- October 24, 2018
Are chief executives overpaid?
In October 2018, Deborah Hargreaves published a new book, under the title “Are Chief Executives Overpaid?”. The question, of course, is rhetorical.
Hargreaves is an ex Guardian business editor and FT journalist who has made it her life’s work to attack fat cat pay, which she believes is having a corrosive effect on the cohesion of our society and is putting liberal capitalism at risk.
Hargreaves has been most effective at creating visibility in this area, although I suspect she fans the flames of discord rather than dampening them down. She was the original Director of the High Pay Commission in 2009 which was founded and funded by Compass, the centre-left pressure group, aligned with the Labour Party. Compass’ mission was to get the Labour Party re-elected, and they figured that dissent over executive pay was a good lever for winning votes. Mirroring the name of an existing official body, the Low Pay Commission, was a clever ploy. It gave the High Pay Commission immediate credibility and a quasi-official status.
In 2012, Hargreaves set up The High Pay Centre (the HPC), its successor organisation. She describes it as an independent think tank, not aligned with any political party, although its spiritual affiliation to the Labour party is evident.
Hargreaves has very firm beliefs on executive remuneration. She believes it is a manifestation of human greed and is escalating far beyond the pay of the average worker and in a way that bears no relation to company performance. Current pay differentials are essentially unfair. Chief executives are not worth anything like the amounts they are paid. She is more sympathetic to entrepreneurs who are people creating wealth through their energy and ideas. But “captains of industry” are essentially bureaucrats – they administer a system someone else has created. This refusal to believe they add so much more value than the average worker leads Hargreaves to use such ploys as “a captain of industry in the UK take 129 times the annual income of someone on average wages” and the more dramatic statement that before the end of the first week in January they will have “notched up” more income than the average annual wage.
In keeping with those beliefs, Hargreaves’ language is heavily value-laden. Executives “pocket” their pay. She talks about “late-stage capitalism”. Remuneration governance is a “religious cult”. Thatcherism was intended to free the “supposed” entrepreneurial spirits in people.
In her criticism of the conspiracy of excessive executive pay Hargreaves takes a swipe at pretty much everyone. US business schools take a lot of stick – principal-agent theory “doing the rounds of US business schools”. Head-hunters are a “coterie” drawing from the same pool of usual suspects. Institutional shareholders are too self-interested to act as effective policemen for executive excess. They provide “weak oversight”. Government crumbles in the face of corporate UK and US. Remuneration committees are afraid of the executives. Former civil servants (in nationalised industries) were “pitched into the premier pay league”. Remuneration consultants, the “high priests of the religion”, work to create high pay through benchmarking, chasing the upper quartile and opaque and complex incentive design. Tony Blair and New Labour sought a cosy relationship with big business. Even Joe Public comes in for criticism: “The modern economy has succeeded in turning peoples’ needs (the basic material goods required to achieve a secure standard of living) into wants which are never-ending.” The puritanical nature of these views indicate an aversion to people earning “loads-a-money” and a desire to produce any argument as to why they do not deserve it.
You can feel sympathy for Hargreaves’ view point. But what disturbs me is her careless use of statistics to support her case and the willingness of business editors and politicians of all parties to accept these statistics without question. One notorious piece of earlier HPC “research” served up again by Hargreaves is the report of October 2014, Performance-related pay is nothing of the sort, produced for HPC by the now defunct Incomes Data Services. This was an appalling piece of sophistry: a fishing expedition which showed no real understanding of statistics or maths. It was full of errors, but one notorious example will suffice here. IDS plotted executive bonuses against company profit for 350 companies on one chart. They showed there was virtually no correlation between profits and bonuses on their graph, and their conclusion was there was no relationship between pay and performance. But this was just nonsense maths. I will demonstrate why. Let us say you paid a CEO a share of profits in his or her company and nothing else, there will be a 100% correlation between his or her bonus and his or her performance. If you accept profit as the measure of performance, his or her pay is perfectly related to performance. Now If you do the same thing for CEOs in five companies – all paid on a profit share, but with a different profit percentage, the correlation for each company is still 100%, but the overall picture become blurred and the overall correlation falls dramatically. Graphically, the points are all over the place because the percentage share varies by company.
