executive pay – Escondido Framework

Investors call a chief executive’s bluff

Don't ask these investors for a pay rise — Don’t ask these investors for a pay rise

News of a chief executive’s resignation following a failed bid for more pay reminded me that back in April, the FT’s Brooke Masters wrote an article about the difficulties faced by both governments and shareholders reining in the excesses of corporate pay. Noting that in 2021 it was possible to believe that “corporate sermonising about the need to look beyond pure profit was beginning to bear fruit”, “that the pandemic had prompted most corporate chieftains to show financial restraint” and that CEO pay in the FTSE 100 had dropped by 10%, she noted that the tide had turned.

Her article was triggered by controversy around the salary to be paid to Carlos Tavers of carmaker Stellantis which attracted the ire of French presidential election candidates and was voted down by shareholders. But this contrasted with larger remuneration packages in Stellantis’s US domiciled competitors, and much large packages in the tech giants.

These big packages have been facing challenges from shareholders. Masters reports that 18% of US companies with revenue in excess of $50 billion failed to get a majority voting in favour of their executive salary resolutions, and there was a 20% increase in shareholder protest votes on pay in Europe. But often these have no effect and merely advisory, with no pain felt by boards that fail to comply with the expressed shareholder will. She indicates that she feels that the pressures for restraint in public companies are insufficient, completing her article by giving the impression that the promise from the Stellantis board that the shareholders’ vote would be “taken into account” in next years’ pay report suggests that shareholders are not being taken seriously.

In contrast, the response on 7 August of the founders of private equity company Carlyle Group to the attempt to extract economic rent from shareholders, otherwise described as a pay claim worth $300m over five years, submitted by chief executive Kewsong Lee, suggests a that they have some backbone. Admittedly, Bill Conway, David Rubenstein and Daniel D’Aniello are all billionaires and can absorb the immediate response of the stock market, a 10% decline in the share price, to the announcement of Kewsong Lee’s departure, but some of this soon recovered and the price remains 13% above the price one month ago.

But given that there is a vacancy at Carlyle and that Kewsong Lee received a total of $42 million last year (mostly in stock awards, but a fair bit of leverage on the base salary of $275,000), anyone willing to exercise a little restraint in the face of some hard-nosed shareholder may want to apply.

Norwegians have the power to tackle executive abuse of power

Norway’s population and land area may be only 0.07% and 0.08% respectively of that of the world, but through their nation’s $1.2 trillion oil wealth fund they own the equivalent of 1.5% of every listed company. If any single organisation is able to help overcome the market failure represented by the capture of economic rent by the managers (and the connivance in this of toothless or complicit remuneration committees), it is the custodians of Norway’s accumulated oil receipts.

It is reassuring to discover that Nicolai Tangen, chief executive of the fund, is on the case. Not only has it just voted against the pay packet proposed for Intel’s executives, but it voted against the remuneration proposal at Apple in March, having voted done the same at IBM, General Electric, and Harley Davidson earlier this year.

In an interview published in this weekend’s Financial Times, Mr Tangen explains that it has remuneration proposals that are not justified by performance, are opaque or not long-term in its sights. “We are in an inflationary environment, where we are seeing many companies with pretty mediocre performance coming out with pretty big pay packages. We are seeing corporate greed reaching a level that we haven’t see before, and it’s becoming very costly for shareholders in terms of dilution.”

He continues by blaming shareholders for not voting their shares: “We feel to a certain extent that shareholders haven’t really done their job in this area. We are sensing a bit of a shift in sentiment among the large shareholders in the world towards more scrutiny and more requirement for alignment.” However, he argues that the fault lies primarily with the boards themselves, stating that the “main blame is clearly with the CEOs and boards.”

Blaming the CEOs may be a bit unfair, even if it suggests that they are being less than strategic and are failing to fulfil their fiduciary responsibilities given that this will probably damage the interests of the company in long term, certainly if the investment community ever gets its act together. But it does point to a failure of the board as a whole, and particularly non-executive directors.

The FT also quotes the fund’s chief governance and compliance officer who says that the fund is currently targeting US companies because this is where the problem is most egregious. This suggests that there is a particular problem in relation to governance in the US. Part of the problem may be that although the US model places, in theory, greater power in the hands of the non-executives who generally compose almost all the board other than the CEO than models elsewhere, there is a tendency towards appointing a high proportion of NEDs who are either current or former CEOs themselves. The problem is compounded further in the US in the ease, particularly in the tech sector at the IPO stage, with which corporations employ share structures that limit the voting power of external investors. In some respects, the US corporate governance is broken, but it most certainly is if other big investors fail to follow the lead of the very large investor from the very small country near the top of the world.

