Anthony Hilton: Executive payouts fall foul of business ethics

by Anthony Hilton,

June 14 09:20 AM

Newton Investment Management’s boss Helena Morrissey is part of an independent working group that says pay should be much more closely tailored to companies’ individual strategies and needs

Fund managers and the people who run money management groups and insurance companies are among the highest paid in the country. Perhaps as a consequence they have not been very effective in curbing the pay and bonus explosion which has swept through British business in the past couple of decades.
Though technically they can hold a board to account — not least by voting directors out of office — in practice they have done little and achieved less. The fund manager with a salary running to several hundred thousand a year, and his or her boss earning millions, tends to have a different view of what is normal than someone working outside the City and financial sector.
It has taken the collapse of public trust in business and opinion polls showing excessive pay as a major cause of outrage for the Investment Association to realise it needs to raise its game. It therefore set up an independent working group chaired by Legal & General’s chief executive Nigel Wilson — a good choice given that L&G’s investment arm is one of the most consistent and vocal critics of excessive executive pay.
He’s been joined on this Executive Remuneration Working Group by Newton Investment Management’s chief executive Helena Morrissey, Sainsbury’s chairman David Tyler, financial entrepreneur Edi Truell, and Aggreko director Russell King and their task is to explore what might be done to help rebuild public confidence by overhauling the way companies pay their senior people. That was a few month ago and, just after Easter, the group issued an interim report as a basis for discussion and consultation.
That report made the right noises in its PR release, saying the present system was not fit for purpose and widely seen as broken. In future, pay should be much more closely tailored to companies’ individual strategies and needs. It should be simpler and there should be more emphasis on long-term success.
But any hopes the committee might have had that that these placatory words would defuse the issue and form the basis of a new deal have been overturned by a blast last week from the Institute of Business Ethics. It clearly thinks the group has not been working — or at least thinking — anything like hard enough.
In a letter to Wilson, the Institute’s director, Philippa Foster Back, kicks off by saying bluntly that “the debate needs to encompass more radical changes than those discussed in your report” and, in particular, that it should give much more weight to simplicity, because few people understand the present system.
“Executive pay is unnecessarily complicated,” she writes. “It is very difficult indeed, if not impossible, to set a clear value on many of the leveraged share arrangements nowadays routinely awarded to directors.”
She goes on to say that the results often are a surprise to everyone, and sometimes big payouts can come down to luck. “Outcomes can fluctuate wildly in ways that are out of the control of recipients… a strong stock market or a calamity at one or more comparator-group companies can boost the reward for a less than outstanding individual performance.”
This leads the Institute to challenge the committee’s view that, with suitable modification, there is still a place for long-term incentive plans. LTIPs are not okay, Foster Back says, because they present “real operational difficulties” since it is “so hard to set meaningful performance conditions”.
The system even encourages bad behaviour: in some cases, executives simply cannot understand the performance criteria laid out for them in an LTIP or have no idea how to achieve what is asked, so they are tempted to cheat. That is what the Institute means when it says “they will often try to game performance criteria over which they feel they do have some control”.
There is more: understanding the need to move against short-term thinking, Wilson’s committee suggested long-term investment plans should be stretched to five years from the present three. This, Foster Back says, is nowhere near adventurous enough.
Specifically, Wilson needs to be much bolder in promoting plans which are not just about share-price performance but take into account management’s achievement in delivering a sustainable and growing cashflow; there should be much greater insistence on credible succession planning; the emphasis on annual bonuses — which appears rather arbitrary — should be reduced in favour of focusing on the payment of dividends on accumulated long-term holdings of shares. In this context, five years should be the absolute minimum — not a maximum — time frame.
Finally, to counter any accusation that she is better at demolition than at building, Foster Back’s final salvo is a guide to what good would look like.
In every case the remuneration committee should be able to answer the following simple questions, she says:
Why have we chosen the level of quantum proposed and can it really be justified?
Can everybody — boards, executives, shareholders — clearly see the value of what is being handed over?
Will the award stimulate the executives to pursue a long-term strategy that is in the interests of the shareholders and the company? 
Will the broader public be able to see a clear connection between performance and the eventual outcome?
The debate needs to be conducted with a lot more urgency, she concludes, adding: “Until remuneration committees can always answer these questions we will continue to have problems with executive remuneration which feed into rising voter concern with inequality on both sides of the Atlantic. We believe the problem is urgent and more serious than your report suggests.”