propose further that company workers should be able to vote on any proposed independent remuneration committee candidates for their company.

5. Is there a need for stronger guidance on membership of remuneration committees, to prevent conflict of interest issues from arising?

The TUC believes that direct conflicts of interests such as when two directors sit on each other's remuneration committees should be absolutely prohibited.

However, we believe that a much greater problem is that currently NEDs are generally either current or recently retired executive directors of other companies. Current executives have an indirect interest in promoting high levels of executive pay and both are groups among whom high pay is regarded as normal and deserved. While it is important that direct conflicts of interests are prohibited, tackling this wider problem is equally important and more challenging.

The TUC has for many years argued that a wider range of people should be appointed to NED positions on companies and has put forward a range of proposals for putting this into practice. One key proposal is that all NED positions should be publicly advertised. At present, NED positions are largely filled using executive search organisations, and this perpetuates the narrow pool from which NEDs are drawn. A first step would be to ensure that a wider range of people could at least apply for NED positions through advertising vacancies publicly.

6. Would there be benefits of requiring companies to include employee representatives on remunerations committees and what would be the risks and practical implications of any such measures?

The TUC strongly supports the proposal for worker representation on remuneration committees. We believe that the so called 'risks' and practical objections to this measure have been overstated.

We believe that worker representation on remuneration committees would bring important benefits:

Workers would bring a fresh perspective and common sense approach to discussions on remuneration, in contrast to the current culture that presides on remuneration committees.

Remuneration committees are required to take account of pay and conditions elsewhere in the company but, as the consultation paper notes, have notably failed to do so. Company workers would clearly be extremely well placed to ensure that issues relating to pay and conditions elsewhere in the group were brought to the remuneration committee's attention.

Workers' interests are inextricably linked to the long-term success of their company; they are therefore well placed to contribute to discussions on an appropriate remuneration strategy to serve the long-term interests of the company.

Including workers on remuneration committees would engender a higher degree of buy-in from employees on pay arrangements at their company. This should contribute to employee engagement, which is shown to be linked to higher company productivity and performance.

Research has shown that worker representation does have an impact on directors' remuneration. One study showed that, among the largest 600 European companies, the presence of board level worker representation is correlated with lower CEO pay and a lower probability of stock option plans. A second study showed that, within large German companies, stronger employee representation on the board led to lower CEO pay and less use of stock-based remuneration.

As noted by Will Hutton's Review of Fair Pay in the Public Sector, there is clear academic evidence that high wage disparities within companies harm productivity and company performance. For example, one study of 4,735 companies between 1991 and 2000 found that within-firm pay inequality is significantly associated with lower firm performance. A second study that used compensation data from Standards and Poor's ExecuComp (covering around 1,500 companies per year) found that firm productivity is negatively correlated with pay disparity between top executive and lower level employees. A third study of over 100 companies found that low pay differentials were associated with higher product quality. The clear and negative impact of high pay differentials on company performance shows that this is an issue that shareholders and Government should take extremely seriously, and makes a strong case for the inclusion of worker representatives on remuneration committees.

If this proposal were implemented, the TUC would work with suitable partners to provide accredited training to worker representatives. We would also organise a network for worker representatives on remuneration committees, as we already do very successfully with trade union member-nominated pension fund trustees. This would help to ensure that worker representatives were able to contribute effectively to remuneration committee discussions.

We do not believe that the issues relating to the legal status of such worker representatives are insurmountable and note that some of those who have raised these objection also object in principle to the idea of workers on remuneration committees. We would note that exactly the same issues would relate to independent members of remuneration committees. We believe that a change to the status of remuneration committees, whereby the remuneration committee would become an advisory committee to the main board, with membership drawn both from the company board (ie, existing NEDs) and outside members, could provide a solution.

The consultation document refers to the existence of studies that point 'to the challenges of making employee representation work effectively'. Our reading of the literature, especially more recent studies that are conducted on an econometric basis, is that the impact of employee board representation is neutral to positive in terms of company performance. We would be happy to discuss this area in more detail if this would be of interest.

7. What would be the costs and benefits of an employee vote on remuneration proposals?

We would support an employee vote on remuneration proposals. This would give employees the opportunity to have their say on proposals for executive remuneration at their own company.

The evidence set out in response to question six above - that a large gap between executive pay and ordinary workers' pay in the same companies harms productivity and company performance - is also relevant to this proposal.

