Comments on Deborah Hargreaves’ new book and my conclusions thereon.
by Cliff Weight, 30 October 2018.
I read Deborah Hargreaves book “Are Chief Executives Overpaid? (The Future of Capitalism)” with great interest. It is an easy read and covers a vast amount of material which illustrates the complexity of any discussion of executive pay. I commend it to all. You can buy it on Amazon.
I was on a panel of speakers at the CSFI event on 15 October where Deborah spoke and introduced her book and views. The event was very well attended (60+) with several members of the press (Anthony Hilton, Jonathan Ford, Phillip Coggan) and many of the great and the good (e.g. Andrew Smithers), although missing were CEOs and fund managers. The meeting conclusion was that capitalism was not working and shareholders (or more specifically their representatives the fund managers) did not really want to control CEO pay. The majority view was for a new and improved form of capitalism.
I went away and thought again. Here are my 10 points/ideas to help improve the problem of FTSE100 CEO pay.
- I am not investing my money in shares in a company unless the CEO has skin in the game. I want him/her to have a significant amount of shares/options/LTIPs.
- Internally promoted CEOs should have acquired significant amounts of shares over their career in the company. Company pay structures should enable successful executives to build up, over time, significant stakes in their companies.
- New hires won’t initially own a significant shareholding in the company, so they must be found a way to acquire shares or an interest in shares quickly so as to align their interests with mine (the shareholder).
- The average FTSE100 CEO is paid £5m p.a. So an average new recruit should expect £25m of pay over 5 years. The new recruit should be given £20million of shares on day 1, which would vest 20% p.a. at the end of each of the first 5 years of his/her tenure; and a salary of £1m p.a. (The precise details can be worked out, but my example illustrates the most important principle. If after 5 years the share price has trebled, he/she has been paid £65m, if it halves he/she gets £15m or less if fired before the five years are up. No change in share price, he/she gets £25m. Really simple.)
- Improved disclosure of pay and Say-on-Pay have been helpful, but some of the details were wrongly specified. And this did not help transparency and trust – it had the opposite effect of increased suspicions about the whole process. Sorting out the problems will further improve the way pay is managed and help to rebuild trust. This is detailed stuff, not headline news but must be addressed. 4 examples that need to be dealt with are:
- The illustration of possible future earnings ignores the share price changes and awards made in previous years. Examples have occurred where payments have exceeded the maximum in the illustrations.
- The expected value of LTIPs in remuneration reporting disclosures is wrong. It is based on the faulty logic used in IFRS2 accounting for share based payments.
- The Single Total Figure of Remuneration definition is wrong. There should be disclosure of two figures, the Total Amount Received (an improved version of the STFR) and the Total Amount Awarded.
- The current advisory vote on remuneration should be made binding, or we should adopt the Aussie two strikes and you are out approach.
- Ratios of CEO pay to number 2 executive’s pay, to the average of the top 10, top 100 and top 1,000 are very useful and should be disclosed in FTSE100 companies. They tell us about possible succession and where the value is created.
- Individual investors invest their own money over the long term and have a long term perspective. They have a valuable input into the remuneration debate. Nominee accounts have disenfranchised the individual investor. Ways need to be found to ensure the individual investor’s voice is heard.
- AGMs are hugely useful for investors to listen to the directors explain what is happening to their business, to meet the directors, to ask questions and to hold directors to account. Questions at AGMs should be balanced and should not be hijacked by customers, employees or pressure groups pursuing narrow specific agendas. Customers, employees and pressure groups and other stakeholder group should be listened to, but part of this can be outside of the AGM. Time allocated to pressure groups in the AGM itself should be limited. Fund Managers should be encouraged to attend AGMs in the knowledge that their time will be well spent, with access to Directors on the day. (Part of the reason that stakeholder groups hijack AGMs is that directors do not listen to them as part of the normal management processes of the company. Companies need to recognise this and address these stakeholder concerns.)
- We need a better form of capitalism. This better form of capitalism won’t be led by the fund managers. They are the wrong people to look to drive change.
- We need to ask what do we want the CEO to do. Is it a stewardship role or that of an entrepreneur? Does the CEO make lots of big decisions by himself, or is it a team effort? What skills and competences does the CEO role need, now and in the future? Are these the same skills we wanted when the CEO was recruited? Has he/she learnt the new skills needed? Can he? How easy is it to measure performance and distinguish between the impact of the actions of the CEO and factors extraneous to the company. Do we understand and recognise the impact of leverage and tail risk on share price performance and hence on CEO rewards? How do the KPIs link into the long term shareholder value? Are we sure we understand the linkage of KPIs to shareholder value? Will this relationship change over time? Do we know how? What is the timeframe for CEO decisions to impact on KPIs, and on shareholder value? Hence, are we paying the CEO for the right things and do we have too much or too little incentive in the reward package?