Yesterday (3/6/2015), I attended the Annual General Meeting of Sprue Aegis (SPRP). Before discussing what was said at that meeting, it’s worth reviewing a recently issued report by the High Pay Centre entitled “No Routine Riches”. It’s a devastating critique of how the existing systems of “performance related pay” for directors has worked.
To quote from the report: “We have looked at the growing complexity of awards that has pushed directors’ pay into the stratosphere, and found there is little discernible link with corporate success. In fact, there is an argument that it is actually damaging the economy“.
It points out that the average pay of FTSE-100 CEOs has grown five-fold since the late 1990s – it’s now about £5 million per year. It claims there is a very weak relationship between pay and company performance. In essence performance-related pay does not do what “it says on the tin”.
It potentially damages the economy because such incentives can reward executives for focussing on practices such as share buy-backs, cost-cutting and under-investment in order to manipulate the targets or achieve short-term objectives.
The High Pay Centre report gives the supporting evidence which stands up to scrutiny, and then goes on to propose some reforms. For example, they suggest Long-Term Incentive Plans (LTIPs) should be abolished, that bonuses should be paid in cash rather than shares because executives tend to undervalue shares, that targets should be broader based (rather than being simply EPS or TSR), and that Remuneration Committees should be more diverse.
You may not agree with all of those recommendations, but they certainly give strong arguments for reform.
A good example of the gross inflation of executive pay is coming up at the AGM of WPP on the 9th June. CEO Martin Sorrell is facing a shareholder revolt over his pay package of £43 million in 2014 making him the best paid CEO in the FTSE-100. Proxy voting services such as Glass Lewis, ISS and PIRC have criticised the award and in some cases recommending voting against. The £43 million is actually 37 times his base salary which just shows how bonus schemes can generate enormous awards. Does the performance of WPP justify these enormous payments to the CEO? In essence NO. Return on capital at the company is nothing exceptional.
At the other end of the company scale, Sprue Aegis is a small AIM company that is about to introduce an LTIP (the details of the scheme were actually announced the day after the AGM so they nicely finessed avoiding discussion of it at the meeting). But not all discussion of it was avoided as you can see from the summarised extract of a report of the meeting below (a full report is present here):
“When it came to the Remuneration Report Resolution, the reason for the proposed introduction of an LTIP was questioned and got the usual answers from non-exec William Payne (need to incentivise management, aligns their interests with shareholders, seen as the modern way to do things, it’s now normal and everybody is doing it, etc.). Mr Payne, Head of the Remuneration Committee, was asked whether he had actually read the recent report from the High Pay Centre on LTIPs. He appeared not to have done so. It was pointed out that short term bonuses are much better if you want to improve performance.
ShareSoc Director Mark Bentley pointed out that the 2 most important directors already had substantial shareholdings which were surely enough to align their interests – he thought shareholdings were better to incentivise directors. He encouraged them to look at the LTIP targets (he was suggesting they are often too weak), and he preferred that bonuses were paid in shares which had to be held for a period of time.
Only later were the proxy voting numbers on the Remuneration Report and the election of Mr Payne disclosed after they were specifically asked for on the basis that this was best practice. We then discovered that they got 1.96m votes against the Remuneration Report and Mr Payne got 578,000 votes against also – these are significant numbers as was pointed out to the Chairman, although he said the turnout was low. Clearly some institutions were unhappy with the remuneration schemes, past and future, but the proxy votes against were not sufficient to defeat the resolutions and they were passed with only one objection on a show of hands vote.
When it came to the last resolution on share buy-backs, Mark Bentley asked under what circumstances they would use that provision. The answer given was convoluted as there was some discussion about the large amount of cash on the balance sheet, the inability to find suitable acquisitions (too high expectations of value), and questions from institutional investors but it was suggested that they might do buy-backs if the directors thought the shares were under-valued. But one shareholder did point out that there is a peculiar incentive arising from LTIPs that have a share price performance element as proposed as this might encourage the use of share buy-backs.”
The LTIP details, as subsequently disclosed, enable the executive directors to achieve large bonuses for unexceptional performance. But in essence the remuneration committee developed these proposals, supported no doubt by the rest of the board, and investors failed to block them. This demonstrates exactly why reform is necessary, and not just at FTSE-100 companies.