New report from HPC and the CIPD, based on interviews with remuneration committee members, investors and other stakeholders in the pay setting process, calls for corporate governance reform, with more emphasis on people management and employment culture
With growing public anger at runaway levels of top pay increasing and the UK suffering from amongst the highest levels of pay inequality in the developed world, there is clearly something going wrong with the pay practices at Britain’s biggest employers. The High Pay Centre and the CIPD undertook a review of the current operation of the ‘remuneration committees’ that set pay at major UK companies, looking at the practices they undertake, the challenges they face, and the different stakeholder perspectives involved. Interviews with committee members, the colleagues they work with, investors and independent experts revealed the following key insights:
- The myth of ‘super talent’ continues to drive excessive pay – remuneration committees continue to fear that executives will walk out on the company if their pay demands are refused, and worry about stock market reactions to an abrupt departure. This is despite questionable evidence of the impact of a single executive on company performance.
- ‘Unknown unknowns’ keep directors awake at night – it’s difficult for the non-executives on remuneration committees to properly understand what’s happening on the front line of their companies. This creates the risk that major failures in culture and governance are not spotted until too late.
- Group think and a lack of professional diversity abound – committee members are drawn from narrow professional backgrounds. The absence of people management expertise is a key concern. Narrow focus leads to ‘non-system’ thinking – the lack of professional diversity means that committees tend to judge company performance in narrow financial terms, and set pay accordingly.
- The work of the remuneration committee is resource-intensive – the executive paysetting process involves considerable contribution, including from HR departments, financial and legal teams, investor relations and PR teams, as well as from external consultants and shareholders. This is a considerable drain on resources for the purpose of setting pay for a small number of individuals and leads to more important issues being neglected.
- Companies are likely to reject workers on boards – there was little appetite amongst current committee members for worker representation. Committees are more likely to appoint a non-executive director with responsibility for stakeholder representation.
The report argues that there is an ‘opportunity cost’ to the considerable resources companies expend on determining the pay of a small number of executives. Remuneration committees’ conceptions of company performance are also too narrow. This undoubtedly results from the narrow range of professional backgrounds from which committee members
On this basis, we make the following recommendations. They are aimed primarily at the boards and shareholders of the major UK-listed companies covered by our research. However, they should also be considered by policy-makers and regulators charged with guidance and oversight of corporate governance in the UK. Similarly, corporate culture, people management and fair pay practices are as important to privately owned companies as to those listed on public markets. Therefore, boards and owners of private companies should also consider implementing these recommendations.
- Companies should consider establishing a formal ‘people and culture’ committee in place of their remuneration committee. Those that choose not to do so should still demonstrate clearly, in their annual reports, how company pay practices relate to their strategy for people management and corporate culture. We have provided a draft ‘Terms of Reference’ in the report to act as a template for those wishing to formally expand their remuneration committee’s remit to ‘people and culture’.
- Companies should formally assess their non-financial performance – for example, by looking at their impact on different stakeholder constituencies, and reviewing their social and environmental performance. They should explain their methodology for this assessment – and the results – in their annual report. Performance in this respect should be a key consideration when making annual pay awards.
- Succession planning and development of long-term executive capability within the organisation should be explicitly included in the committee’s remit, as should organisational fairness in relation to pay.
- To this end, professionals with people management experience should be appointed to remuneration committees – or people and culture committees – as well as representative of the company’s stakeholder communities, including its workforce.
- Long-term incentive plans should be replaced as the default model for executive remuneration with a less complex system based on basic salary, with an incentive to deliver sustainable long-term performance provided by a much smaller restricted share award
These recommendations may seem bold and radical, but we do believe they are achievable. It is clear from faltering public confidence in top pay practices, and corporate culture and employment models more generally, that a radically different approach to the remuneration committee is needed.
We will be discussing the report’s conclusions at an event in Central London on February 5th – for more info, see here.