At a time of acute economic pressures and rising unemployment, the prospect of chief executives receiving high and excessive pay awards will undoubtedly arouse much controversy and resentment.
It is not simply the quantum of the pay award that is important. The structure of the pay package – whether it is made upon of cash, bonuses or share incentive schemes – is also vital. We have seen a distinct shift over the past few decades; in the 1970s and early 1980s, the vast majority of executive pay was made up of cash and bonuses. This steadily changed over the next thirty years to the point where in this decade the majority of executive pay is made up of long-term incentive schemes. Only a quarter of total pay consists of base salary.
There is nothing inherently wrong in principle with long-term incentive schemes, or LTIPs. They were originally designed to align better the interests of shareholders ad executives to ensure creation of value for the ultimate owners of the business over the long term. Broadly, LTIPs consist of shares which can be vested after a period of time, usually in the range of three to seven years, with the quantity depending on agreed performance metrics.
Although welcome in principle, LTIPs have tended to distort pay and behaviour, and ultimately added to the anger and erosion of trust over the matter of executive pay. LTIPs are complex and are often based upon a bewildering array of metrics which are difficult to follow. There were factors which had nothing to do with the calibre of the management team or the vision and execution skills of the CEO, such as government policy, which moved the share price. This resulted in the situation where in the housebuilding industry the nature of LTIPs, combined with the share pricing moving because of the Government’s Help To Buy scheme, ensured that a particular chief executive was eligible for a pay award of over £100 million. Schemes are becoming more opaque, rather than more transparent and easy to understand. They can also distort behaviour, ensuring that a chief executive may be incentivised due to the timing of vesting shares to take corporate decisions such as cutting R&D investment which may boost immediate financial results but at the expense of long-term value for the business.
When I chaired the House of Commons BEIS Select Committee in the 2015 Parliament, we looked at Corporate Governance and Executive Pay. We felt that LTIPs were opaque, far too complex and distorting and did nothing to better evaluate the important link between executive pay and corporate performance. We recommended that LTIPs should be scrapped as soon as practicable, replaced by deferred share schemes with components including restricted shares or pregnant performance conditions.
This approach was shaped by evidence we heard from the likes of the Investment Association and the Purposeful Company Executive Remuneration Report. Since that time, great work has been undertaken by the Purposeful Company and influential and visionary leaders in the business world who chair remuneration committees, such as Clare Chapman, NED at Weir Group. In the last few weeks, the Purposeful Company has revisited this issue and found that about one-in-ten FTSE 350 companies, including firms like BT, Burberry and Weir Group have replaced LTIPs with a clearer remuneration scheme which tries to align pay with true long-term value creation. Clearly there remains a long way to go, but the great leadership provided by Clare and other remuneration committee chairs shows what can be achieved.
The report is available online and is well worth a look:
Author
Iain Wright FCA
Director, Business and Industrial Strategy, ICAEW
Iain.wright@icaew.com
