Remuneration Committees are ripe for reform

By 23.04.19BlogAugust 27th, 2020No Comments

Pay setting committees have failed to address stakeholder concerns about executive pay practices. There should be an explicit mandate to deliver fairness and proportionality, with workers given a voice in the process. HPC Director Luke Hildyard’s article for the Institute of Chartered Accountants of England and Wales

Excessive pay has been a growing source of public anger in recent years. And despite being snobbishly dismissed as populist prejudices, public perceptions of executive pay practices are largely accurate. Top pay growth over the past couple of decades has greatly outpaced the meagre pay rises experienced by the wider workforce – and has not been matched by an obvious improvement in company leadership.

This is important for a number of reasons. Firstly, it has a terrible effect on the reputation of business.  Secondly, very high executive pay both reflects and drives societal inequality.  Finally, very high pay is a potential ‘canary in the coalmine.’ If the boards of big companies have allowed such disproportionate pay increases to accumulate unchallenged, without any corresponding increase in executive performance, this surely raises question about the governance, values and accountability to stakeholders of the UK’s leading companies.

These questions should be directed, in particular, at the remuneration committees that set pay at listed companies in the UK. A recent report that we have undertaken at the High Pay Centre in partnership with the CIPD, based on extensive interviews with remuneration committee members and other stakeholders in the pay-setting process including investors, consultants, trade unions and academic experts, looked at this topic in more detail.

The report found a number of flaws in current remuneration committee practices. Only 26% of FTSE 100 committees currently include someone with a professional background outside business and finance. It is unsurprising that the majority of board members at big businesses have a background in big business, but the extent of their dominance creates an obvious conflict of interest. People who benefit or have benefitted from a high pay rate for business leaders are unlikely to be sufficiently critical of very high pay awards.

Our report also noted that remuneration committees rarely situated their work within the context of the wider corporate culture and pay practices of their organisations (for example, just 16%  of remuneration committees include an HR or people management professional, while none include a representative of the company’s workforce). This is despite the extensive resources the company expends structuring, benchmarking and measuring executive performance and pay.

As part of the prescription for these problems, our report suggests that as a first step, companies should guarantee HR professionals and elected workers’ representatives seats on remuneration committees. This would do a great deal to improve public confidence in pay practices – workers’ representatives are not likely to underpay a CEO who is doing a good job and thereby sustaining their employment. At the same time, they would introduce a little real world perspective into deliberations on pay. Anyone reading news of a very generous pay package, would have their concerns about inequality and corporate greed assuaged by the knowledge that the company’s workers had contributed to the pay setting process.

Remuneration committees should also have an explicit responsibility to deliver fairness as an objective of the pay-setting process, and should recognise the impact that pay differences have on corporate culture. In line with directors’ duties in the 2006 companies act, committees should assess performance in relation to a balance of the outcomes delivered for different stakeholder groups, with a particular focus on the company’s social and environmental impact as well as its financial performance.

This would represent a substantially expanded remit, but remuneration committees could create space for the additional workload in one simple step, by moving from complex pay awards based on so-called long-term incentive plans to a simpler structure involving a basic salary and a deferred share award.

These are undoubtedly controversial proposals. But as controversial as collapsing trust in business, the highest inequality in Europe and the potential  eventual political repercussions? Boards unwilling to change their approach to pay and governance as advised by think tanks and campaigners now may be forced to deal with more severe changes imposed upon them further down the line.