We do not believe that there would be significant costs associated with an employee vote. Staff surveys have become an increasingly common tool for companies to use to gauge the views or levels of satisfaction of their staff. An employee vote on executive remuneration could be incorporated into a stuff survey system. It would be important that the employee vote was conducted independently, but this is true also of staff surveys, and is well established best practice.

We believe that all company workers should be eligible to vote. In terms of timing, as the consultation paper suggests, the vote should be conducted in time for the results to be included in remuneration committee reports.

8. Will an increase in transparency over the use of remuneration consultants help to prevent conflict of interest or is there a need for stronger guidance or regulation in this area?

The TUC is very doubtful that further transparency in relation to remuneration consultants will have much practical impact on their role. As the consultation paper notes, there has for years been a requirement in the Combined Code for remuneration committee reports to disclose whether remuneration consultants have been used and if so whether the latter have any other connection with the company. This has not addressed the conflicts of interest that clearly exist when remuneration consultants carry out other services for the same company.

The TUC believes that the only solution is to prohibit companies from engaging remuneration services from an organisation with whom they have an existing commercial relationship and vice versa.

In addition, it is essential that remuneration consultants should be appointed by and report to remuneration committees only, and not to the executives whose pay is being discussed.

Structure of remuneration

Performance-related pay - questions 9 - 14

As the consultation document notes, incentive related pay has to date failed to correlate effectively with company or individual performance. The consultation document questions whether this is because it has failed to motivate directors effectively; or whether it has failed to reward performance effectively. In the TUC's view it has failed on both counts.

  • It has proved extremely difficult to set stretching targets that pay out only for good or outstanding performance, and incentive-related elements of pay continue to reward mediocre and even poor performance on a regular basis. As the consultation document argues, this is partly because the difficulty of finding one indicator that encapsulates 'good' performance has led to incentive schemes becoming more and more complicated, which in turn has had the effect of creating so many different incentives that directors regard them as neither aligned with business strategy nor within their control.
  • This makes incentive-related pay ineffective on both counts. The lack of an effective link between incentive-related pay and performance means that it is the incentive-related elements of pay that have contributed most to the growing gap between directors' pay and that of ordinary workers.
  • There are strong practical reasons against the over-reliance on performance-related pay relating to the demonstrable difficulties in setting appropriate targets. However, the TUC also believes that there is a more fundamental question about whether the reliance on financial incentives to encourage directors to do a good job is really the best way of building successful and innovative companies led by talented and dedicated directors. There have been many directors who have rejected the idea that they only do a good job because of the amount or the way in which they are paid; indeed, to suggest that the only reason directors do their best in their job is because of their LTIPs or annual bonus is in the TUC's view insulting. While the TUC does not believe that the majority of directors are motivated primarily by financial motives, there is a danger that incentive-related pay could become self-fulfilling and will attract to the role people who are motivated primarily by individual greed rather than a commitment to their company and dedication to their role. Indeed, it could be argued that in the financial sector this has at least to some extent occurred and remuneration design has affected both behaviour and the type of person attracted to the industry, with disastrous consequences for the sector and the wider economy.
  • There is convincing academic evidence that performance-related pay does not generate higher levels of motivation or performance. This should not be a surprising finding. People in many walks of life are expected to, and indeed do, do their best at work for a fixed salary, and the TUC can see no reason why directors should be any different in this regard.Surely it is desirable that those running Britain's companies should be motivated by a commitment to their company and a desire to do a good job, and to be fairly rewarded for doing so, rather than driven by money above these other motivations.
  • We believe that the approach promoted by public policy since the Greenbury Committee of trying to improve the link between pay and performance has failed. It is time for a different approach.
  • The TUC would like to see a step-change in relation to incentive-related pay:
  • the incentive-related element of remuneration should be a much lower proportion of total remuneration than is generally the case at present (we suggest around 10%) and should not dominate the total package;
  • no more than one incentive-related element should be used;
  • targets should be long-term only (at least five years) and should include non-financial indicators.

9. Could the link between pay and performance be strengthened by companies choosing more appropriate measures of performance?

As argued above, we believe that more appropriate measures of performance could be used, and that these should include non-financial indicators including, for example, staff satisfaction figures. However, on its own this will be insufficient to achieve the necessary degree of change.

10. Should companies be encouraged to defer a larger proportion of pay over more than three years?

We believe that targets should be at least five years in order to address the risk that targets add to the problems of short-termism. We understand the merits of deferred pay, but if it is to be used effectively it is essential to address the risk that discounting of future pay has the effect of raising remuneration over time.

11. Should companies be encouraged to reduce the frequency with which long-term incentive plans and other elements of remuneration are reviewed? What would be the benefits and challenges of doing this?