In fact IDS did this exercise not for five, but for 350 companies, the FTSE 100 and FTSE 250 combined, again making the assumption that profit was a good performance measure. Not surprisingly they found the correlation to be vanishingly small for the sample as a whole. Does this mean that bonuses bore no relation to profit for these companies? Of course not: you have to look at the correlation company by company, not the market as a whole– but that is what the IDS study concluded. They then went on to do the same thing with long-term incentives and relative TSR. Same conclusion: no relationship to performance. At the report launch meeting, John Plender, the FT financial journalist sighed with relief “I always suspected this was the case” and heads all around the room nodded. Since then the canard has been repeated time and again. David Davis, the right wing Tory MP wrote an essay for the High Pay Centre in which he said “CEO pay has massively outpaced anything with which it can even remotely be correlated”.
Rachel Reeves, chair of the Commons BEIS select committee told the Mail on Sunday the committee is going after the fat cats again later this Autumn. Their April 2017 report said “executive pay is increasing at a rate that vastly exceeds increases for ordinary employees and which seemingly is at odds with the value created in the company”. This statement is wrong on both counts – Minerva (formerly Manifest) data shows that, since 2010, CEO salary increases have fallen to a level much in line with the 2%-3% increases in the general workforce and this is has been the case for the past eight or so years. What have gone up are the earnings from long-term incentives but this is precisely due to share price increases and consequent shareholder returns ie “the value created in the company”.
Does this inaccurate propaganda matter? Well yes it does. It becomes accepted as fact and it affects Government policy and inflames public disenchantment with business.
Hargreaves takes another swipe at non-executive boards, who she thinks are not doing their jobs effectively. Then she adds “ remuneration committee members are well-paid too. Average pay for a remuneration committee member was £441,383 in 2015 (remember they are part-time jobs), 16 times the average for a UK employee”. This suspiciously precise figure is in fact dangerous rubbish. The proxy agency Minerva produced an analysis for the MM&K Chairman and Non-Executive Director survey covering 2015. The average total fees for a FTSE 100 NED was £115,386 (median £94,000).
These figures are accepted by journalists and politicians simply because they want to believe them.
This is from Margaret Hefferman in the FT on 1 October 2018:
“Hargreaves amasses devastating data to prove that performance-related pay massively outpaces all rational measures, and that rewarding failure is routine”.
Powerful stuff, except it is not true. People want to believe it because they resent the pay for top executives in a way they do not, for example, resent pay for international football stars (Ronaldo and Messi each earn about £40m gross per annum at Real Madrid).
Hargreaves devotes quite a lot of the book to arguing that companies introducing performance related pay fail to understand human motivation. Executives do not need all this money. But this misses the point. By blaming executive greed, Hargreaves’s book does not follow through on the real economic issue, which is low pay for the average worker. She blames low wage growth on low investment which in turn she blames on executive incentives with a short-term focus. She would rather pay the money directly to the workers than increase investment. She claims to believe in free markets, but doesn’t like it when the market decides some people are worth a lot of money and pays them accordingly. This jars with her puritanical viewpoint. Hargreaves ends her book with a menu of actions that could be taken to pull down the share of wealth taken out by top executives:
• Put up top taxes for executives and corporations. Block loopholes.
• Publish tax returns on-line like Sweden does (the “shaming” approach).
• Move corporate focus away from achieving returns for shareholders towards achieving benefits for stakeholders, especially workers so as to create a new corporate ethos. She (wrongly) claims that the legislation for requiring the delivery of benefits to wider stakeholders already exists in Section 172 of the Companies Act. (In fact Section 172 requires boards to have due regard for the interests of these other groups, but shareholder interests clearly have primacy.)
• Give the workers a say in bosses’ pay – by a worker representative on the remuneration committee or board (“to inject some common sense”) or even by having a worker’s vote on the remuneration policy.
• Improve companies’ consultation with workers. Introduce a structure of councils.
• Give the FRC the power to investigate and prosecute company directors for poor corporate governance. Create new statutory bodies in the UK and US focused purely on corporate governance, with new enforceable guidelines.
