Excessive executive pay has been common currency for some time. Hardly a day goes by without headlines referring to ‘fat cat’ pay causing public anger. Since the early investor revolts at British Gas (1995) and GlaxoSmithKline (2003), there has been ongoing debate about excessive pay, its structure, links to performance and rewards for failure. But for investors, just how much is too much?
In 2015 the median gross annual salary in the UK was around £27,600 (€33,000); but this obscures great disparities between the lowest paid (around £12,000 on the National Minimum Wage or £15,000 for the lowest 10%) and the highest. Research shows FTSE 100 chief executives are paid, on average, 183 times that of a UK worker. A FTSE 100 chief executive’s package, which typically includes base salary, benefits, short term bonus, long-term incentives and pension, is now £5m (€5.9m)a year. Individual cases of extreme earning power – the CEO of FTSE 100 company WPP for instance, earned £43m in 2014 – also brings large pay disparities into stark relief.
Another way of looking at the issue is via the differential between the highest paid and the lowest (or average paid) within a company. On this basis, the extremes are again striking – FTSE 100 CEOs had reportedly made more money by the first Tuesday of 2016 than the typical UK worker earns all year!
So how much is too much? Attempts to quantify ‘excess’ have proved elusive. In the 1920s the celebrated banker JP Morgan insisted that the differential between the highest and lowest paid within the bank should be no more than 20 times. The John Lewis Partnership model applies a multiplier of no more than 75 times, whilst the Church Investors Group, a coalition of faith investors, suggested that a multiplier of more than 75 times ‘was hard to justify’ in terms of social cohesion and fairness. In 2015, the US Securities and Exchange Commission (SEC) adopted a rule that requires a public company to disclose the ratio of the compensation of its CEO to the median compensation of its employees, which, it’s hoped, will provide greater transparency around pay differentials. In the UK, 66% of people support the idea of the introduction of a maximum pay ‘gap’, so bosses cannot earn more than a fixed amount above the average employee of their company.
Compensation is on the whole lower in continental Europe, and lower still in Asia.
In Europe, the UK and Germany have higher overall levels of executive pay, the former perhaps reflecting the importance of financial services to the UK economy and where a ‘bonus culture’ is well entrenched.
We pay careful attention when it comes to voting on executive pay. We apply an ‘excess test’ in cases where annual and long-term awards in aggregate exceed 300% of salary per year. Awards may be justified by exceptionally challenging performance hurdles, or unusually low base salaries, or they may just be excessive!
We publish our thoughts on pay in our Corporate Governance and UK Stewardship Code Policies. Essentially, we look for three things in assessing whether remuneration policy is fair and designed to incentivise superior outperformance: first, the quality of disclosure to allow shareholders an informed view; second, whether performance hurdles are genuinely stretching and aligned to shareholders; and finally any potential for excess. The latter is, of course, subjective, but we understand clients will not want us to support rewards for failure, incentivising undue risk or in paying excessively. Shareholders sometimes approve high rewards for superior performance but we subscribe to the view that excessive pay should always be avoided. Factors we look for in choosing whether to oppose include undemanding performance criteria; hurdles linked to share price increase; factors generally outside of a director’s control; and long-term incentives tiered towards rewarding for average performance.
In 2015, 59% of all resolutions we opposed or abstained related to remuneration and long-term incentive plans, opposing 75 company remuneration reports and 23 long-term incentive plans. Over the five years (2011–2015), 68.2% of all action against company proposals EdenTree took was remuneration based.
Esmé van Herwijnen is an SRI analyst at Eden Tree Investment Management. She has addressed the key question of executive remuneration – how much is too much? – in a report on corporate governance. The context is the new Conservative Party leader Theresa May, who has vowed to tackle executive pay in a pledge to create a Britain that ‘works for all’.