Moody’s says Lloyds’ ethnic diversity plan is ‘credit positive’

The Financial Times reports today that Lloyds Banking Group’s plans for promoting more black employees have been described by Moody’s as “credit positive”, the first time that a credit agency has explicitly linked a company’s stability to ethnic diversity measures. Moody’s has not gone as far as to upgrade Lloyd’s credit rating at this point, but it clearly indicates that Lloyds’ plans are “credit positive [implying that they have the potential to reduce the company’s cost of capital, even if not immediately] because they will improve staff diversity at all levels and reduce Lloyds’ exposure to social risk”.

Lloyds has stated that it recognises that some groups are under-represented in its ranks. Anyone viewing the current TV advertising campaign for its domestic mortgage lending arm, Halifax, showing a diverse mix of staff ready to serve customers despite working under Covid-19 restrictions at home, can see that Lloyds is not talking about front-line staff in this instance. It has set a target to increase five-fold the number of black staff in senior roles by 2025 and will be publishing data on its ethnicity pay gap.

Investors and rating agencies have been taking increasing account of environmental, social and governance (ESG) risks, reflecting the importance of sustainability, on all measures, to the corporation and to those who invest in it or lend to it. The note about Lloyds published by Moody’s on Thursday is a welcome acknowledgement of the work Lloyds is undertaking. Action of this sort should improve internal culture, communication, engagement and ultimately operational performance and profitability. The motivation behind showing a diverse face to the TV audience is that it contributes to winning customers and increasing revenue. The response of Moody’s suggests that yields benefits in addressing the capital market interface, ultimately increasing access to capital and reducing its cost.

Let us hope that Moody’s response to Lloyds’ efforts spurs others to recognise that action on equality, diversity and inclusion is good for business.

Corporate Governance Code: “the mountain in labour has brought forth a mouse”

Parturient montes, nascetur ridiculus mus[1]

It’s bit harsh to describe the Financial Reporting Council’s new Corporate Governance Code as a “ridiculous” mouse, but after the hopes raised by Mrs May on the steps of Downing Street two years ago for real reform to corporate governance and the effort expended in consultation since, this reform is timid, diminutive and disappointing.

It is hardly surprising. The Prime Minister’s original challenge to the corporate world was muddled. She faced plenty of reasoned opposition to specific ideas she floated. The scandals that probably spurred her to fly the kite for reform have faded with the passage of time. Brexit has diverted attention from almost everything else.

Nonetheless, the new code includes some steps forward. There is a some modest recognition of the wider duties of the company beyond those of the shareholders in the new Principle A:

“A successful company is led by an effective and entrepreneurial board, whose role is to promote the long-term sustainable success of the company, generating value for shareholders and contributing to wider society.”

There is a further new provision which requires that a board should:

“…..understand the views of the company’s other stakeholders and describe in the annual report how their interests and the matters set out in section 172 of the Companies Act 2006 have been considered in board discussions and decision-making.”

The reminder to boards of their duties under Section 172 is welcome, but the new code falls well short of the proposals described on this site for the creation of a commissioner with power to refer companies to the Secretary of State, on application from stakeholders who could demonstrate that companies had failed to engage with Section 172. The provision in the 2018 Code has a declaratory value and will focus the attention of company secretaries and communications teams on crafting suitable words, but it lacks the backup of teeth or sanction.

The 2018 Code contains some new provisions for remunerations committees, but they are weak and do little to address the problems of runaway executive pay. Encouragement of “review of workforce remuneration and related policies and the alignment of incentives and rewards with culture” and the requirement that chairs of remuneration of committees should first have served for at least 12 months on a remuneration committee is unlikely to make one iota of difference to outcomes. These are unlikely to shift the behaviour of remuneration committees, which requires changes to the accountability of directors (as addressed elsewhere in the Escondido Framework) and a more courageous and challenging approach by the members of remuneration committees to the settlements that they are expected to endorse.

The 2018 Code pays lip service to the Prime Minister’s support in 2016 for the 1970s panacea of worker representation on boards:

“The board should keep engagement mechanisms under review so that they remain effective. For engagement with the workforce, one or a combination of the following methods should be used:

a director appointed from the workforce;

a formal workforce advisory panel;

a designated non-executive director.

“If the board has not chosen one or more of these methods, it should explain what alternative arrangements are in place and why it considers that they are effective.”

We have explained the drawbacks of these approaches elsewhere: conflicts of interest, undermining of the unitary board, challenge of adequately representing the diversity of workforce, and – core to the model of the firm described the Escondido Framework – a failure to understand the relationship of the firm to all its “stakeholder” groups.