• Phase out LTIPs.
• Make any bonuses a pure profit share only.
• Pay cash only – no shares. Executives should buy their own shares.
• Have a binding vote once the non-binding vote falls below 75%.
• Reduce salaries to a reasonable level – all stakeholders to decide what is “reasonable”.
She summarises by saying “a critique of the self-serving justification is often attacked for relying on the wrong data, a misunderstanding of the way companies work and plain old envy. But if capitalism is not seen to be fair by much of the public there will be moves for something more drastic to replace it. It is time for the business sector to listen to the moderate voices for reform or reap the consequences of growing inequality, anti-business sentiment and possibly more dramatic clashes. If it does not rise to the challenge, the fundamental trust that makes a liberal market democracy function could be damaged beyond repair.
In fact there are only a few companies with the excessive pay arrangements this book is railing against. Hargreaves’ proposals would result in a regime which would restrict legitimate reward and damage companies generally, without helping in any way to address the key problem, which is low wages.
For further information contact firstname.lastname@example.org
- October 24, 2018
Irish salaries beat UK salaries
MM&K recently compared data from the Willis Towers Watson cross industry databases to find out how salaries compare between Ireland and the UK.
The chart below compares UK and Irish employees’ salaries to their ‘Global Grade’ (the Willis Towers Watson Global Grading system assigns a job size to employees’ roles). We have analysed data across all job functions, producing a broad-brush comparison of Irish and UK salaries.
Since the results of this analysis depend strongly on the exchange rate, and the Pound is currently fairly weak against the Euro, we have used a historically average £=1.25 EUR for the study.
As you can see from our chart, the Irish junior staff workforce receive a slightly higher salary than their equivalents in the UK. At the middle management level, the gap begins to close, and for top executives, those in the UK are paid much more. The result is a 6% average differential* in Irish salaries over the UK. Analysing data we have from 2007, we found similar results – a 5% differential over the UK.
Although the average differential between Ireland and the UK has not changed much since 2007, we see there has been a change for top executives. In 2007 we found that top executives in Ireland were paid more than their UK counterparts. Clearly this dynamic has now reversed, with UK employees at global grade 20 receiving on average just under 50% more than Irish equivalents.
*the 6% average differential is a result of calculating the % difference in Irish salary vs UK salary for each Global Grade, then averaging those figures.
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- October 23, 2018
Are you taking full advantage of tax-exempt share plans?
In last month’s newsletter, we explained why the Inclusive Ownership Fund (IOF), proposed in the September 2018 Labour Party Conference, may not be the best method of enabling workers to share in the wealth they create. We agree wholeheartedly that employee ownership can help increase a company’s productivity and encourage employees to identify more closely with the business; but there is already a good range of tax-advantaged share plans available. It is a shame that they are not more widely used!
There has been support for employee share ownership from all the main political parties for nearly 40 years. Their incentive effect is also recognised by institutional investors whose guidelines allow up to 10% of a company’s share capital to be issued for share plans every 10 years – the same percentage as proposed for IOF.
We now have tried and tested share plans which are flexible enough to reinforce most companies’ business and HR strategies. However, whilst 20 years ago (according to HMRC statistics) about 1 million employees participated in each of the approved Profit Sharing Share Schemes (now replaced by Share Incentive Plans) and SAYE Option Schemes, in 2016-17 participants in SAYE and SIPs had fallen to about 400,000 in each plan. We think that smaller companies, in particular, may have been put off by the apparent complexity of the legislation; even though MM&K have found it is possible to design share plans which are simple to administer and to communicate to employees.
Is your company taking full advantage of the opportunities to incentivise employees and provide them with valuable tax reliefs?
Using a SIP, every employee can participate up to the following annual limits:
• £1,800 of contributions from their earnings before income tax and NICs (or 10% of PAYE earnings, if less) to buy Partnership Shares
• £3,600 (2 for 1 match) in tax-exempt Matching Shares awarded by the company
• £3,600 in tax-exempt Free Shares awarded by the company, for example as part of a profit share.
In practice, only half of companies with SIPs award Matching Shares and only about a quarter award Free Shares.
