- July 29, 2019
Government response to BEIS Select Committee
The Business, Energy and Industrial Strategy Committee of the House of Commons (the BEIS Select Committee) published on 26 March a further report on Executive Rewards. It contained 16 recommendations to Government.
The Government’s response to the report (HC2306) was published on 13 June
The Select Committee comprises six Labour MPs (including the Committee Chair, Rachel Reeves) five Tory MPS and one SNP MP. Not surprisingly, the Committee’s conclusions and recommendations on executive pay and corporate governance reflect the political balance of its membership. It starts with an acceptance that executive pay is disproportionate and not linked to performance and that differentials are growing; it looks for measures to control and reduce executive pay, particularly using new powers to be given to the new Regulator due to replace the FRC.
The Government’s response is measured and, whilst it “welcomes” the Committee input, it accepts practically none of the recommendations. Its position is that a lot of corporate governance changes have been introduced in the past 18 months: a revised UK Code, a new set of corporate governance disclosures including the pay ratio publications; most recently changes to the Directors’ Reporting Regulations to comply with the requirements of the Shareholder Rights Directive II. In parallel the IA “name and shame” register has been introduced as have the Wates principles for private companies. It wishes to allow these measures to bed down and be appraised before introducing any new measures. It also takes the view that the requirements of companies and shareholders vary widely and changes are principally a matter for shareholders, not government prescription.
MM&K believes this is a sensible response.
Particular recommendations and responses include the following:
Further recommendations for change (e.g. on pension contribution alignment and revisions to the Stewardship Code) appear to be already under way.
For further information, contact Damien Knight.
- March 28, 2019
Pending changes to Directors’ Remuneration Report Regulations
On 3 March the European Commission issued new guidelines on the standard presentation of the remuneration report under Directive 2007/36/EC. This was to comply with a mandate presented in Article 9(b)6 of the 2017 revisions to the second Shareholder Rights Directive (SRD II). The guidelines are non-binding and the UK Government has to decide how far it will translate the new guidelines into revised regulations by the deadline of 19 June.
The original Shareholder Right Directive was issued in 2007 and was concerned with strengthening corporate governance and particularly the rights of shareholders in relation to voting at general meetings. It applied to companies which have their registered office in a member state trading on a regulated market situated in a Member State. This definition includes Main Board listed companies on the London Stock Exchange but not AIM companies, which fall into the category of “exchange-regulated’ rather than EC regulated.
In 2017, the EC issued revisions and extensions to the Directive, aimed at strengthening the first Directive and encouraging institutional investors and asset managers to take a longer-term view of the market. One new set of articles focused on directors’ remuneration:
• Article 9a covered the requirement of companies to prepare a remuneration policy and to submit it for a (binding or non-binding) shareholder vote in general meeting on inception and whenever a material change is made and, in any case, at least every four years. The Article covered the information to be provided in the policy, which is very close in content to that required for UK companies under Schedule 8 (the 2013 Directors’ Remuneration Reporting Regulations, DRRR) as amended by the Companies (Miscellaneous Reporting) Regulations 2018, and the associated voting requirements of the Companies Act.
• Article 9b covered the information to be provided in the remuneration report (ie the implementation report for the previous year) and the requirements to submit it to a shareholder vote. Again, the requirements are very similar to the UK regulations. However, 9b(6) mandates the Commission to adopt guidelines to specify the standard presentation of the information laid down. These are contained in the communication from the Commission on 3 March labelled “Guidelines on the standard presentation the remuneration report under Directive 2007/36/EC”. The aim of the Commission is to achieve a standard format across Europe. Unfortunately, the requirement is more detailed than the DRRR, especially in relation to individual directors’ performance over time and their pay movements compared to average employee remuneration.
Fortunately for UK companies, it looks as if the Government does not intend to adopt the detail of these guidelines. We spoke to BEIS who told us that they are proposing to put a new statutory instrument (SI) in front of Parliament in the next few weeks. It will be accompanied by a table comparing what is already in place in the DRRR with what needs to be implemented under SRD II Article 9. The regulations will be mandatory, but they do not intend to require companies to adopt the full EC guidelines.
If the new SI is approved by both houses, it will enter into force on 10 June, which is the transposition date for SRD II. However, it will contain various transitional provisions for companies and it will not need to be adopted by companies for reporting until 2020.
BEIS will be publishing FAQs on the new regulations and the GC100 Investor Group will be updating their own Guidance. BEIS are thinking of appending the final EC guidelines for information, allowing companies, if they choose, to adopt some of the new guideline provisions, if they appear useful. We got the impression that all this will go ahead whatever the Brexit outcome.
For further information, contact Damien Knight
- March 23, 2019
The AIM Market – heading for trouble in 2019?
On the face of it, things do not currently look too rosy for the AIM market. There has just been one new IPO on AIM since the turn of the year. In the same period last year, there were nine.
Indeed, last year as a whole saw a regular stream of IPO’s on AIM. In 2018 there were 9, 19, 6 and 8 listings respectively, per quarter.
The health of any market is shown, to a greater or lesser extent, by the number of new companies that are willing to go through the time and (considerable) expense to raise finance.
Moreover, given that Q4 of 2018 saw an almost record breaking number of trade and Private Equity M&A deals (748 in total), it would be easy to conclude that the AIM market is facing trouble with company owners increasingly considering alternative ways of obtaining the finance to either exit or grow their business.
However, as always when confronted by headlines and statistics it is worth digging deeper to understand the broader picture.
On a macro level, whilst the 43 admissions of 2018 is down from 50 l in 2017, it is still one more than the 42 that occurred in 2016. This would seem to indicate that there is no overall downward trend –other factors are likely to be at play.
The overwhelming weight of evidence indicates that the principal reason for the lack of AIM IPOs so far this year is nervous investor sentiment generally. There is no shortage of companies seeking admission to AIM.
We have recent first-hand knowledge of companies who are keen to IPO but have had to delay on advice from their brokers that the market would not buy at a price that would have made the transactions viable.
It is undeniable that in the short term, the uncertainty of Brexit has caused a pause in making such “public” investments by Institutional investors. However, monies have been raised and need to be placed in order to grow. With the comparable difficulties of finding the “right” investment to place PE money, it is likely that, once the markets have settled (hopefully by this summer) a flurry of deals will come to AIM.
Ironically, whilst there are risks associated with any investment, the requirements of AIM Rule 26 that each AIM company must adopt a corporate governance code, identify the chosen code on its web-site and explain how it complies (or why it has not complied) with that code makes the AIM market a better regulated place for making investments.
We will continue to watch the AIM market with interest and will provide updates throughout the year. For further information or to discuss any questions you may have, contact Stuart James.
- 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 email@example.com
- 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.
For further information please contact firstname.lastname@example.org
- 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
- November 1, 2016
- August 1, 2016
Board Walk – August 2016
Please see the latest copy of Board Walk, our briefing for remuneration committees and those who support them. This latest edition is dedicated to the recent report published by the Investment Association working group looking into the simplification of directors’ pay. It also contains a summary of the discussion on the same subject among guests at our remuneration committee dinner, which you were unable to attend, held on the night before publication of the IA report. Please click here to read the latest Board Walk.
- January 4, 2015
- January 1, 2015