We do not support the use of LTIPs as currently designed. They have proved very unresponsive to performance and yet have become an increasingly large proportion of total remuneration.

If LTIPs are to be used, we would agree that there are likely to be advantages in reviewing them less frequently, although again care must be taken that this does not lead to increases in quantum as a trade off for flexibility.

12. Would radically simpler models of remuneration which rely on a directors' level of share ownership to incentivise them to boost share value, more effectively align directors with the interests of shareholders?

13. Are there other ways in which remuneration - including bonuses, LTIPs, share options and pensions - could be simplified?

The TUC strongly agrees that simpler models of remuneration are essential. Our recommendations on incentive related pay, set out above, are:

  • the incentive-related element of remuneration should be a much lower proportion of total remuneration than is generally the case at present (we suggest around 10%) and should not dominate the total package;
  • no more than one incentive-related element should be used;
  • targets should be long-term only (at least five years) and should include non-financial indicators.
  • In terms of total remuneration increases, the TUC believes that directors should receive the same percentage increases as the rest of their workforce. At a minimum, directors should receive the same percentage increase in annual salary as their workforce. There cannot be a justification for paying directors higher percentage increases of their already much higher salaries year after year. This practice has fuelled ever-rising differentials between company directors and their staff. The TUC believes that current levels of directors' remuneration significantly over-value their contribution to the company in relation to that of their workforce.
  • While as already stated we would strongly support using just one performance-related element of pay, our reservation about share ownership is that this could create incentives for directors to follow short-term strategies to boost their share price, rather than investing in long-term organic growth. Requiring directors to hold their shares for significant periods of time - at least ten years - could help to address this risk.
  • In terms of pensions, the TUC believes that directors should be in the same schemes as their staff on the same terms. It is essential that the disgraceful situation where companies cut pensions for their workforce but offer their directors pensions on much more generous terms should end. Please see our response to the BIS Narrative Reporting consultation for our proposals for disclosure on pensions.

14. Should all UK quoted companies be required to put in place claw-back mechanisms?

The TUC believes that claw-back mechanisms could be beneficial if performance-related pay continues to remain at very high levels and continues to dominate the total remuneration package. As already noted, we would support radical change in this area, which, if implemented, would make claw-back mechanisms much less relevant.

Promoting good practice

15. What is the best way of coordinating research on executive pay, highlighting emerging practice and maintaining a focus on the provision of accurate information on these issues?

The TUC would support the establishment of a High Pay Commission to monitor trends, policy and implementation in relation to executive pay, but only if this body had a genuinely diverse membership which included representation of employees and other groups that have a stake in real and significant change in this area.


http://www.tuc.org.uk/tucfiles/137/Fund_Manager_Voting_Survey_2011.pdf

Engaging for Success: enhancing performance through employee engagement by David MacLeod and Nita Clarke, July 2009

Board Level Employee Representation, Executive Remuneration And Firm Performance In Large European Companies, Sigurt Vitols, March 2010; and Arbeitspapier 163, Beteiligung der Arbeitnehmervertreter in Aufsichtsratsausschüssen, Auswirkungen auf Unternehmensperformanz und Vorstandsvergütung, Studie im Auftrag der Hans-Böckler-Stiftung, Sigurt Vitols 2008; both available from the TUC

Pedro Martins, Dispersion in Wage Premiums and Firm Performance, Centre for Globalisation Research Working Paper No. 8 April 2008

Olubunmi Faleye, Ebru Reis, Anand Venkateswaran, The Effect of Executive-Employee Pay Disparity on Labor Productivity, EFMA, Jan 2010

Douglas M. Cowherd and David I. Levine, Product Quality and Pay Equity Between Lower-Level Employees and Top Management: An Investigation of Distributive Justice Theory, Administrative Science Quarterly, Vol. 37, No. 2, Special Issue: Process and Outcome: Perspectives on the Distribution of Rewards in Organizations June 1992

Board-level employee representation rights in Europe Facts and Trends, Aline Conchin, ETUI Report 121

See Executive Compensation Review of the Year, PWC 2009

See, for example, The False Promise of Pay for Performance: Embracing a Positive Model of the Company Executive, James McConvill, 2005; The Upside of Irrationality: The Unexpected Benefits of Defying Logic at Work and at Home, Dan Ariely, 2010; Not Just for the Money: Economic Theory of Motivation, Bruno Frey, 1997; The Hidden Costs of Reward: New Perspectives on the Psychology of Human Motivation, Mark R. Lepper & David Greene, 1979

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