Employees can contribute up to £500 per month over three or five years. At the end of this savings period, they can buy their company’s shares at a discount of up to 20% of the share price at the start. The discount is exempt from income tax and NICs.
Both SIPs and SAYE require all UK-resident employees who meet any qualifying period of service to participate and all must be offered the same terms (which can include the same percentage of salary). If these conditions are too onerous, companies may be able to use one of two ‘discretionary’ tax-advantaged share plans for employees generally:
EMI plans can be used to grant options over up to £3 million worth of shares to a company’s employees and the increase in the share value up to the exercise date is exempt from income tax and NICs and may qualify for entrepreneurs’ relief from capital gains tax.
These arrangements are available for smaller companies, with fewer than 250 employees and gross assets not exceeding £30 million, except for some excluded activities.
Options can be granted over shares worth up to £30,000 per employee and the gain on exercise is exempt from income tax and NICs.
Please contact Michael Landon if you would like to discuss in more detail how the above tax-advantaged share plans can be adapted to meet your company’s particular objectives.
- October 23, 2018
Value Creation Plans – genuine attempts at designing executive LTIPs or too complex to explain?
Some years ago, I attended the AGM of one of the UK’s biggest supermarkets. A shareholder asked a question about the proposed new executive LTIP. After a pause, one of the non-executives stood up and replied “it is too complex to explain”. I was reminded of this recently when MM&K inherited two Value Creation Plans (VCPs) adopted by clients who had recently appointed us.
In both cases, the client had been advised by the same firm and there was an apparent lack of appreciation among the Board and shareholders about the details of how the plans worked or the financial/economic consequences of having adopted them.
The VCP concept is simple – in essence VCP’s are stock appreciation rights settled in shares (or nil-cost options):
Stage 1: Award notional performance units to participants
• Performance units are not equivalent to shares; they define an allocation of future value created
Stage 2: Units convert into nil-cost options according to the value created
• TSR is calculated at a designated future date or dates
• If TSR exceeds a threshold compound annual growth rate, some or all of the units convert into nil-cost options
• The number of shares into which units convert is a function of the number of units awarded, the company’s TSR performance above the threshold and the market price of a share in the company on the conversion date
Stage 3: Nil-cost options vest and become exercisable
• Nil-cost options are held until a vesting date or dates
• On each vesting date, nil-cost options vest and become exercisable if the company’s TSR/share price growth has exceeded a specified minimum acceptable rate
• Post-vesting, options remain exercisable up to 10 years after the award of units
The above outlines the general principle but plans may vary in detail. For example, if units fail to convert (because TSR performance at the relevant date fails to exceed the threshold) VCP rules may provide for re-testing at a subsequent date. Re-testing performance and adopting LTIPs linked exclusively to TSR (share price growth, if there are no dividends) with no financial or operational targets are not the flavour of the month with investors in listed companies.
As ever, the devil is in the detail and there was a lot of impenetrable detail in the plan rules we inherited. However, the purpose of this piece is not to dwell on this or that form of words or complex formula. Our inherited VCPs were almost identical, clearly hewn from the same block, and yet they had been adopted by two very different companies in terms of size, activity and market positioning. There are good reasons for standardisation and “working smarter” but an incentive should be tailored to the business for which it is being designed. Corporate governance now has a much higher profile in relation to executive pay than hitherto. Incentive plans must be technically sound, work for the business and take account of applicable good governance principles.
But the most striking feature of our VCP inheritance has been the lack of appreciation about how the plans operate and potential outcomes. This emphasises the need for clear explanation. It also underlines the essential value of modelling a wide range of potential outcomes to minimise the risk of future surprises which might cause companies and their shareholders to regret their decision to adopt a VCP in the first place and there is the prospect of adverse publicity if payments are more generous that had been expected.
As a concept, VCPs tick the box of aligning executives with shareholders, insofar as they are linked to TSR or share price growth. Added features such as awards of notional performance units, complex conversion formulae and consequentially impenetrable rules are not necessary. It is, however, critical that companies, their shareholders and remuneration committees fully appreciate the plan which they have adopted – and its potential consequences.
