The standardisation of executive remuneration structures restricts innovation, valuations and shareholder returns

MM&K has built its practice over 50 years on the principle that executive remuneration is the most powerful tool available to a board to focus executive management on where the business is going and rewarding them for their success in getting it there. 

Consistent with that principle, the primary focus of our advice and support is on what is right for our client’s business, taking account of its stage of development, business strategy and management culture. Stages of development, strategies and culture vary, so it follows that remuneration policies and structures should vary, too. 

We believe all companies, listed and unlisted, should operate within a robust and proportionate corporate governance framework but have observed that the current form and structure of UK corporate governance has resulted in a one-size-fits-all approach to executive pay design, which is more prevalent among listed companies subject to more stringent governance, but has also spread to private companies.

Ironically, standardised remuneration structures are inconsistent with both the UK Corporate Governance Code (UK Code) and the QCA Code. Section 5 of the UK Code starts with this statement:

“Remuneration policies and practices should be designed to support strategy and promote long-term sustainable success. Executive remuneration should be aligned to   company purpose and values, and be clearly linked to the successful delivery of the company’s long-term strategy.”

Principle 9 of the QCA Code starts in a similar vein:

“It is the board’s responsibility to establish an effective remuneration policy which is aligned with the company’s purpose, strategy and culture, as well as its stage of development.”

A paper published this summer in the US recognises that remuneration executive structures have become standardised and explains, backed by robust statistical evidence, the reasons for and effects of standardisation. In summary, its key findings include:

• There is an observable standardisation of executive pay structures
• This leads to firms being less likely to adopt pay structures tailored to their particular needs 
• Institutional shareholders contribute to pay structure standardisation
• Proxy advisors, who tend to give negative recommendations for firms adopting non-standard pay structures, also contribute to pay structure standardisation
• Firms receiving negative proxy recommendations tend subsequently to standardise their pay structures 
• Increased amounts of information about competitors pay structures (the result of more demanding disclosure requirements) leads to greater similarity of pay structures between firms
• The impact of disclosure on standardising pay structures is greater for firms having a higher proportion of institutional investors, who use disclosures to press for uniform structures consistent with their preferences
• Pay structure standardisation limits a board’s appetite to design optimal pay structures to support their specific needs and business strategies
• Research indicates that greater standardisation of pay structures is associated with lower valuations and shareholder returns.

The above is but a brief summary of a carefully thought-through, detailed and thought-provoking paper, the full text of which can be found at: Executive compensation: The trend toward one-size-fits-all – ScienceDirect. We would urge you to read it.

The inference is that the combination of institutional shareholder and proxy agent actions and boards’ reactions will perpetuate the spiral of pay structure standardisation, leading potentially to reduced valuations and shareholder returns. 

That may be an unintended consequence of current UK corporate governance requirements. It is, however, inconsistent with the stated objective of both the Government and regulators to promote economic growth. 

Whilst the challenges have increased, we will continue to hold firm to our core principle and approach to advising on executive pay structures. The London Stock Exchange and others have commented that to promote competitiveness and growth, UK executive pay must increase. That may be right but we would say that it is more important to design pay structures tailored to the specific needs and characteristics of the business. 

Breaking the cycle of standardisation requires boards to take the lead and present clear thought-through pay structure proposals to shareholders. The question of amount should flow through from the design and reflect an equitable share of value created as between management and shareholders. 

It is not easy for boards, with increasing pressures on their time and in the face of institutional shareholder pressure, to break the mould.  However, the alternative is likely to produce the lowest common denominator – good for neither business nor the economy.

Please contact paul.norris@mm-k.com to discuss any points arising from this article.

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