However, if any company is looking for “alternative arrangements” that address the criticisms set out above of the Code’s approach to workforce engagement, we commend the approach described in our letter to the Financial Times on 3 November 2017 and response the Green Paper on Corporate Governance.

[1] “the mountain in labour has brought forth a ridiculous mouse” Horace: Ars Poetica, 136–9

At last, spine stiffening among investors on executive pay

It may be the height of the August “silly season”, but who can fail to welcome the news in today’s Financial Times that:

“Shareholder anger over executive pay switched from FTSE 100 to FTSE 250 companies during the annual general meeting season, as large investors protested with greater force over individual pay packages and company remuneration policies”;

and that a report

“from the Investment Association, the trade body representing UK asset managers, found a doubling to 29 in the number of FTSE 250 companies that had 20 per cent or more votes cast against remuneration policies.”?

The bad news is that after an increase in voting against remuneration reports in the FTSE 100 last year, there was a downturn this year. But at least there have been a few significant defeats, such as at Pearson, which may be a welcome sign that at last there may be a stiffening of spines in the City.

Evidence at Pearson for management hi-jack at the expense of shareholders

News of a shareholder revolt at Pearson over chief executive pay illustrates the Escondido Framework analysis of the company as an entity owned by no-one, but open to hi-jack by the management.

Pearson’s shareholders have struck out at the company’s and its remuneration committee by voting down the proposed 20% pay increase to chief executive John Fallon after he presided over record £2.5 billion loss for the group last year. Meanwhile, employees are laid off and the returns to shareholders are in freefall. The comment of the company, that it was “disappointed” by the vote but that the pay increase goes ahead, supports the underlying Escondido Framework thesis of management capture.

“Naturally, we acknowledge this feedback and thank those shareholders who have already spoken with us,” the company said. “The remuneration committee is committed to continuing dialogue with our shareholders to help shape the implementation of our remuneration policy going forward.

“Mr Fallon said his £1.5m payout in 2016 was a matter for Pearson’s board and its remuneration committee, but added he had used his £343,000 bonus, net of tax, to buy shares in the company on Friday morning.”

The FT notes that the vote at Pearson was the biggest investor revolt against executive pay at a major UK company so far this season, with the next nearest being a 40 per cent vote against the remuneration report at AstraZeneca. FTSE 250 housebuilder Crest Nicholson is the only other large listed UK company to have suffered a defeat on pay this season, with 58 per cent of votes cast against its pay report.

It can only be regarded as good news that the FT further reports that other FTSE 100 companies that faced pay protests last year, including BP and Reckitt Benckiser, have cut remuneration packages in an effort to avoid similar difficulties at their shareholder meetings this year – and indeed make an effort to reposition the companies against the market interface with their investors.

Highlights from October 2016 Harvard Business Review

My two picks from the latest Harvard Business Review relate to two Escondido Framework themes: the way that executive teams have been the beneficiaries of the misunderstanding by shareholders (or, rather, their representatives on remuneration committees) of what motivates them and how the relevant market relationships work; and the need to think about employees as customers.

An article titled “Compensation, the case against long-term incentive plans” reviews the work of Alexander Pepper, set out in his book “The Economic Psychology of of Incentives: New Design Principles for Executive Pay (Palgrave Macmillan 2015). Pepper documents how pay for performance incentives, and Long Term Incentive Plans in particular, fail to work as proponents expected. The four reasons are summarised as follows:

Executive are more risk-averse than financial theory suggests
Executives discount heavily for time
Executives care more about relative pay
Pay packages undervalue intrinsic motivation

HBR’s review of Pepper’s work, in its Idea Watch section, comes not long after news broke in London on 22^nd August that Woodford Investment Management was to scrap all staff bonuses, based on the belief that ‘bonuses are largely ineffective in influencing the right behaviours.’

The second article of interest is an article by Cheryl Bachelder, CEO of fast food franchise Popeyes: “How I did it…… The CEO of Popeyes on treating franchisees as the most important customers”. It’s not so much the lesson expressed in the article’s title that excites me, but an extract in the middle of the text that takes the message a stage further, recognising staff as customers:

At one point in my career, I was touring restaurants to talk to team members about the importance of serving guests well. I met a young man who was not excited about my “lesson”. He asked who I was. “I’m Cheryl,” I said. “Well Cheryl,” he said, “there’s no place for me to hang up my coat in this restaurant, and until you think I’m important enough to have a hook where I can hang up my coat, I can’t get excited about your new guest experience program.” It was a crucial reminder that we are in service to others – they are not in service to us.