As VCP’s attract no special tax advantages, it is hard to see what the added complexity brings to the table, when a similar result can be achieved with a much simpler share plan.
Paul Norris, Chief Executive
MM & K Limited
- October 18, 2018
How do not-for-profits design their long-term incentives?
MM&K investigated the LTIP policies for 59 of the largest not-for-profit organisations to answer this question.
Our sample consists of Charities, Housing Associations, Co-operatives, Building Societies, Mutual Insurance companies and Education Establishments (Universities and College Groups). It is important to note that the vast majority of these organisations do not operate an LTIP. Policy data is publicly available for 16 companies, which we have analysed.
Firstly, we found that the performance measures are very specific to the individual organisation. This contrasts with what we see in many listed companies, which often have very similar designs of LTIPs within certain sectors, especially the performance measures. For example, Oil & Gas exploration and production companies will often place a heavy weighting on a TSR based target. In contrast, in not-for profit companies the performance measures vary greatly; examples include return on capital, revenue, profit and net debt to EBITDA ratio. There are a few measures we do see recurring – such as employee engagement and customer service, but even these only occur in just over half of the companies we looked at.
This isn’t the only way in which the designs differ from listed companies. All the not-for-profit plans are cash-based (as there aren’t any shares available!) whereas it is much more common for listed companies to award shares through their LTIPs. Also, the earnings opportunity is generally more modest, with exceptions such as Liverpool Victoria offering a maximum opportunity of 300% of salary to its CEO.
In all cases, awards are granted annually and vest over a period of three years, a paradigm often seen in listed companies’ LTIP designs. We found only two cases in which an additional deferral/holding period is required. This is where the company defers the award for a further period of time (usually between one and three years), with no further performance conditions, a practice that is rapidly becoming the norm among listed companies.
For further information contact firstname.lastname@example.org
- October 18, 2018
Negative Feedback is Good for You
It is curious how many technical expressions slip into the common language with a meaning entirely different from their true meaning – and often opposite.
A couple of examples are “epicentre” and “lowest common denominator”. People commonly use “epicentre” to mean the very heart of the centre. The press might report “Tottenham was the epicentre of the London riots in summer 2011”. Users of the word clearly think that there is something especially central about the epicentre. But the word is borrowed from seismology and refers to earthquakes. The epicentre is the point on the surface of the Earth above (usually some miles above), the place deep underground, where the rock slip happened.
The lowest common denominator of a set of numbers is the lowest number that all the numbers in the set will divide into exactly. By definition it is as high as or higher than all the numbers in the set. If it is borrowed as a metaphor it should mean the best in the set. But people don’t mean that at all; they mean the lowest in the set, the slowest vessel in the convoy. lowest sounds appropriately disparaging.
Another expression misused in management is “negative feedback”. It is used to mean giving people performance feedback which criticises. as opposed to praising them. “You did a great job in that project but (points one to ten…)”
“Negative feedback has a very specific meaning in systems design. A common example is in electronic amplification. By taking a small amount of the output of the amplifier, reversing the polarity and feeding it back into the input stage, the signal becomes stabilised. If ever you have held a microphone too near a loud-speakers you will know what positive feedback does – the system starts screaming. Negative feedback damps down the system output and ensures a high quality output.
It occurred to me that performance reviewers do, unconsciously, provide negative feedback in the true meaning of the expression. They tell the appraisee the opposite of the truth to keep them on the rails. You don’t say “you did a total lousy job” even if they did. You say, you missed your targets, but the strategy report you wrote was good. Why? Because we want to keep them motivated.
On the other hand, to the successful appraisee we don’t say “you did a fantastic job, the best we ever saw”. We don’t want it going to their head. So we tone it down – “you did well, but here are some areas you could improve”. In other words, we tell a few white lies – we give negative feedback. We are not taught to do this – it’s something we pick up in the process of managing effectively. The important thing, however, is not to overdo it. Otherwise the appraisee will be confused. There are some famous stories about people who went into a meeting with the boss where he (women don’t make this mistake) was supposed to be firing them, and who came out thinking they had been promoted, he was so lavish with his praise!
For advice on Performance Management systems contact email@example.com
- September 27, 2018
When is an employees’ share scheme not an employees’ share scheme?
The answer is: when it’s an Inclusive Ownership Fund (IOF).
Few would disagree that an engaged workforce delivers greater productivity or that offering shares to employees creates direct engagement with the financial and economic performance of the business. But proposals announced at the Labour Party Conference this week that would require companies employing more than 250 people to set aside up to 10% of their shares to be held in an IOF fall short of the mark. In common with many proposals from political parties, a shortage of detail raises a number of questions.
Shares will be held collectively – who bears the cost of transferring shares to an IOF? Shares cannot be traded; individual employees will not enjoy the full benefits of share ownership – who will be the legal owner and who benefits from any capital growth? Voting will be in the hands of fund representatives – will they be subject to the same requirements to disclose how they have engaged with and taken account of the interests of the workforce as boards of directors will be under recent changes to corporate governance codes and regulation? The extent of an individual employee’s rights will be to receive dividends capped at £500 per year – any excess going to the Government.
This has been variously described as part nationalisation of the private sector and a tax on private sector companies. The Guardian https://www.theguardian.com/politics/2018/sep/23/labour-private-sector-employee-ownership-plan-john-mcdonnell referred to the proposals as “a new levy on private business”. Concerns have been raised about the potential adverse effect on investment in the UK, on productivity and employment if businesses curtail recruitment, go private/private equity owned or relocate overseas.
Whilst the upside is limited, it has to be said that there appears to be little downside for employees in Labour’s proposals. But if Labour’s motive is to promote wider share ownership, engagement and alignment, a framework already exists read more
- September 27, 2018
How will Remuneration Committees cope with their expanded remit?
Changes to UK corporate governance guidance and disclosure regulations introduced this summer have expanded the remit of remuneration committees. The effects reach beyond quoted companies. We have designed a programme to help navigate through the added complexity.
The UK Corporate Governance Code (UKCGC), applicable to companies with a premium listing in London, now requires remuneration committees to have delegated responsibility for setting remuneration for senior managers. It goes further, requiring remuneration committees to review workforce remuneration and related polices and the alignment of incentives and rewards with culture, and to take these into account when setting executive remuneration policy.
Regulations made under the Companies Act, which govern the content of the Directors’ Report, Strategic Report and Directors’ Remuneration Report (DRR), will require enhanced disclosures. Some of the changes will affect all companies, depending on size but only quoted companies are required to publish a DRR. Most of the changes come into force for financial years starting on or after 1 January 2019, so their effect will not be seen until the annual reports published in 2020 are available. However, some committees may wish voluntarily to comply in their 2019 annual report to test the water.
The objective is greater clarity about actions taken, the reasons why they were taken and their effect on key decisions made during the year to which the relevant report relates. Specifically in relation to the DRR, remuneration committees will have to make additional disclosures about read more
- September 27, 2018
Commons Committee on the tail of the fat cats again
The Commons Committee is chasing a myth again. Its chair, Rachel Reeves, has told the Mail on Sunday that the Committee is going to ramp up its attack on fat cats this autumn. She believes that executive pay is increasing at a rate that vastly exceeds increases for ordinary employees and which seemingly is at odds with the value created in the Company. Damien Knight shows that neither part of this belief is true. But fat cat pay is too easy a target for the press to leave it alone. Read more or for more information contact firstname.lastname@example.org
- September 27, 2018
Governance landscape at a glance “the most eventful year in history”
2018 has been, probably, the most eventful year in UK history on remuneration governance. The year saw the culmination of the Government’s wide initiative on corporate governance reform, with a revised UK Corporate Governance Code published by the FRC in July and new corporate disclosure regulations approved by Parliament in June. This was supplemented by a revised corporate governance code from the Quoted Companies Alliance in April and the draft of new governance principles for private companies from the Wates committee.
In addition we have had the reports on the first gender pay gap disclosure by companies, and a new AIM rule requiring all AIM-listed companies to publish by the end of September details of the recognised corporate governance code they intend to adopt and their level of compliance.
Starting from last December we have now had two reports from the Investor Association of the voting “name and shame list”, showing AGM resolutions that fail to gain more than 80% of the votes. Read more
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